Australia’s Energy and Utilities sector seeks significant opportunities amidst increased domestic demand for electricity generation and consequent escalation of urbanization. Record-hitting energy generation from renewable capacity confirms Australia as a world leader in renewable energy. Renewable energy contributed ~27.7% of total electricity generation in 2020, according to Clean Energy Council. Further, the sector remains resilient due to the considerable base of natural resources.

An Overview of Mining and Resources

Key Statistics in Mineral Exploration Activities: Industrial production and economic growth are considerably rebounding amongst Australia’s key trading partners, raising demand for ferrous and non-ferrous metals. Total expenditure in mineral exploration has surged by 13.7% QoQ in March 2021 quarter and stood at $843.9 million. Drilling activities clocked 3.26 million meters, up by 10.6% on a sequential basis.

Figure 1: Uptrend in Exploration Expenditure and Activities:

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

Recent Commercial Indicators in the Sector: In March 2021 quarter, mining value-added surged by 0.7%, and exploration spending reached $956 million for all commodities. Resources and energy Export Values Index kicked up by 33% since June 2020 quarter. Energy exports were clocked at $115.53 billion in real terms in 2019-20.

Favourable Prices Exhibit a Significant Driving Factor: Prices of resources and energy products have driven significant export earnings to the industry. Asian LNG spot prices rebounded from a record low of US$1.68/mmBtu on 30 April 2020 to a record high of US$39.72/mmBtu. Oil prices are expected to exhibit steadiness at US$70/barrel, according to the Department of Industry, Sciences, Energy and Resources.

Key Statistics on Electricity

COVID-19 Hardships: Amidst the beginning of COVID-19 turmoil, the customer count on electricity and gas payment plans declined and sought resurgence from July 2020. For the March 2021 quarter, the disconnection count stood at 7,036 relative to 18,321 PcP. Average hardship debt for both electricity and gas surged by 25%.

The trend in Household Electricity Usage: Over the past four years, average household electricity consumption assumed a downward trend, falling in a range of 5-10% in South Australia, NSW, the ACT and Victoria’s AusNet Services network. However, extreme climatic conditions in Tasmania lead to a 3% increase in consumption. The downward trend was broadly advocated by the uptake of solar PV systems and improved energy efficiency of home appliances.

Figure 2: Average Household Electricity Consumption:

Source: Based on Economic Benchmarking Regulatory Information Notice (RIN) Data, Analysis by Kalkine Group

Market Contracts Overshadow Standing Offers: Proportion of customers on market contracts inclined relative to more expensive standing offers. In the ACT, counts of market contracts accounted for 71% of total residential electricity customers in March 2021 quarter, relative to 61% PcP.

Key Statistics on Gas

2020 Production Updates: Eastern Australia clocked 2,000 PJ gas production, wherein 68% accounted for exports in the form of LNG, while the remainder was designated to cater domestic market. Queensland’s Surat-Bowen Basin supplied circa 76% of gas production in Eastern Australia. The Northern Gas Pipeline, inaugurated in January 2019, delivered an average of 56 TJ/day - ~62% of total capacity.

Figure 3: Gas Consumption in Eastern Australia:

Source: Based on Australian Energy Market Operator (AEMO) Data, Analysis by Kalkine Group

Exports of Liquified Natural Gas (LNG): Alongside Queensland’s dominating LNG industry, Australia operates two LNG projects in the Northern Territory and five in Western Australia. In FY20, LNG export earnings clocked ~$50 billion, positioning gas as the second-largest resource and energy exports.

Gas Storage Capacity Update: Storage performs a vital role in managing the demand and supply of LNG. Storage levels at the Moomba, Roma underground sites and Silver Springs facilities assumes sequential drawdown to cater to LNG export demand. Overall, average storage levels in 2020 have increased relative to 2019.

Commercial Aspects of Gas: Customer counts on hardship program as of 30 March 2021 was registered at 13,983 compared to 16,096 reported the previous year. Average hardship debt for gas surged to $783 from $628.

Key Risks and Challenges

With lower hardship debts in place, electricity consumers have signaled a drastic shift towards investments in Distributed Energy Resources (DER). From December 2019 to February 2021, 2P gas reserves have dropped by ~22% in the Gippsland Basin and by 5% in the Bass Basin, signaling reserves depletion. Energy Network Australia estimates an annual decline of $400 of household electricity bills due to high investments in DER. Oil prices assume a prolonged recovery period due to OPEC+ group’s considerable excess production capacity and price vulnerability to the potential resurgence of COVID-19. Australia’s competition with the US for gas exports may increase in the short term as the US turned to be the most significant driver of global recovery in LNG export volumes.

Figure 4: Key Risks and Challenges in Energy and Utilities Sector:

Source: Analysis by Kalkine Group

Outlook

Project Marinus to Develop Interconnection: In line with AEMO’s actionable ISP projects, Project Marinus has proposed 1,500MW in interconnection capacity between Victoria and Tasmania to support increased exports from Tasmania’s storage and renewable energy resources.

Project EnergyConnect for Immediate Development: The project includes a new interconnector linking South Australia and NSW to unlock stranded renewable investments. Expected completion by 2024-25.

Uptake of Virtual Power Plants (VPP): AEMO anticipates VPP capacity to reach 700MW by 2022 to address active forms of DER for consumers, for instance, EVs, battery storage or demand response, to coordinate decisions on discharging and charging amongst providers.

LNG Export Earnings Revised Upwards: In line with higher expectations from oil-linked contract prices and LNG spot prices, export earnings for FY22 are revised upwards by $5.3 billion. Further, LNG trade is forecasted to surge by 7.7% in FY22, according to the Department of Industry, Sciences, Energy and Resources.

Favourable Export Volumes for LNG: With resolutions to technical issues in Prelude and Gorgon LNG plants, Australia’s export volumes are estimated to spike by 5.3%. LNG exports are expected to rebound to circa 83 million tonnes in FY22.

II. Investment theme and stocks under discussion (MEZ, OSH, SKI, VEA)

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/EBITDA’ multiple methods.

1. ASX: MEZ (Meridian Energy Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$12.11 billion)

Meridian Energy Limited (ASX: MEZ) is involved in 100% renewable electricity generation through wind farms and hydroelectricity plants.

Valuation

The stock has been valued using the EV/EBITDA multiple-based illustrative relative valuation method and arrived at a potential upside of 17.87% on 19 August 2021. The company might trade at some premium compared to its peers’ average EV/EBITDA (NTM trading multiple) given stable operating expenses, improved cash position, and sustainable operating cash flows after one-off expenses. For the purpose of valuation, few peers such as Spark Infrastructure Group (ASX: SKI), Genex Power Ltd (ASX: GNX), Infratil Ltd (ASX: IFT) have been considered. Considering the prompt balance of power generation and sales volume, asset portfolio diversification, dominant liquidity position, and valuation, we give a “Buy” recommendation on the stock at the market price of $4.810, as on 19 August 2021, 11:20 AM (GMT+10), Sydney, Eastern Australia. In addition, the stock has delivered an annualized dividend yield of 3.13%.

2. ASX: OSH (Oil Search Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$7.89 billion)

OSH is engaged in mining and developing oil and gas fields both as an operator and non-operator participant.

Valuation

The stock has been valued using the EV/EBITDA multiple-based illustrative relative valuation method and arrived at a potential upside of 17.69% on 19 August 2021. The company might trade at a slight discount compared to its peers’ average EV/EBITDA (NTM trading multiple), given high sensitivity to average realized oil & condensate price and average realized LNG & gas price. For the purpose of valuation, few peers such as Ampol Ltd (ASX: ADL), Senex Energy Ltd (ASX: SXY), Worley Ltd (ASX: WOR) have been considered.  Considering the prudent liquidity position, underway project pipeline, improved production, and potential risks from the acquisition of Santos, and valuation, we give a “Buy” recommendation on the stock at the current market price of $3.690, down by ~2.895% on 19 August 2021. In addition, the stock has delivered an annualized dividend yield of 0.17%.

3. ASX: SKI (Spark Infrastructure Group)

(Recommendation: Hold, Potential Upside: High Single-Digit, Mcap: A$4.87 billion)

SKI is a leading owner of a diversified portfolio of quality essential service infrastructure.

Valuation

The stock has been valued using the EV/EBITDA multiple-based illustrative relative valuation method and arrived at a potential upside of 9.30% on 19 August 2021. The company might trade at some premium compared to its peers’ median EV/EBITDA (NTM trading multiple), given the successful placement of the renewable pipeline. For the purpose of valuation, few peers such as Meridian Energy Ltd (ASX: MEZ), Genex Power Ltd (ASX: GNX), Mercury NZ Ltd (ASX: MCY), have been considered. Considering the stable fundamentals, marginal impact from exogenous factors, diversification into renewable projects, and valuation, we give a “Hold” recommendation on the stock at the current market price of $2.730, down by ~1.799% on 19 August 2021. In addition, the stock has delivered an annualized dividend yield of 4.67%.

4. ASX: VEA (Viva Energy Group Limited)

(Recommendation: Hold, Potential Upside: High Single-Digit, Mcap: A$3.16 billion)

VEA is engaged in the manufacturing, distribution and supply of petroleum products to retail and commercial customers.

Valuation

The stock has been valued using the EV/EBITDA multiple-based illustrative relative valuation method and arrived at a potential upside of 9.87% on 19 August 2021. The company might trade at some discount compared to its peers’ average EV/EBITDA (NTM trading multiple), considering significant exposure to commodity prices and declining refining business contributions. For the purpose of valuation, few peers such as Ampol Ltd (ASX: ADL), Senex Energy Ltd (ASX: SXY), Worley Ltd. (ASX: WOR), have been considered. Considering the sales volume recoveries, expectations on positive NPAT, long-term view over capex, and valuation, we give a “Hold” recommendation on the stock at the current market price of $1.945, down by ~1.270% on 19 August 2021. 

Note: All the recommendations and the calculations are based on the closing price of 19 August 2021. The financial information has been retrieved from the respective company’s website and REFINITIV.  

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

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