Ord Minnett has made a significant change to its valuation estimates across its energy and utilities coverage. We have lowered our risk-free rate to 2.5% (from 3.5%) and the inflation rate for costs and prices to 2.0% (from 2.5%), as in an environment where low returns are likely to remain these estimates appear too high to us. We have also reduced our long-term price estimates on the basis that companies are willing to accept lower project returns.
These changes have resulted in higher equity values and we have upgraded our recommendations on AGL Energy (AGL), Origin Energy (ORG) and Beach Energy (BPT) to Accumulate from Hold. We remain positive on Woodside Petroleum (WPL, Accumulate) and Beach Energy (BPT, Accumulate) as our key sector preferences, and WorleyParsons (WOR, Buy). We have downgraded our recommendation on Infigen Energy (IFN) to Hold from Buy based on valuation.
- AGL Energy – AGL Energy is at an interesting juncture. The share price has been reasonably strong in recent months, while FY20 guidance implied earnings could fall 17–25%. We believe there are reasons to be positive on the stock, however: 1) wholesale electricity prices remain strong and the short-end of the forward curve continues to lift, implying potential upside to earnings forecasts; and 2) our in-depth analysis of AGL’s financials points to forward earnings in a range of $650–850m for the next decade on P/E multiples of 15–20x. The stock is trading at a discount to our valuation and we have upgraded our recommendation to Accumulate from Hold.
- Beach Energy – Since late September, Beach Energy’s share price has significantly underperformed the broader index. We believe this recent derating has provided a buying opportunity and we have upgraded our recommendation to Accumulate from Hold. We note the company offers good production growth and a well-funded balance sheet with strong cash flow generation, and now better value. Beach also provides the best leverage to rising domestic gas prices among stocks in our energy sector coverage universe.
- Origin Energy – Over the past four years, Origin has solely focused on debt repayment through a combination of asset sales and low shareholder returns. The company has the strongest free cash flow yields across stocks under our coverage and, while it remains focused on deleveraging in the near term, management has flagged the possibility of increased shareholder returns. Growth appears limited to the Beetaloo Basin in the integrated gas division, and some flexible generation options in the energy markets business, reflecting a suite of assets that is suitable to the current macro-economic environment. The stock is trading below our revised valuation, leading us to upgrade our recommendation to Accumulate from Hold.
- Infigen Energy – Previously, Infigen’s share price implied a value for the company’s assets that was well below the cost to build. We now believe that gap has now closed. Furthermore, the industry appears to be focused on investing in fast-response generation technology (such as pumped hydro, battery or gas plants) rather than baseload. The stock is trading close to our valuation and we have downgraded our recommendation to Hold from Buy.