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Battle royale: AGL vs. Origin – which won’t shock you?

Posted By James Dunn On In Markets | No Comments

Last week we looked at gas, and the export outlook for LNG [1]. This week we’re going back down the pipe, to the business of supplying energy to households, where it’s a battle royale between arch-rivals, the big diversified utilities AGL Energy (AGK) and Origin Energy (ORG).

As it happens, Origin has a finger in the LNG exports pie, too, but we’ll get to that later.

Origin clocks in as Australia’s largest integrated energy company, with four million customers and a 33% market share. Its portfolio of base-load, intermediate and peaking electricity plants has a capacity of 6,000MW and a 13% market share. Origin also owns 53% of Contact Energy, New Zealand ‘s second-largest integrated energy company, and 37.5% of the Australia-Pacific LNG (APLNG) project being built in Gladstone in Queensland.

AGL Energy is the number two retailer of electricity and gas, with more than 3.5 million retail customers in the eastern and southern Australian states, giving it a 27% market share. It also generates about 6,000 MW of electricity.

For history buffs, AGL was founded as The Australian Gas Light Company in the first year of the reign of Queen Victoria – in 1837 – and lit the first gas street light in Sydney in 1841. It is one of the oldest companies listed on the ASX, with an original listing on January 1, 1871.

In contrast, Origin Energy was established in 2000, when Boral spun off its energy business from its building and construction materials business. As is often the way with such things, selling off the energy business just before the China boom caused a shortage of energy around the world, looks an awful decision now: the division that Boral did not want has grown into a company worth $13.3 billion, compared to Boral itself, at $3.7 billion.

For AGL, retail electricity generates about 40% of revenue, wholesale electricity about 25% and gas about 15%. In operating profit terms, wholesale energy produces the lion’s share, at 61%, while the retail business contributes about 37%.

At Origin, the energy markets division generates by far the lion’s share of operating earnings, more than 69%, with exploration and production and Contact Energy both producing about 14.5%, and the remainder attributable to APLNG.

Highly defensive stocks

The main investment attraction for both AGL and Origin is familiar to anyone who has ever played Monopoly: the cash flows utilities derive from providing essential services to households. The revenue and earnings flows from electricity and gas are considered highly defensive.

But those cash flows are also politically sensitive when prices rise, as has happened in both electricity and gas, for a range of reasons, including the carbon tax, the subsidies flowing from the government’s renewable energy target (RET) and the impact of rising gas exports from Australia on domestic prices. (International gas prices are about double what Australian households pay at present: the more gas Australia exports, the closer the domestic price must rise to the international price.)

Both AGL and Origin have fallen foul of state regulators in Queensland and South Australia, which have acted to regulate down retail prices and thus limit the retailers’ margins. Both companies have downgraded their profit guidance for the current financial year, and wound back marketing and discounting activities in those states.

If the New South Wales government pricing regulator, the Independent Pricing and Regulatory Tribunal (IPART), were to follow the lead of its Queensland and South Australian counterparts, the impact on both companies’ earnings would be material. For example, AGL has applied to IPART to lift gas prices by 10.4% in 2013-14. IPART’s decision is due in May.

(AGL’s long-term gas purchase contracts from gas producers are expiring over the next few years, leaving it fully exposed to the anticipated surge in gas prices.)

What’s the difference?

Still, the pair’s earnings from electricity generation and retailing should continue to prove defensive. Now let’s look at what sets them apart.

AGL’s standout difference is its renewable energy portfolio, consisting of wind, hydro, landfill gas and biogas. AGL’s installed renewable energy generation capacity comprises around 27% of its generation portfolio. (It also owns the country’s single largest emitter of CO2, the Loy Yang A power station in Victoria, but AGL says it will use the cash generated by Loy Yang – which came with the largest brown-coal mine in Australia, but also $2.25 billion worth of carbon tax subsidies and free carbon permits – to invest further in its renewables projects.)

Origin’s difference is coal seam gas (CSG), which it has produced in Queensland for the last 12 years. AGL is also involved in CSG, but Origin is turning CSG into a source of export income through its 37.5% stake in the $23 billion APLNG joint venture, based at Gladstone in Queensland. (Origin intends to lower this stake to 30%.)

Origin’s partners in APLNG are the project’s operator ConocoPhillips (37.5%) and Sinopec, one of China’s largest petroleum products suppliers and crude oil and natural gas producers (25%). The project will convert CSG to LNG based on Australia’s largest CSG 2P reserves base, to supply both domestic contracts and export contracts with two of Asia’s largest energy companies, Sinopec and Kansai Electric Power Company of Japan. The project’s first LNG exports are scheduled to start in mid-2015.

How’s the yield?

On yield grounds, at $16.63, AGL is priced on market consensus at a 4.2% fully franked yield in FY13, rising to 4.3% in FY14. To an SMSF in accumulation mode, that is equivalent to 5.1% in FY13 and 5.2% in FY14. In pension mode, the equivalent yields to an SMSF would be 6% in FY143 and 6.1% in FY14.

Origin is yielding just a touch lighter, at 4.1% in FY13 based on a share price of $12.21,and the same in FY14. Fully franked, that is equivalent to 5% for an SMSF on the 15% accumulation tax rate and 5.9% for an SMSF in pension mode.

These yield figures do not take into account the earnings stream from APLNG. The market appears to be factoring in cost pressures at that may not eventuate, given that APLNG started later than the other projects. Profit growth in the energy retail business is under-pinned by regulated price rises, and the APLNG ‘kicker’ could well push this stock in front of AGL over the medium-term. But if renewable energy interests you more than CSG exports, AGL provides a nice solid yield in the meantime.

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.

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