Still Investing Down Under

Still Investing Down Under


Scott Morrison, Australia’s prime minister-designate and leader of the Liberal Party, right, speaks as Josh Frydenberg, Australia’s energy minister and deputy leader of the Liberal Party, looks on during a news conference in Canberra, Australia, on Friday, Aug. 24, 2018. Morrison pledged to bring stability once he becomes Australia’s sixth prime minister in 11 years after Malcolm Turnbull relinquished power on Friday in a party coup. Photographer: Mark Graham/Bloomberg

</div> </div> <p><span>At the end of August Australia got its sixth prime minister in a decade, when the ruling Liberal Party/National coalition ousted Malcolm Turnbull.</span></p> <p><span>New PM Scott Morrison will have to boost the government’s sagging popular support in advance of parliamentary elections, which must be held by May of next year. And it won’t be easy, with recent polls showing the Labor Party running 10 percentage points ahead and its leader Julie Bishop the first choice of voters to be the next Australian PM.</span></p> <p><span>Political upheaval has pushed the Australian dollar to its lowest point in two years at 71.9 US cents. The currency has also struggled on concerns about how US trade protectionism will affect China, Australia’s largest trading partner. China accounted for 24 percent of the country’s total imports plus exports in 2017, and trade has grown at a compound annual rate of 12.1 percent since 2007.</span></p> <p><span>Australia has also been rocked by an energy crisis. A roughly 50 percent increase in exports of LNG over the past two years has soaked up supplies of natural gas, pushing up prices as well as wholesale electricity rates. Ongoing retirements of aging coal-fired power plants and subsidies for wind and solar generation have raised rates further.</span></p> <p> </p> <p><span>The defeat of Turnbull’s National Energy Guarantee policy at the hands of pro-coal forces was the immediate catalyst for his ouster as PM. Incoming energy minister Angus Taylor is a long-time opponent of wind power and has pledged to “wield a stick” against electricity companies to bring down rates. The closer the election gets, the more likely he is to take dramatic action.</span></p> <p><strong><span>AGL</span></strong><span> Energy’s (AGL, AGLXY), one of Australia’s leading energy companies, recent replacement of CEO Andy Vesey with the less controversial CFO Brett Redman seems like an attempt to head off such a blow. Tensions between Vesey and the government had escalated over the past year. That was in part because of AGL’s record profits but also its decision to replace the 50-year-old Liddell coal-fired power plant with a combination of natural gas, renewables and energy storage.</span></p>

<p><span>AGL’s underlying strategy, however, seems unlikely to change much. One big reason is Labor’s “Climate Change Action Plan,” calling for 50 percent renewables by 2030. Another is Australia’s states are empowered to set their own energy policies.</span></p> <p><span>Liberal Party controlled Southern Australia, for example, has a 75 percent renewable energy target by 2025. That’s even more ambitious than Victoria’s Labor Party government’s 40 percent by 2025. New South Wales reached its official target of 20 percent in 2016 and will bring another 5,000 megawatts of solar on line this year. Labor controlled Queensland says its on track to meet its official renewable target of 50 percent by 2030.</span></p> <p><span>Together, these four states account for 85 percent of Australians. That makes them arguably as important as the federal government to energy policy.</span></p> <p><span>To be sure, Australia’s power sector is caught in a political crossfire. The failure of the Turnbull plan demonstrated once again how difficult it is to reach consensus, particularly with country’s influential coal mining business fighting for its life. And approaching elections make compromise unlikely.</span></p> <p><span>The political risk basically overshadows everything else at this point. In August, for example, AGL posted a 28 percent boost in its underlying profit for fiscal year 2018 (end June 30) and raised its semi-annual dividend by 29 percent. Management also announced the company generated over $1.4 billion in free cash flow after all capital spending, more than twice what it paid out in dividends.</span></p> <p><span>Such powerful results should by rights have pushed AGL shares higher. But the stock careened lower following the announcement, as investors worried that big numbers would invite more political fallout. And as a result, the stock now trades for just 8.5 times trailing 12 months earnings and its dividend yield before taxes is very high at 7.6 percent.</span></p> <p><span>Is Australia’s power sector still a worthwhile investment in light of these headwinds? Analysts tracked by Bloomberg are split. AGL, for example, draws 3 buy ratings, 7 holds and 2 sells. <strong>Origin Energy</strong> (ORG, OGFGY), the second largest power company, is slightly better at 6 buys and 6 holds with no sells. Victoria power grid operator <strong>AusNet Services</strong> (AST, SAUNF) has 2 buys, 6 holds and 2 sells.</span></p> <p><span>We come down on the side of the bulls for three main reasons:</span></p> <p><span>Low valuations equal low expectations.</span></p> <p><span>Politics notwithstanding, meeting Australia’s energy needs long-term requires a massive investment that only the country’s power companies can reasonably make.</span></p> <p><span>The Australian dollar is likely to rebound to the neighborhood of 80 US cents in the next 12 months, pushing up the value of Australian stocks dollar for dollar.</span></p> <p><span>To be sure, there’s a risk government policies will compress sector earnings in the coming year, no matter who wins the election. That risk, however, is arguably reflected in the rock bottom expectations behind power companies’ low valuations. And they may be a lot easier to beat than most expect.</span></p> <p><span>For example, AGL achieved its FY2018 results despite a -53 percent drop in margins at its consumer business, as it elected to eat wholesale price increases. Results could therefore improve nicely next year if AGL continues to hold its industry low customer attrition rate.</span></p> <p><span>Management is also executing AUD120 million in cost reductions, which will go a long way toward offsetting expected lower margins in wholesale generation. Cash flow could get a further boost from AUD2 billion in renewable energy investment and the company’s expansion in Western Australia.</span></p> <p>These developments and/or any sign of progress on the regulatory front would likely rally AGL shares. As for the Australian dollar, whenever it’s lagged oil prices this long and dramatically, it’s always gained value in the following 12 months. Those are good reasons why the best in class down under are still worth our investment dollars.</p>”>

Scott Morrison, Australia’s prime minister-designate and leader of the Liberal Party, right, speaks as Josh Frydenberg, Australia’s energy minister and deputy leader of the Liberal Party, looks on during a news conference in Canberra, Australia, on Friday, Aug. 24, 2018. Morrison pledged to bring stability once he becomes Australia’s sixth prime minister in 11 years after Malcolm Turnbull relinquished power on Friday in a party coup. Photographer: Mark Graham/Bloomberg

At the end of August Australia got its sixth prime minister in a decade, when the ruling Liberal Party/National coalition ousted Malcolm Turnbull.

New PM Scott Morrison will have to boost the government’s sagging popular support in advance of parliamentary elections, which must be held by May of next year. And it won’t be easy, with recent polls showing the Labor Party running 10 percentage points ahead and its leader Julie Bishop the first choice of voters to be the next Australian PM.

Political upheaval has pushed the Australian dollar to its lowest point in two years at 71.9 US cents. The currency has also struggled on concerns about how US trade protectionism will affect China, Australia’s largest trading partner. China accounted for 24 percent of the country’s total imports plus exports in 2017, and trade has grown at a compound annual rate of 12.1 percent since 2007.

Australia has also been rocked by an energy crisis. A roughly 50 percent increase in exports of LNG over the past two years has soaked up supplies of natural gas, pushing up prices as well as wholesale electricity rates. Ongoing retirements of aging coal-fired power plants and subsidies for wind and solar generation have raised rates further.

The defeat of Turnbull’s National Energy Guarantee policy at the hands of pro-coal forces was the immediate catalyst for his ouster as PM. Incoming energy minister Angus Taylor is a long-time opponent of wind power and has pledged to “wield a stick” against electricity companies to bring down rates. The closer the election gets, the more likely he is to take dramatic action.

AGL Energy’s (AGL, AGLXY), one of Australia’s leading energy companies, recent replacement of CEO Andy Vesey with the less controversial CFO Brett Redman seems like an attempt to head off such a blow. Tensions between Vesey and the government had escalated over the past year. That was in part because of AGL’s record profits but also its decision to replace the 50-year-old Liddell coal-fired power plant with a combination of natural gas, renewables and energy storage.

AGL’s underlying strategy, however, seems unlikely to change much. One big reason is Labor’s “Climate Change Action Plan,” calling for 50 percent renewables by 2030. Another is Australia’s states are empowered to set their own energy policies.

Liberal Party controlled Southern Australia, for example, has a 75 percent renewable energy target by 2025. That’s even more ambitious than Victoria’s Labor Party government’s 40 percent by 2025. New South Wales reached its official target of 20 percent in 2016 and will bring another 5,000 megawatts of solar on line this year. Labor controlled Queensland says its on track to meet its official renewable target of 50 percent by 2030.

Together, these four states account for 85 percent of Australians. That makes them arguably as important as the federal government to energy policy.

To be sure, Australia’s power sector is caught in a political crossfire. The failure of the Turnbull plan demonstrated once again how difficult it is to reach consensus, particularly with country’s influential coal mining business fighting for its life. And approaching elections make compromise unlikely.

The political risk basically overshadows everything else at this point. In August, for example, AGL posted a 28 percent boost in its underlying profit for fiscal year 2018 (end June 30) and raised its semi-annual dividend by 29 percent. Management also announced the company generated over $1.4 billion in free cash flow after all capital spending, more than twice what it paid out in dividends.

Such powerful results should by rights have pushed AGL shares higher. But the stock careened lower following the announcement, as investors worried that big numbers would invite more political fallout. And as a result, the stock now trades for just 8.5 times trailing 12 months earnings and its dividend yield before taxes is very high at 7.6 percent.

Is Australia’s power sector still a worthwhile investment in light of these headwinds? Analysts tracked by Bloomberg are split. AGL, for example, draws 3 buy ratings, 7 holds and 2 sells. Origin Energy (ORG, OGFGY), the second largest power company, is slightly better at 6 buys and 6 holds with no sells. Victoria power grid operator AusNet Services (AST, SAUNF) has 2 buys, 6 holds and 2 sells.

We come down on the side of the bulls for three main reasons:

Low valuations equal low expectations.

Politics notwithstanding, meeting Australia’s energy needs long-term requires a massive investment that only the country’s power companies can reasonably make.

The Australian dollar is likely to rebound to the neighborhood of 80 US cents in the next 12 months, pushing up the value of Australian stocks dollar for dollar.

To be sure, there’s a risk government policies will compress sector earnings in the coming year, no matter who wins the election. That risk, however, is arguably reflected in the rock bottom expectations behind power companies’ low valuations. And they may be a lot easier to beat than most expect.

For example, AGL achieved its FY2018 results despite a -53 percent drop in margins at its consumer business, as it elected to eat wholesale price increases. Results could therefore improve nicely next year if AGL continues to hold its industry low customer attrition rate.

Management is also executing AUD120 million in cost reductions, which will go a long way toward offsetting expected lower margins in wholesale generation. Cash flow could get a further boost from AUD2 billion in renewable energy investment and the company’s expansion in Western Australia.

These developments and/or any sign of progress on the regulatory front would likely rally AGL shares. As for the Australian dollar, whenever it’s lagged oil prices this long and dramatically, it’s always gained value in the following 12 months. Those are good reasons why the best in class down under are still worth our investment dollars.



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