Key points

• The sector provides a reliably safe source of strong yields, with some issues around revenue.
• Some savvy restructuring from AGL Energy means it is now looking for FY15 profit of $575 million–$635 million, up from $570 million in FY14.
• APA Group has very strong potential in its exposure to the Gladstone-based LNG projects, as it services LNG exporters.

Anyone who has ever played Monopoly knows that the utilities can generate a very handy income stream, but they don’t have the same capital growth potential of properties or railroads.

The utilities sector on the Australian Securities Exchange (ASX) is usually considered a defensive sector with good dividends – but full franking is not uniform. However, the low-interest-rate environment has seen the utilities viewed as a relatively safe source of strong yields. Many of the stocks have also shown good capital growth in recent years, with the result that five-year total return (capital gain plus dividends) figures are reasonably healthy in most cases. But utilities are certainly not a set-and-forget investment, with potential revenue issues aplenty.

Revenue risks

Firstly there is the fact that when you have regulated assets, there is the potential for regulatory “re-sets” of what revenue proportion the regulator will allow. For the states in the National Electricity Market (NEM) – New South Wales, Victoria, Queensland, South Australia and Tasmania – the regulator is the Australian Energy Regulator (AER): Western Australia and Northern Territory are not part of the NEM and have their own systems of regulation.

Then there is the phenomenon of continued weakness in electricity demand: as older appliances are replaced with more energy-efficient appliances, per capita use of electricity is expected to continue to decline. Add to this the deep discounting prevalent in the retail market. Then there is the complication of the renewable energy target (RET): with the government aiming to enact legislation by 30 June, market attention is fixated on the potential impact on wholesale and retail markets.

Further out there is the potential of distributed (that is, at individual household or factor level) demand and supply – for example, rooftop solar power – and its potential to transform the energy market. Rooftop residential solar generation has already had a significant impact on the electricity market, with electricity demand from the NEM falling every year since 2008

With that caveat, lets have a look at the major utilities stocks on the ASX.

1) AGL Energy (AGL)
Consensus estimate FY15 forecast yield: 4.1%
Consensus estimate FY16 forecast yield: 4.3%
Five-year total return: 7.4% a year
Franking: 100%
Consensus estimated price target: $16.33 (5% upside risk)

AGL’s generation portfolio includes coal, natural gas, wind power, hydro-electricity and coal seam gas sources. Last year AGL bought the Macquarie Generation assets from the New South Wales government, and analysts say the contribution from MacGen will be the major driver of an improved profit performance in FY15, offsetting the effect of falling electricity consumption.

The company’s guidance is looking for FY15 profit of $575 million–$635 million, up from $570 million in FY14, with analysts now expecting a figure at the high end of that range. As the largest listed producer of renewable energy, AGL is most exposed to RET risk. AGL has a relatively low headline yield, but full franking must be factored in: the consensus forecast FY16 yield of 4.3% equates to an effective 5.2% in the hands of a self-managed super fund (SMSF) in accumulation phase, and 6.1% to a SMSF in pension phase. In addition, on analysts’ consensus target price, AGL appears to be under-valued.

Source: Yahoo!7, Data as at 9 June, 2015

2) APA Group (APA)

Consensus FY15 forecast yield: 4.3%
Consensus FY16 forecast yield: 4.7%
Five-year total return: 28.8% a year
Franking: nil
Consensus estimated price target: $9.21 (5.9% upside risk)

Gas pipeline operator APA owns the dominant network of gas transmission and distribution infrastructure assets across Australia. Like electricity, retail domestic gas demand is soft, but APA has very strong potential in its exposure to the Gladstone-based LNG projects, as it services LNG exporters. In particular, APA’s QCLNG gas transmission pipeline, a 42-inch pipeline that transports coal seam gas from south-west Queensland to Gladstone, is potentially transformational for the company, and will be a major driver of returns over the medium term. APA has been an excellent share price performer in recent years, moving from $3.50 in 2010 to $8.70 at present. APA is also undervalued compared to its analysts’ consensus target price, but lack of franking compromises its dividend yield.

Source: Yahoo!7, Data as at 9 June, 2015

3) AusNet Services (AST)

Consensus FY16 forecast yield: 6.1%
Consensus FY17 forecast yield: 6.3%
Five-year total return: 19.7% a year
Franking: 52.6%
Consensus estimated price target: $1.45 (1.1% upside risk)

Formerly known as SP AusNet, AST is a regulated utility that owns generation, transmission, distribution, metering and retail operations in both gas and electricity. Its major assets are three regulated energy networks in Victoria: the state’s main high-voltage electricity transmission network; an electricity distribution network; and a gas distribution network. With revenue being almost 90% regulated, it is thus very secure and predictable – between regulatory resets, that is. The gas reset in 2013, and the electricity transmission reset in 2014, were unfavourable to the company, and there is a reset coming up for the electricity distribution network in early 2016. Therefore distributions (dividends) cannot be considered locked-in for FY17. However, potential upside comes from the possibility that Ausnet could bid for the New South Wales transmission and distribution assets, which are expected to go on sale in the second half of this year. But analysts see the stock as fully valued.

Source: Yahoo!7, Data as at 9 June, 2015

4) DUET Group (DUE)

Consensus FY15 forecast yield: 7.2%
Consensus FY16 forecast yield: 7.2%
Five-year total return: 19.3% a year
Franking: nil
Consensus estimated price target: $2.55 (3.1% upside risk)

DUET Group is a diversified energy infrastructure investor. Its portfolio comprises majority stakes in three major Australian assets: the Dampier to Bunbury natural gas Pipeline (DBP); Victorian electricity distributor United Energy; and Victorian gas distributor Multinet Gas. Multinet and United Energy are regulated utilities while the DBP mainly operates under contracts. Broker Citi says DUET offers the highest dividend yield (albeit unfranked) and lowest re-set risk of the sector, and is least exposed to electricity with 75% of its assets being gas. At the half-year, United Energy and Multinet were weak performers, but the DBP did better than expected. DUET is considered close to full value, but has the strongest (unfranked) yield of the major utilities.

Source: Yahoo!7, Data as at 9 June, 2015

5) Origin Energy (ORG)

Consensus FY15 forecast yield: 4.0%
Consensus FY16 forecast yield: 4.0%
Five-year total return: 20.4% a year
Franking: nil
Consensus estimated price target: $13.50 (7.1% upside risk)

Technically not a utility – more a vertically integrated energy company – Origin owns and develops gas-fired power generation in Australia, produces renewable energy from wind farms, and operates as an energy retailer in NSW, QLD, SA and Victoria, while also producing its own gas onshore in Australia, and exploring for gas in Australia, New Zealand and the Pacific. Origin is also involved in liquefied natural gas (LNG), owning a 37.5% stake in the Australia Pacific LNG (APLNG) coal seam gas to LNG export project at Gladstone, which received its first gas earlier this year and is expected to be commissioned later in 2015 and reach full production the next year.

APLNG could have a huge effect on Origin. It is expected to boost net profit and earnings by up to 50% in FY16 and potentially by even more in FY2017 financial year. Analysts are generally positive on Origin, while relatively low-yielding, it has good upside to the consensus target price.

Source: Yahoo!7, Data as at 9 June, 2015

6) Spark Infrastructure (SKI)

Consensus FY15 forecast yield: 6.3%
Consensus FY16 forecast yield: 6.5%
Five-year total return: 20.4% a year
Franking: nil
Consensus estimated price target: $2.12 (11.3% upside risk)

Spark Infrastructure owns 49% of three electricity distribution networks: Victorian Power Networks (VPN), which comprises CitiPower and Powercor in Victoria; and SA Power Networks (SAPN) in South Australia. All three have secure, predictable, regulated revenue streams, with pricing typically reset every five years. Spark has just entered a regulatory reset cycle: each of SKI’s business units face resets in the next twelve months. The AER’s draft decision on SAPN came out in May, and the regulator slashed the network’s revenue allowance by 26%. The final decision will be handed down in October. Despite the tough regulatory environment – and final-decision risk – the market appears to see most of that factored in to the share price, which has fallen by 15% since February. The consensus target price implies that analysts expect SKI to regain much of that lost ground.

Source: Yahoo!7, Data as at 9 June, 2015

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.