NextEra gets it, but Origin and AGL don’t – and their shareholders have suffered

NextEra Energy is a major US utility and is well named, and it is doing for shareholders what AGL and Origin Energy in Australia won’t.

The figure below is a 10 year graph of the AGL, Origin and NextEra share prices. Each is expressed as an index that starts at 100.

Figure 1 Share price index. Source: Factset

Because NextEra has done so well it tends to overshadow just how badly Origin has done in this 10 year period, and the fact that AGL share price has nearly doubled.

Figure 2 Source: Factset

The ten-year averages are just an arithmetic calculation and disguises the fact that Origin has done quite well since hitting its lows back in 2016. Still, it’s the low volatility of NextEra’s returns as well as the 17% annual average gain that have been so good for investors.

Past performance is no guarantee of future performance and no company is going to keep on increasing its share price at 17% per year for ever. NextEra probably won’t be able to keep it up for more than a few years, but right now it’s still in a sweet place.

The real point though is that NextEra now has a market cap of $US129 billion, up from around $US30 billion ten years ago, and now about 80% more than Commonwealth Bank. And it’s done this substantially by investing in wind and solar.

To be sure, about half of NextEra’s earnings comes from providing vertically integrated electricity in Florida and it’s managed that part of its business exceptionally well.  Its average charge to customers per megawatt hour has consistently been at the lower end and it has kept prices down.

But equally it’s now the largest wind and solar owner in the world, and it’s done that in Donald Trump’s America.

I’ll get to the current NextEra generation portfolio in a moment, but first let’s look at what they were telling investors back in 2011.

The slide below is from a 2011 Investor conference.

Figure 3 Source: 2011 Nextera

Does this resonate with today’s Australian market?

Even in 2010 NextEra was easily the largest wind developer in the USA.

Figure 4 Source: 2011 Nextera

Note that in Australia at this time (i.e. back in about 2010) AGL was rapidly becoming the largest wind developer in Australia, but then it gave up and decided coal generation was a better bet. Origin in 2010 could think of nothing but gas. Infigen was on NextEra’s 2010 chart but it didn’t have the equity base to stay the course and also couldn’t deliver the costs and wind farm output it had indicated was possible.

There are a couple of other points from NextEra investment presentations  that are probably of more interest to the professional analyst (that’s me) than the average reader and those points are how consistent Nextera’s presentations are from one year to the next and also their  willingness to forecast earnings per share growth not just one but two and three years in advance.

For instance here’s a statement from their 2015 presentation:

“Expecting 6-8% compound annual growth rate in adjusted EPS through 2018 off a 2014 base.”

Here’s another slide from that same 2015 conference:

Figure 5 Source: 2015 Nextera

Today, AGL and Origin can probably produce the same slide. Back in 2015 they would never have put a slide like that in front of investors. Most of AGL and Origin management would never think about talking to investors about voltage support. That’s because in 2015, and in my opinion even today, Origin in particular and AGL to a lesser extent are still not on the bus.

They talk, but they don’t walk the talk. They don’t really believe that it’s renewables or nothing. And until the CEOs really get it ,shareholders will most likely continue to be under rewarded.

So with the smallest  bit of background on how NextEra got to 2019, let’s see what they are saying now. The reason for doing this is because it’s my view that it’s not too late for Origin and even coal heavy AGL to go down something of the same path.

From a financial perspective NextEra is saying publicly they expect compound dividend growth of 12-15% per year and a 4% yield. So if they sell at a constant yield (that’s my caveat) investors will earn 16%-19% return a year, and in a low risk fashion.

Looking at the generation portfolio in 2019 NextEra added 2.7GW to its wind and solar asses base and added in a further 5.8 GW to its backlog. Interestingly,  NextEra also expects a PTC extension to support incremental wind demand in 2023 and 2024.

How is it the US can offer a PTC credit (which ITK estimates is worth about US$20/MWh) but Australia offers nothing?

At any rate, NextEra plans to add about 6GW of wind  about 5.5GW of solar and about 1GW of batteries over the next 3 years. In addition it has a further 0.44 GW of batteries “signed for post 2022 delivery”.

Finally, it’s worth noting that all of the 561MW of  announced contracted battery storage to be installed in 2021 and 20220 is of 4 hour duration, 5 separate projects and each of 4 hours.

Batteries are on equal footing with gas in Australia for peaking generation. The market is proving that

Two new peaking generation projects have been announced in Queensland recently. One was subsidised by the Federal Government and one was done entirely at market.

The subsidized project was Quingrook’s 132 MW gas peaker. The unsubidised project is AGL/Vena’s 100 MW 1.5 hour battery. Yes the battery is still only 1.5 hours, and yes it will require FCAS revenues, but even so it shows that batteries are already competitive in the peaking space and battery costs are falling 15% per year.

A lot more will be said about this.

AGL & ORG could focus on wind and solar

It’s not necessarily current management’s fault that AGL and Origin are so badly positioned for the next ten years. I will cover AGL in another note.  In ORG’s case Grant King, the former CEO, never liked wind energy and always believed, like any good oil or gas person, that the return on capital in oil and gas far exceeded the returns on wind and solar.

In this he and his like-minded generation of  Australian business elders are going to be increasingly on the wrong side of history. Origin’s share price is evidence enough. The current CEO, Frank Calabria has a background in finance rather than line management and is, in the author’s opinion, by nature a cautious manager.

As such Origin’s strategy has not really changed.  It remains based around hitting a jackpot in oil and gas. At the moment the current “pot of gold” is the Beetaloo Basin in far away Northern Territory.

What has changed under Calabria is Origin’s balance sheet which has gone from the desperate to the mildly comfortable as a result of APLNG taking advantage of its oil linked gas sales contracts to actually generate some cash flow, and the sale of the conventional gas business.

Equally, Calabria has cut out most of the increasingly absurd long shots that cost Origin a lot of money in the 2010-2016 period.

Investors with an eye to the medium term will welcome the better balance sheet and the resumption of dividends but will continue to worry about potential price reopeners in APLNG contracts possibly in calendar 2021 or 2022. Some small protection is that the buyers of the gas, aka Sinopec are part owners of APLNG.

Much  further down the track the quality of  reserves available to meet the tail end of the contracts remains up for discussion. Investors will also  have a smaller but still interested concern in what ORG will have to pay for its domestic gas once contracts associated with the sale to Beach run off also in a year or two.

But the main point is Origin’s electricity business looks marooned.

Origin has the largest retail customer base in the country.

Origin has more firming generation capacity than it knows what to do with.

Origin has some talented senior management, eg Greg Jarvis and Anthony Lucas who very likely have many ideas for how to develop the business but they are kept on a very short leash.

Origin could use those assets to develop real expertise in wind and solar and use that low-cost energy to take over from AGL as the largest and more importantly highest return on capital generator in the country. But it doesn’t.

The point here is that Origin doesn’t own any wind or solar projects. It signs PPAs, to the minimum extent it can get away with, to buy the output. Variable renewable energy will be about 25% of supply when Stockyard Hill is running but that only puts it in line with the broader Australian market or even behind it.

There is nothing resembling anything more than a recognition that there will be lots of variable energy in the Australian energy mix. Origin hasn’t signed a new wind and solar PPA for a while.

Nor does Origin have any strategy or presence in the behind the meter market. Its experimenting with firming PPAs but in terms of impact on profits it wont be a big topic of discussion in investor meetings.

Origin’s top 3 priorities as identified at its November 2019 investor day were:

• Grow production at APLNG; (that is produce the reserves faster rather than slower)
• Invest in oil & gas exploration;
• Reduce energy markets costs.

Down at priority 5 we read “Energy supply…. Cautious on investment”

Origin’s strategy is dumb

Origin’s strategy is dumb because.

Oil and gas reserves will have declining returns on capital due to decarbonisation and reducing demand relative to supply. Even if Origin makes a big discovery at Beetaloo it will take years to develop and require significant expensive infrastructure development by which time the carbon emissions will be much more expensive.

Even in the US fracking is running into profitability issues. That is not to deny the fantastic way fracking has grown US oil production but investors haven’t done as well as they thought they might;

Origin has next to no global comparative advantage in oil and gas.

Other than a brief period of very successful CSG tenement acquisition in Qld, Origin has little to point to in the way of an oil and gas track record. In the long run Origin will be the least important member of the APLNG ownership consortium and Sinopec the most important member.

As already stated the business that Origin has the greatest comparative strength, electricity retailing, is being left to almost wither on the vine. That is putting it too strongly and for sure the retailing business has issues in the sense its price controlled but competitive.

However ,as ITK sees it, the main strength of the retail business is the market it offers to generation. In the same way that concrete is the loss leader and aggregates and cement are the profit makers in a building materials business so it is that retailing is a loss leader and generation is the profit maker.

AGL understands this, or at least has executed better than Origin, but Origin has the flexibility to catch up and surpass AGL if only it could commit.

What “should” Origin do?

Notwithstanding my outstanding ability to sit behind Graham Arnold and tell him what to do when he was Sydney FC coach, and to my eternal chagrin he never acknowledged the good advice, it’s not easy for a CEO to make good calls.

(And by the way they don’t get paid for making good calls as CEO, they get paid for getting the job in the first place. See Boeing, but that’s another story).

My advice would be to negotiate an exit from APLNG and use the money to build a strong Australian and Asian position in 21^st century energy. That’s mainly wind and solar backed up by modicum of firming.

There are massive opportunities not just in Australia, but in energy hungry asia. Wind and solar  are going to keep making market share gains in virtually every country. Batteries are going to largely displace gas in the in the 5 minutes to 4 hour per day market (and that’s most of the gas market).

You don’t need to be Mckinsey or Boston Consulting to work this out, it’s blindingly obvious. So blindingly obvious that Origin can’t see it.  GL and Hydrogen can be a side bet, starting small and learning.