Investment implications
FY22 Results displayed no significant new issues, but a weak result across the board. EBITDA and NPAT missed consensus by -4% and -8% respectively. ROE came in at 3.7% which suggests 2H22 ROE was ~1%. The final dividend came in slightly below consensus. Net debt ended the year at $2.7bn, benefiting from a large working capital benefit.
Taking a closer look at the results: Revenue $13,211m vs $11,166m market. EBITDA $1,218m vs $1,270m market. NPAT $225m vs $246m market. EPS 34cps vs 38cps market. Final DPS 10cps vs 13cps market. Strategic review and earnings guidance to come in late September.
FY23 consensus suggests a significant lift in NPAT growth with the expectation that the power stations can manage to run reliably. This is optimistic seeing as it hasn’t exactly been a strong point for the group with multiple plant-related issues occurring over FY22.
Management suggests FY23 earnings should be ‘resilient’, which doesn’t give much indication about growth. We remain concerned that the market is too bullish around FY23 earnings which implied +90% consensus earnings growth at the time of the reporting. This has come down to ~30%, which we still view as too high.
The soft result and lack of guidance give the market little to hold onto. Market consensus has commenced its earnings downgrade cycle however, we expect that more downgrades will follow through FY23. We remain concerned that the share price does not reflect what we believe will be another tough year for earnings.
Coal power stations. Alongside this, the thermal fleet’s lifespan continues to slowly diminish. The short-lived low multiple segment of the business currently provides some value; however, a substantial amount of CAPEX will be needed to replace these earnings once these generators are switched off in the coming years.
There remains significant uncertainty about both AGL’s strategic position and the new Government’s policy for energy producers and retailers. In this environment, we are sceptical of any re-emergence of M&A for AGL.
Risks to investment view
Key risks to our investment view 1). Uncertainty around global factors (e.g Ukraine / European winter) impacting input costs; 2) slowdown of the thermal coal power station fleet, coupled with short-lived and low multiples applied to these earnings; 4) substantial growth CAPEX will be needed to replace earnings; and 4) new government energy policy may diminish AGL’s position in the market.
Investment Thesis
AGL has produced poor operating performance over the past few years. An aging set of coal-fired power stations is proving very difficult to run reliability or efficiently. Sitting over the top of poor operating performance has been a significant management change on the Board, and in the Executive team.
At the heart of the issue is confusion around capital allocation, in part due to the uncertain government policy environment. At the core of the issue is the fact that the electricity generation business is being competed away by its own customers in form of solar rooftop panels. Whilst AGL carbon-intensive generators have very little value attributed to them by the market.
Recent M&A interests only highlight the company's dilemma. We view the likelihood of any successful M&A for full control of the company as low.
With the share price still reflecting a partial M&A premium, we have downgraded AGL to Sell. We hold doubts that operating performance can materially improve over 2023, despite the prospect of high wholesale electricity prices.
Whilst the company benefited from a surprise $400m working capital benefit in 2H22, we remain concerned that the balance sheet is tight. The recent practice of underwriting the DRP in 2019-21 suggests management is also concerned.
There is no balance sheet capacity to entertain the billions of dollars of growth CAPEX needed for lower carbon intensity electricity generation. With the share price up ~20% this year, we downgrade AGL to Sell.
Recommendation
We have changed our Hold rating to a Sell.
Figure 1: FY22 Underlying profit after tax breakdown. Loy Yang outage largely attributed for the miss on consensus.
