AGL Energy (AGL) reported an underlying net profit of $802 million, representing earnings growth of 14% on FY16 and above the top end of guidance. Ord Minnett considered this a strong result and the guidance provided a justification for a positive view on the stock.
Earnings growth came primarily from the electricity portfolio with earnings before interest and tax (EBIT) up $260 million, which more than offset the expected EBIT decline of $129 million in the gas portfolio. Free cash flow (FCF) declined to $589 million due to a $431 million margin call on higher forward prices. FCF was not enough to offset buybacks and dividends, with net debt increasing $336 million to $3.2 billion.
AGL guided to an underlying net profit of $940–1,040 million in FY18, implying earnings growth of 17–29%, with growth expected to come from the electricity business. Management also talked positively about the outlook for electricity forward prices, indicating that current prices were not high enough to incentivise new generation capacity. The gas business is expected to see “margin growth”, but this could imply reduced earnings should sales volumes decline, as we expect.
Despite the financial result being generally positive, the market appeared to react negatively to AGL’s growth strategy. The company outlined a number of projects with $1 billion of major programs already under way.
Capital expenditure is expected to be $984 million in FY18, including $509 million of growth capital expenditure, up from $518 million in FY17. It is difficult to ascertain how these projects will contribute to earnings growth; and the potential for entry into offshore markets has been perceived as particularly risky.
These risks could take some time to play out, but as the market digests the strong result we expect to see a positive stock price reaction. We also continue to see upward movement in forward prices as we get closer to summer peak loads. We reiterate our Accumulate recommendation and have lifted our target price slightly to $28.30 from $28.20 in line with our DCF valuation.