AGL Energy recently posted first-half FY17 underlying net profit of $369 million, around 5% above Ord Minnett’s forecast, with the beat driven by higher-than-expected retail electricity prices. The result showed some early signs of the tailwinds that are driving substantial earnings growth. Retail price rises have already come through – driven by the impact of increasing price and volatility in wholesale markets on retail competition.
We expect retail electricity prices to continue to increase, driven by higher wholesale procurement costs, and higher hedge costs for pure retailers. AGL could use the natural hedge from its generation portfolio to expand its margins, or alternatively undercut competition to increase market share.
Wholesale forward prices have increased substantially in recent months as market participants project higher spot prices due to the upcoming closure of the 1,600MW Hazelwood power plant. However, AGL has yet to realise these higher prices in its profitability due to the long-dated nature of its hedge book. As these hedges roll over to higher prices, AGL’s profitability could take another step higher.
There remain opportunities for consensus upgrades as the market factors in higher wholesale and retail prices. We believe the market has yet to factor in these tailwinds, leading us to reiterate our Accumulate recommendation on AGL and raise our target price to $25.00 from $23.00.
In the near-term, the biggest risk is that increasing pressure on the government to address rising energy costs could result in detrimental policy change. However, we believe this would likely mean moving away from environmental policies which we would consider to be highly unlikely.