AGL’s surprisingly soft results, and a question over future of Portland smelter

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It is now clear that what happens to Portland smelter and the Halewood brown coal generator are the most significant items for AGL investors this year.

Other key markers are whether AGL buys the Alinta retail business in WA or not; the market’s views around the wholesale electricity margin, and what emerges on the policy arena. The forthcoming AEMC decision around 5 minute pricing is one small but important policy that will be decided this year. Bigger issues will be talked about but we expect few decisions. Still, as Irving Fischer was wont to say: “coming events cast their shadows before them”.

Another key issue is the detail around the new renewable energy fund, and the new assets to go into the funds. Still, the direct financial impact of this will always be diluted given the small equity investment and the fact the new projects are years away from completion.

Finally we don’t expect investors to care about the $300 million to be invested in digital transformation, which was announced today. This will tend to be seen as maintenance capex, a necessary investment but one that doesn’t earn a direct return.

Result Key Points:

June half electricity results were soft, but cost control was strong

AGL’s wholesale electricity results in the June half were below last year. Overall Ebitda in the June half was up 5% but due to increased depreciation the Ebit fell 2%.

After higher depreciation, but lower tax and interest net profit after tax was just 2% higher in the June half. We focus on the June half since that is the new information. December half results were released back in February. Lower results in the June half were partly the result of a conveyor breakdown at Loy Yang A and some outages at Macquarie generation.

The point is that the higher pool prices and even futures prices don’t seem to have benefitted AGL in the half, perhaps due to the company’s hedging profile. Further, the company was relatively cautious on the outlook going into FY17

Results did benefit from a much stronger Ecomarkets result, reflecting the big solar PV plants at Nyngan and Broken Hill coming online, along with the higher REC prices.

Results were also assisted by lower costs where AGL has broadly done an excellent job over the past year.

DPS lifted 6%.

AGL effectively wrote down its contract with Alcoa for Portland by $349m pretax

One of the most notable line entries was the effective write down of its contract with Alcoa for the future power supply to the Portland smelter in Victoria. The contract was written down by $244m after tax, or $349m pre-tax.

This contract is for the supply of electricity to Portland aluminium smelter from November 2017. AGL stated on its results conference call that AGL’s accounts had been prepared on the basis that Portland will keep operating and the electricity futures market also seems to have that assumption built in.

Still, AGL has prepared for the eventuality that Portland closes by effectively removing some profits it estimates it would have made from that contract over its long life. As futures prices in Victoria have moved up over the past couple of years to levels nearer those embodied in the contract AGL believes that loss of the contract won’t have much impact on profits.

Of course that is only true for so long as Portland operates. If Portland closes, and as we have noted several times, there will be a big oversupply of baseload power in Victoria that would almost certainly put increased pressure on for a closure of the rival Hazelwood brown coal generator.

We repeat the chart from the July 18 issue of our weekly update “Know Your NEM” which essentially shows AGL via Loy Yang A is a winner if Hazelwood and Portland both close.

Outlook

AGL was cautious on the outlook, stating that July had been below expectations and reaffirming that wholesale gas profits would be $100 m or more below last year.

Our back of the envelope summary P&L is adjusted to look as follows:

To our way of thinking the main uncertainty in the FY17 profit is the wholesale electricity margin. AGL was relatively cautious in their statements and so we have just allowed for a $120 m increase, together with a further $37 on consumer electricity. Overall we currently project 6% growth in EPS but see both upside and downside to this estimate.

FY17 results will be impacted by the setting up of the PARF fund as the Nygan and Broken Hill plants are moved into that fund around half way through the year. Still we will adjust our model for that post the interims.

David Leitch is principal of ITK. He was  formerly a Utility Analyst for leading investment banks over the past 30 years. The views expressed are his own. Please note our new section, Energy Markets, which will include analysis from Leitch on the energy markets and broader energy issues. And also note our live generation widget, and the APVI solar contribution.