Company Overview – AGL Energy is Australia’s second largest retailer of electricity and gas. It services 3.5 Million retail electricity and gas accounts in the eastern and south eastern states representing a 27% market share. Profits are evenly split between energy retailing and energy generation and procurement activities. It is the oldest company listed on the ASX having been founded in 1837. Generation capacity comprises a portfolio of peaking, intermediate and base load electricity generation plants with a combined capacity of 6,000 MW. AGL operates in four segments: 1- Retail energy which includes selling natural gas, electricity and energy related products and services; 2 – Merchant energy which is engaged in developing, operating and maintaining power generation assets; 3 – Upstream Gas – which includes investments and operations in gas exploration; 4 – Energy Investments. In October 2013, AGL Energy Ltd through its wholly owned subsidiary acquired the remaining 80.1% interest in Australian Power & Gas Co Ltd. Concurrently AGL acquired a 19.9% stake in Australian Power.


Analysis - Retail Energy segment engages in the sale and marketing of natural gas and electricity. Besides, the segment also offers related energy products and services. It has Australia's largest retail energy and dual fuel customer base, including approximately 3.5 million customers across New South Wales, Victoria, Queensland and South Australia.
 
Merchant Energy segment develops, operates and maintains power generation assets. It also manages risks associated with the procurement and delivery of gas and electricity for its Retail Energy segment and wholesale portfolio. Through the segment, the company manages relationship with its 700 largest energy customers and provides them with energy efficiency advice and carbon management services. Merchant Energy segment is further divided into four sub-segments, namely, Energy Portfolio Management, Power Development, Merchant Operations and Energy Services. Through, Energy Portfolio Management sub-segment, AGL Energy manages the risk associated to procuring gas, electricity and environmental market certificates, particularly Renewable Energy Certificates (RECs).
 
 
Under the Upstream Gas segment, AGL Energy is engaged in exploration, extraction, production of coal seam gas including exploration and development of geothermal renewable energy sources. The company has its upstream gas operations in New South Wales and in a joint venture operates in Queensland and South Australia. Its New South Wales portfolio comprise Camden Gas Project, Sydney Basin exploration (including Hunter Valley) and Gloucester Basin assets, while the Queensland/South Australia portfolio consists of the Moranbah Gas Project joint venture. Besides, AGL maintains asset base in north Queensland’s Bowen Basin around Moranbah.
 
 
AGL Energy Investments segment has investments in the ActewAGL Retail Partnership and Greater Energy Alliance Corporation Pty Limited. ActewAGL is a 50/50 partnership between AGL and Actew Corporation, an ACT Government owned enterprise.
 
One of the key strengths of AGL is their diversified asset portfolio. AGL operates a wide range of power generation facilities across Australia. It generates power from coal, natural gas, hydro wind power, landfill gas, biomass and bagasse. It owns and operates 16 hydroelectric power plants with an aggregate capacity of 781 MW in NSW and Victoria. Besides asset diversity they also have customer diversity with them catering to nearly 3.5 Million customers within NSW, Victoria, South Australia and QLD. The company offers competitively priced products at lower cost for consumers in the low income bracket, through its staying connected program. Also AGL takes a very strategic investment approach where they retain a strong capital investment structure in assets. For example the company increased its ownership interest in the Loy Yang A power station to 100% from 32.54%.

Price		Price % Change
Close:	14.86 (28-Jan-2014)	3M:	(1.24%)
52 Wk High:	16.60 (15-Mar-2013)	6M:	1.48%
52 Wk Low:	13.85 (24-Jun-2013)	1Y:	(3.02%)

Falling churn rates, scaled back discounts and increasing retail prices are all positive signs for the industry. This should allow retailers to recover margins lost in the churn battle earlier this year. However due to the length of discounted contracts we would not expect meaningful favourable financial impact until FY15.
 
AGL’s retailing business   potentially has a competitive advantage due to efficient scale. The efficient scale advantage exists when competitors are deterred from entering an industry due to the negative impact their participation would have on industry returns. This is the case in Australian energy retailing whereby the market can only support a small number of participants and returns are low.
 
Australia’s abundance of cheap coal sees the electricity generation sector dominated by coal fired plants and nearly 75% of the capacity is covered by those, comprising 75% of the National Electricity market. Aside from being very low cost coal generation is reliable and stable in contrast to renewable generation. Australian power stations are commodity producers and price takers meaning competitive strength depends on the short run marginal cost (SRMC). Loy Yangs’s SRMC of around $2 per MW is well below the historical wholesale prices.
 
Australian natural gas demand is expected to increase significantly during the next decade thanks to the construction of liquefied natural gas or LNG, export facilities. Australian gas prices will align more closely to the export prices. We believe the domestic gas prices to increase the SRMC of gas fired generation thereby increasing the competitiveness of the coal fired station.
 
AGL is significantly influenced by the government energy policy. Key environmentally related energy legislation included the RET and the carbon tax. The legislation increases the cost of energy production but ultimately the cost is borne by a combination of the retail customers, generators and government.

AGL(Millions, AUD)	2013	2012	2011	2010	2009
Revenue	9,714.8	7,454.0	7,071.8	6,609.9	5,953.9
Gross Profit	2,263.5	1,535.6	1,365.4	1,282.0	1,197.3
Total Operating Expense	9,251.7	7,295.6	6,278.9	6,239.5	5,857.9
Net Income After Taxes	388.7	114.9	558.7	356.1	718.2

AGK’ earnings are highly defensive and should grow with the government mandated retail energy price rises. Fully franked dividends are comfortably covered by operating cash flow. Gearing increased to 28% at 30 June 2013 following the Loy Yang Acquisition.  AGL does not expect gearing to exceed 30% in the long term and aims to maintain an investment grade credit rating.
 
AGK has a simple and stable capital structure. Strong and stable operating cash flows enable internal funding of dividends and capital expenditure. AGK’s principal risk is changes in government energy policy. Federal and state governments have significant influence over the Australian energy market which influences company strategy. Profitability may be restricted by regulators concerned about the public opinion. AGL is exposed to energy risks as 40 % of its energy requirements are purchased from third parties.

AGL	2013	2012	2011	2010	2009
Profitability
Gross Margin	23.3%	20.6%	19.3%	19.4%	20.1%
EBITDA Margin	13.1%	11.5%	10.8%	10.7%	22.9%
Operating Margin	4.8%	2.2%	11.2%	5.7%	14.7%
Pre-tax Margin	4.8%	2.2%	11.2%	5.7%	17.0%
Earning Power
Pre-tax ROA	3.3%	1.3%	8.6%	4.3%	10.9%
Pre-tax ROE	6.4%	2.4%	13.1%	6.5%	18.7%
Liquidity
Quick Ratio	1.23	1.51	1.06	1.36	1.59
Current Ratio	1.29	1.58	1.11	1.42	1.63

We don’t consider AGL to be a growth stock but management’s conservative approach means the business is well placed if opportunities arise. The successful purchase and sale of the Queensland Gas company shares in 2008 is an example  of such a scenario where value was created.
 
The impact of high levels of discounting and expensive customer acquisition strategies are likely to linger throughout FY14. We are putting a HOLD on this stock for the subscribers who are currently holding this stock.

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