I. Sector Landscape

Australia’s energy and utility sector seeks substantial opportunities amid surged domestic demand for electricity generation and subsequent escalation of urbanisation. Record-hitting energy generation from renewable capacity warrants Australia’s world leadership in renewable energy. Renewable energy contributed circa 24% of total electricity generation in 2020. Further, the sector remains resilient due to the considerable natural resources base.

Key Takeaways from Mining and Resources Segment

Substantial Bounce in Mineral Exploration: The total expenditure on mineral exploration extended by 4.5% or $39.5 million and clocked $925.9 million in September 2021 quarter. Existing deposits and new deposits in the country advanced by 5.8% (clocked $636.3 million) and 11.5% (clocked $346.1 million), respectively. Although total meters drilled slipped marginally by 1.9% to ~3.39 million meters in September 2021 quarter, the series has increased since the June 2020 quarter.

Figure 1: Expenditure on Mineral Exploration Trending Upwards

Source: Based on Australian Bureau of Statistics Data, Analysis by Kalkine Group

Recovery in Demand for Thermal Coal: Australian thermal coal exports had declined from 213 million tonnes in FY20 to 192 million tonnes in FY21, but recovery is expected back to 204 million tonnes by FY23 due to rapid global recovery intensified demand for power generation. In October, a spike in thermal coal spot prices resulted from resilient Chinese demand against capacity constraints and global supply disruption. The Newcastle benchmark price was estimated to average US$134/tonne in 2021.

Growth Forecasted in Global LNG Trade: In September 2021 quarter, Australia’s LNG exports struck 21.4 million tonnes, up by 14.4% QoQ and 16.2% PcP, primarily driven by the resolution of Gorgon, Ichthys, and Prelude LNG plant issues in the June 2021 quarter. Production improvements in all three plants have outstripped the lower production from North-West Shelf, Pluto and APLNG in September 2021 quarter.

Figure 2: Selected Energy Exports by Product

Source: Based on Australian Bureau of Statistics Data, Analysis by Kalkine Group

Retail Energy Market Performance Update by Australian Energy Regulator (AER)

Key Statistics of Electricity Market: For September 2021 quarter, the residential electricity customer disconnections slipped by 27% from 7,327 in Q4 2020-21 to 5,381 in Q1 2021-22. AER’s instructions warranted this sharp decline to retailers to disconnect customers amid unprecedented times.

Residential Energy Customer Debt: The count of residential energy customers in debt surged across FY21 but has since declined by almost 10%, primarily driven by Queensland retailers returning to regular debt practices and $50 of state government credit to facilitate customers in the retail bill. The count of residential electricity customers on payment plans has maintained elevated levels and remains consistent with pre-COVID levels.

Figure 3: Annual Household Electricity Usage

Source: Based on Australian Energy Regulator Data, Analysis by Kalkine Group

Index Performance

The ASX 200 Utilities (GIC) and ASX 200 Energy (GIC) have generated a 6-months return of ~19.33% and ~14.79%, respectively, compared to ~-3.62% return by the ASX 200 Index. Increasing exports of the resources sector, favourable pricing across most minerals, and recovering business sentiments drove the sector gains.

Figure 4: The ASX 200 Utilities (GIC) and ASX 200 Energy (GIC) Index outperformed ASX 200 Index in the past 6-months by ~22.95% and ~18.41%, respectively.

Source: REFINITIV as of 10 February 2022

Key Risks and Challenges

Total meters drilled in September 2021 quarter slipped from 3.454 million meters to 3.388 million meters, down by 1.9% QoQ. Surging coal prices have not culminated in a rush of coal investment amid market and policy pressures, affected by the announcements in the COP26 summit. Gross value added (GVA) by the electricity, gas, water, and waste services industry slipped by 2% in September 2021 quarter, relative to December 2019 quarter. Post-lockdown recovery has forced workers to cash in on country-wide labour shortages by seeking higher wages, increasing operating costs for the sector. The significant global supply disruption has inflated the cost of energy transport.

Figure 5: Key Drivers v/s Key Constraints

Source: Analysis by Kalkine Group

Outlook

Improved Business Turnover: The Electricity, Gas, Water, and Waste Services Industry experienced a monthly business turnover of 6.8%, clocking a business turnover index of 100.0 for November 2021.

Australian Thermal Coal Exports: The Australian thermal coal exports have declined to 192 million tonnes in FY21 but are expected to recover at 204 million tonnes by FY23, backed by increased global demand and surging price support.

Increased Gas Export Volumes: The Australian LNG export volumes are estimated to expand by 6.5% to 82 million tonnes in FY22, as significant technical issues across gas plants are resolved. Subsequently, export earnings are estimated to surge to $63 billion in FY22 from $30 billion in FY21.

LNG Export Supported by Oil-Linked Contract Prices: The LNG export earnings are estimated to advance on the back of oil-lined contract prices, which are forecasted to elevate over pre-COVID levels, coupled with high Asian LNG spot prices.

Stability in Electricity Prices: Electricity prices in most distribution avenues clocked historically high levels in 2018 and 2019, following surged market and standing offers. Prices have since eased, alongside median market offer prices falling in FY21.

II. Investment theme and stocks under discussion (SOL, PDN, MEZ, WHC)

After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on the ‘EV/Sales’ multiple and ‘Price/Book value’ multiple methods.

1. ASX: SOL (­­­Washington H Soul Pattinson & Company Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$9.81 billion)

SOL is an Australian-based investment company, driving revenue through stakes in coal mining, gold, and copper mining, refining operations, and consulting services.

Valuation

The illustrative valuation model suggests that the stock has a potential upside of 16.03% on 10 February 2022. However, the stock might trade at a slight discount compared to its peers’ average EV/Sales (NTM trading multiple), given considering fluctuations in coal supply and changes in macroeconomic factors. For valuation, peers such as Santos Ltd (ASX: STO), Senex Energy Ltd (ASX: SXY), Beach Energy Ltd (ASX: BPT), and others have been considered. Given the diversification benefits, potential merger synergies, improved net asset value, current trading levels and upside indicated by valuation, we give a “Buy” recommendation on the stock at the closing market price of $26.840, down by ~1.360% on 10 February 2022. In addition, the stock has delivered an annualised dividend yield of 2.30%.

SOL Weekly Technical Chart

Source: REFINITIV

2. ASX: PDN (Paladin Energy Limited)

(Recommendation: Speculative Buy, Potential Upside: Low Double-Digit, Mcap: A$1.98 billion)

PDN is a uranium mining, exploration, development, and evaluation company. It operates the Langer Heinrich mine in Namibia and other mines in Australia and Canada.

Valuation

The illustrative valuation model suggests that the stock has a potential upside of 17.72% on 10 February 2022. However, the stock might trade at a slight discount compared to its peers’ average Price/Book Value (NTM trading multiple) given the high price volatility of rare earth metals and a trend of shortages & oversupply. For valuation, peers such as Boss Energy Ltd (ASX: BOE), Ampol Ltd (ASX: ALD), Comet Ridge Ltd (ASX: COI), and others have been considered. Given the PDN engagement with global nuclear power utilities, favourable developments across Langer Heinrich Mine, decent cash position for operational expenditure, current trading levels, upside indicated by valuation, and key risks associated with the business, we give a “Speculative Buy” recommendation on the stock at the current market price of $0.780, as on 10 February 2022, at 12:53 PM (GMT+10), Sydney, Eastern Australia. 

PDN Daily Technical Chart

Source: REFINITIV

3. ASX: MEZ (Meridian Energy Limited)

(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$11.74 billion)

MEZ is engaged in renewable energy generation. It mainly involves electricity generation from 100% renewable sources – wind, solar, and water.

Valuation

The illustrative valuation model suggests that the stock has a potential upside of 10.96% on 10 February 2022. However, the stock might trade at some discount compared to its peers’ average EV/Sales (NTM trading multiple), given the reduced bargaining power of MEZ and potential cash burn from high hedging costs. For valuation, peers such as Origin Energy Ltd (ASX: ORG), AusNet Services Ltd (ASX: AST), New Energy Solar Ltd (ASX: NEW), and others have been considered. Given the rising customer sales, developments over Harapaki wind farm, increased north island storage, current trading levels, and upside indicated by valuation, we give a “Hold” recommendation on the stock at the closing market price of $4.600, up by ~0.877% on 10 February 2022. In addition, the stock has delivered an annualised dividend yield of 3.39%.

MEZ Weekly Technical Chart

Source: REFINITIV

4. ASX: WHC (Whitehaven Coal Limited)

(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$3.07 billion)

WHC is mainly involved in exporting high-quality thermal and metallurgical coal from Australia to the rest of the world.

Valuation

The illustrative valuation model suggests that the stock has a potential upside of 10.87% on 10 February 2022. However, the stock might trade at a slight discount compared to its peers’ average EV/Sales (NTM trading multiple) given high susceptibility to the forex market and logistical challenges. For valuation, peers such as Ampol Ltd (ASX: ALD), Beach Energy Ltd (ASX: BPT), New Hope Corporation Ltd (ASX: NHC), and others have been considered. Given the favourable coal pricing, surged demand for seaborne thermal coal, decent development expenditures, current trading levels and upside indicated by valuation, we give a "Hold" recommendation on the stock at the closing market price of $2.960 down by ~0.672% on 10 February 2022. In addition, the stock has delivered an annualised dividend yield of 10.64%.

WHC Weekly Technical Chart

Source: REFINITIV

Note: All the recommendations and the calculations are based on the closing price of 10 February 2022. The financial information has been retrieved from the respective company’s website and REFINITIV.  

Investment decisions should be made depending on the investors' appetite for upside potential, risks, holding duration, and previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the valuation has been achieved and is subject to the factors discussed above.

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