AGL powers up for the long term

For AGL, the forecast is mixed although we believe there should be many sunny periods and the recent result is a case in point. Net profit after tax for the year to June increased by 20.2% to $178m, representing close to a four-fold increase in earnings over the last 4 years and its 8th consecutive year of profit growth - an impressive record.

Acquisition benefits

Bear in mind though that a large part of this arose from the recently acquired 50% interest in Solaris, an electricity retailer and distributor. This acquisition was almost entirely debt funded although placements during the year helped to limit the need for additional debt. Nevertheless, the debt-to-equity gearing ratio still rose from 38% to 63%. A 22 cent final dividend was paid (franked to 77%), which pushed the full year dividend up to 41 cents (franked to 71%).

Like many recently privatised industries, a degree of uncertainty exists due to the changing regulatory regime. This is especially true in Victoria where proposals from regulators and the ACCC regarding appropriate rates of return for the soon to be privatised Victorian gas assets have raised uncertainty over the profitability of the future operators. As a result, the offshore heavy weights that have driven up prices of previously sold energy assets may now be less willing bidders in the next round of asset sales. This could benefit AGL as they may well find far fewer hats in the ring this time round.

Positive progress

Acquisitions make up an important part of AGL's growth strategy and new projects are always coming on stream. A number of milestones were achieved during the year including the completion of the $180m Bailera to Mt Isa pipeline that stretches 840 kilometres. Together with Petronas of Malaysia, AGL has been selected by Chevron as the preferred developer to build, own and operate the 2,100km Australian section of the proposed PNG-Queensland gas pipeline. Bear in mind though that this prospective and much talked about project is one for the future.

This though should be viewed positively. In our view, too many companies indulge in share buy-backs as sweeteners to shareholders (and perhaps Director's share options) when they should be investing for the long-term. This is clearly not the case with AGL.

The $28.5m acquisition of a 50% interest in the Chilean gas distributor, GasValpo, represents its first equity investment in an overseas gas distribution network. With over 18,000 customers, Gas Valpo owns the gas distribution network in the coastal cities of Valparaiso and Vina del Mar and we can expect more acquisitions of this type in the future.

The 140km pipeline from Wodonga to Wagga Wagga has also been completed, linking the NSW and Victorian gas markets for the first time. Ironically, it came on stream just in time to help out Victoria when their taps ran dry last month.

Another investment covers the partnership with CMS Energy and TransAlta Energy Corporation in the purchase of WMC's 62.6% interest in the Goldfields Gas Transmission Pipeline. At $402m, this gives AGL access to many gold and minerals processing facilities in Western Australia which are massive energy consumers.

Over the last twelve months 623km of gas mains were laid, bringing total mains pipelines owned by AGL in NSW and ACT to 24,000km. Total gas sales volumes were up by 3.6%, underpinned by a 7.7% rise in sales in NSW/ACT and a 4.3% rise in the customer base. Electricity sales volumes increased by a smaller margin of 1.1%.

AGL is a dynamic company with good prospects as a long-term investment but be prepared for a few bumps along the way. The most immediate are the new pricing proposals in Victoria and the open access regulations. These force AGL to open its gas and electricity transmission systems to 'all interested parties' and are an invitation to open competition. However, this is similar to the Telstra 'inter-connect' situation and we can expect a similar response - AGL will still control the delivery systems.

At current prices AGL is by no means cheap but with the herd chasing defensive stocks as fast as they can we're unlikely to see much weakness in the short term. And anyway, a proven growth strategy goes a long way to justifying such prices. ACCUMULATE as a medium term investment.