Why do AGL Energy (and Origin Energy) insist on being losers?
AGL’s share price was down 10% on its results day, because its FY2021 guidance was way below expectations. It’s back book of low price gas is quickly running out (easily predicted some 5 or 6 years ago) and electricity futures are back to the old days. And as things stand, that’s the way it will always be for AGL, a sad old play on electricity prices with ageing assets that no one wants.
I cherry picked three leading green utilities from around the world. This is how investors have rewarded themselves and management:
As we briefly mention below, these companies are of varying size and geography: Nextera is a giant, Orsted used to be an oil and gas company as much as anything, and SolarEdge, although now the world’s largest inverter manufacturer, is still a small company by the standards of the other two.
Yet the market has given them all a massive thumbs up and I would argue it’s because (a) they focus on one industry, renewable energy and (b) they get very, very good at it.
By contrast despite the fantastic renewable resource in Australia, despite the highly skilled work force, despite the world’s leading behind the meter solar industry, despite the software skills in Australia, despite a very willing banking sector full of highly skill financiers, despite all these things AGL (and Origin) persist with coal and gas. Most investors hate the stuff, not all, but most. And more will retreat from it in the future. The near future.
I don’t know how Brett Redman and AGL can take the loser hand they were passed by Michael Fraser and the board of the time lead by Jerry Maycock and turn it into a winner, but I do know, or think I do, that it will involve taking advantage of all the wind and solar resource Australia has.
The way AGL has sat on its hands, and notwithstanding writedowns at PARF, has been shocking to see because the company had a very strong set of skills in renewable energy but just ignored them.
AGL still has the customer base and the demand to succeed, but it’s going to need a big effort. I personally doubt that investing in the odd gas firming and gas import asset is the way to do it. Those investments are too small to make any real difference.
Similarly, a smattering of batteries to be built years in the future looks good in the Annual Report but won’t build a strong stream of revenue and profit growth. A far bigger, bolder and riskier plan is required. But that’s what CEO’s are paid big bucks for. Ex analysts get to be keyboard warriors in their own lunchtimes.
Michael Fraser’s strategy unravels
Over the years AGL has had more strategies than my grandkids had nappy changes.
Twice at least AGL decided to get big in upstream gas and oil and both times retreated. It was going to be the next big thing in New Zealand until if found out that Kiwis can do more than play rugby and burned up lots of capital.
AGL was going to be the master of electricity retailing, then it was going to be big in telcos, then it was going to be big in renewable energy, to the point where its CEO was Chair of the Clean Energy Council, building lots of wind farms in the process, and then it decided to be the biggest coal generator in the countr,y buying first Loy Yang A in 2012 and then Macgen (Bayswater and Liddell) in 2014 before the reins passed to Andy Vesey.
AGL thought that carbon risk was over discounted in the market at the time, that a Liberal Government would roll back the carbon tax, and AGL would get a bargain.
Initially, due to the unexpected closure of Hazelwood, the strategy was a massive success with profits and share price zooming up.
Andy Vesey, as far as I can tell, didn’t think much of AGL’s strategy but was more than happy to trouser the bonuses and the goodwill that surrounds good results. For other reasons though Vesey moved back to the US without having actually done very much other than abandoning Fraser and AGL’s NSW gas assets, leaving Brett Redman with the problem of how to use the coal cash flows to build a business with a future.
So far that absolutely has not happened and indeed based on the company’s profit guidance profits are going back to pre Macgen acquisition levels.
Yesterday ,AGL shocked its investors when it released results which showed an underlying Net profit [NPAT] of $816 million, down from $1,040 million in FY19. The shock though was the FY21 guidance, which at the midpoint was $600 million. Quelle horreur!
Even worse was that guidance included $100 million of insurance recoveries, making the true guidance $500m, less than half the level of two years ago and not what is supposed to happen to stable utilities. In good “earnings torpedo” style the guidance was buried at the end of pages describing all the positive news around customer accounts, positive net promotor scores and cost initiatives.
In addition as various catty analysts on the conference call happily pointed out the negative trends driving down FY21 will likely carry on into FY22 and then be followed by the negative profit impact of Liddell closing.
The following figure shows earnings before interest and tax [EBIT] by half year from 2014. I factored in midpoint guidance for FY21 with a mildly H1 seasonality.
On this set of numbers it’s more or less as if the Macgen acquisition didn’t happen.
AGL states that the profit decline is due to a $150 million of loss of gas profits and $150 million of lower wholesale electricity profits with a bit of COVID impact thrown in for good measure.
Fortunately for AGL, its balance sheet is strong but even though there is a share buyback, dividend franking, one of Paul Keating’s best innovations, will be suspended for a couple of years.
As we have told anyone that would listen – which to be fair, isn’t a big audience – every result from 2014 through to today it’s not just an electricity price issue, but also a cost issue for AGL.
Loy Yang is a very old coal mine – if you can call the carbon-intensive brown mud coal – and every year the coal mine gets 100 metres further away from the plant. Of course those coal costs are also passed onto Alinta’s Loy Yang B. Maintenance costs, control systems, and a highly unionized, broadly ageing, Victorian work force is never going to be as low cost as the labour in the average suburban hot bread shop.
When AGL bought Macgen, its advisor, the unrelated Macquarie Bank and AGL told everyone in very loud voices over and over that Macgen had great coal contracts which would lock in a low cost position.
That’s true, but it left out the bit about how those contracts had escalators of their own and relatively limited life spans. In addition, the contracts did have some elements that related to export prices. Again, at the pain of repetition, it’s the lack of sufficient low cost coal that is one of the main drivers behind the Liddell closure, they want to keep what’s left for Bayswater. Perhaps that’s gilding the lily, but it’s bound to be a factor.
Strategy is the underlying problem
AGL has ended up in a bad position, in my opinion, because it didn’t think far enough ahead and constantly tried to be too clever. Its not the only big utility in Australia to have a CEO that constantly outsmarted himself.
You can’t in 20 years be a big corporate and constantly change strategy just because the Government of the day has changed or you need an agent of change one day and a steady hand the next. Nor can you really think that investors will believe that as a low touch electricity retailer selling what is essentially a “grudge purchase” product you are going to be a successful telco just because you’ve spent a lot of money on IT and no longer have to worry about door to door salesmen driving up your churn rate.
One company I completely underestimated for many years was James Hardie. That is a company that was in a worse position by far than AGL and took a gamble on fibre cement in the USA market. Every other asset was eventually sold to focus on that one product and its become one of the great success stories of Australian manufacturing.
A senior management person told me 20 years ago that businesses aren’t borne with competitive advantage, they develop it.
I previously pointed out how NextEra has been massively more successful than AGL or Origin and indeed it’s been massively more successful than most US utilities. It’s done that with a relentless focus on wind and solar development in the US and by excellent cost control in its core Florida Utility.
Elsewhere in utility world we see Solaredge, which has gone from zero, like not existing, to being the world’s biggest inverter manufacturer in 14 years with a price increase of about 9X in just the past five years as the strategy developed and executed with rigid purpose over a long period pays off.
Not everyone is a success, of course, and in markets zero to hero to zero is a common fate, but a business with a clear long term strategy is much more likely to end up in a good place than one that changes its mind twice a decade.
Why would any utility move out of electricity?
Over the next 30 years, at the outside, the world will move from using roughly US$3 trillion per year of coal, gas and oil at point of production to other lower or zero carbon products. The pace will vary from year to year and from geography to geography but that is what is happening. This presents, for management able to see the future, excellent opportunities in electronics, in software, in clean energy and in storage.
Many utilities who cannot see the future will, like dinosaurs, become extinct. They can run but they can’t hide. Or they can seize the opportunity. Exhibit A is NextEra, Solaredge and Orsted. Three different companies, three different products in the utility industry but a common theme of success.
You could argue that Orsted, formerly Dong Energy, is quite similar to AGL, or for that matter Origin. It had an oil and gas business but bet the future of the company on offshore wind. Investors love it. This is what AGL doesn’t really get. Investors will pay over the odds for sustainable growth. Do I need to mention Tesla?.
SolarEdge – World’s No1 inverter manufacturer
Solaredge revenue growth:
Orsted – Danish wind producer
In 2015 Orsted made more ebitda from oil and gas than from wind, DK9.8 billion from oil and gas and DK6.2 bn from wind. By 2019 wind ebitda was DK 14.8 billion and the oil, gas and LNG operations were divested and the growth has only just started.
Orsted targets carbon neutrality by 2025 having reduced its emissions by 86% since 2006. Anyone who says these things can’t be done just isn’t looking. But guess what. You don’t want to be the last cab off the rank.
Firstly Orsted’s offshore wind buildout. If AGl had stuck to its wind farm strategy, would it be further ahead? Hard to say. Certainly not all the wind farms were wondeful but even the dogs like “Macarthur” have greatly increased in value thanks to the magic of AGL guaranteeing the return.
That’s just the offshore buildout in contemplation right now. Onshore there is the ambition to move from current 1.5 GW to 5 GW by 2025.
I’ve written about NextEra a couple of times, it may represent a curse but its now one of the most respected Fortune 500 companies EPS was $2.49 per share in 2004 and is now $8.37 i.e. up close to three times and it started as a large company.
Market cap was $10 billion in 2001 and is now $137 billion, so up 13 times in 20 years. And this was achieved basically by investing in wind and now solar and batteries. Nextera plans to reduce its emissions by 67% by 2025 off a 2005 base.
Like AGL, NextEra is moving to batteries and as of the August presentation expect to have battery storage investments of over US$1 billion by 2021. NextEra Group has invested about US$90 billion cumulatively in the past 10 years alone, much of it in wind and solar. And there is plenty more to come.
David Leitch is a regular contributor to Renew Economy. He is principal at ITK, specialising in analysis of electricity, gas and decarbonisation drawn from 33 years experience in stockbroking research & analysis for UBS, JPMorgan and predecessor firms.