AGL

AGL Energy’s profits for the half year didn't reflect the current fierce competition in the retail energy market. Revenue rose 4% to $3.6bn while underlying profits, which exclude the impact of volatile derivatives and hedges, rose 3% to $233m. From underlying earnings per share of 50.3 cents an interim, fully franked dividend of 29 cents was declared (ex-date 1 Mar). AGL added 100,000 new customers thanks to an aggressive marketing drive; what it is losing in margin, it's clearly making up in volume.

The result, although fairly good, was overshadowed by news that the company would raise $1.5bn to help fund the purchase of the giant Loy Yang A brown coal power plant in Victoria. AGL has long had a 32.5% stake in the plant which is now due a capital injection. Troubled Japanese utility and Loy Yang A partner, Tepco, has been struggling to find the funds. AGL will pay $448m to lift its stake in Loy Yang A to 100% as a result.

The implied asset price is cheap, certainly cheaper than the book value on AGL’s balance sheet. But we have reservations about the purchase. As sole owner, AGL will assume the plant’s $2.8bn debt and, although the brown coal that surrounds Loy Yang is cheap, it’s also filthy; AGL’s emissions intensity will more than triple. In a world where carbon is priced, Loy Yang A remains commercial only because it receives more than $1.2bn in subsidies. If successful, AGL will be exposed to a large and heavily regulated asset that operates thanks to government largesse.

AGL’s share price has fallen 7% since 26 Aug 10 (Hold - $14.90) and it’s a complex business we have been spending more time to understand. Expect a review comparing it and Origin Energy this week; until then the AGL recommendation is UNDER REVIEW.