Four energy stocks

The energy sector is a political football in Australia, and is also closely scrutinised by ESG activists; often, it seems as if investors are the last “stakeholders” left. But in the swirling eddies of the energy world, there look to be some great opportunities on offer at present on the ASX. Here’s a look at Australia’s four big energy stocks.

1. AGL Energy (AGL:ASX)

Market capitalisation: $8.4 billion
One-year total return: –25.9%
Three-year total return: –11% a year
Five-year total return: +1.4% a year
FY21 (June) forecast yield: 7.4%, unfranked
FY21 price/earnings ratio: 13.5 times earnings
Analysts’ consensus valuation: $14.62 (Thomson Reuters), $14.72 (FN Arena)

AGL is one of the three main “gentailers” – that is, generator and retailer – of energy in Australia, with a range of energy generation assets, both renewable and non-renewable (traditional coal and gas-fired generation).

In FY20, AGL supplied 43,725 gigawatt hours (GWh) to the National Electricity Market (NEM) pool, with about 66% of its generation coming from coal – it is the country’s biggest coal-fired generator – 14% from gas and 20% coming from its renewables portfolio (wind, hydro and solar.) By FY24, AGL plans to lift its output of renewable electricity to 34% of the total.

AGL is in something of a bind, viewed from the perspective of the “green” expectation that Australia is heading to a future of 100% renewable energy: while this may one day occur, until then, the company’s coal and gas-fired plants keep Australia’s lights on. The company is on schedule to start closing its coal-fired Liddell plant in NSW in 2022 and close it fully by April 2023: but it still expects to run its Bayswater plant in NSW until 2035 and the Loy Yang A power station in Victoria until 2048.

AGL has been struggling in recent years on the back of weak wholesale power prices, which have been hampered by ample supply of cheap gas, new renewable energy supply, mild weather and this year, by softer demand during the COVID-19 pandemic. In FY20, underlying net profit fell by 22% to $816 million, thanks to the major outage of the Loy Yang station for much of 2019. The company has given profit guidance for a further drop in underlying profit in FY21 to a range of $560 million–$660 million. While this is annoying enough for shareholders, according to broking firm JP Morgan, if electricity prices stayed at current spot rates, AGL would be losing money.

It’s no wonder that the share price is down 50% from its 2017 peak. Investors buying the stock now at least have the cheapest entry point in quite some time – since about 2014 – and they also should have the benefit of eventual recovery in wholesale power prices, and thus, recovery in AGL’s earnings, although don’t necessarily look for that in the next couple of financial years. Analysts are fairly bullish on AGL, with the most so being Ord Minnett, which has a target price on the stock of $17.30, followed by UBS, which sees $15.60. The analysts’ consensus implies about 8%–9% upside from present levels. AGL has told shareholders that it expects to reduce franking on dividends to zero in FY21 and FY22 while it uses-up historic tax losses. It says it hopes to offset the impact of loss of franking through a special dividend program in those years, and AGL expects to return to generate franking credits from underlying earnings as early as the FY23 interim dividend.

2. Origin Energy (ORG:ASX)

Market capitalisation: $7.8 billion
One-year total return: –40.9%
Three-year total return: –12.3% a year
Five-year total return: –5.5% a year
FY21 (June) forecast yield: 4.7%, 60% franked (grossed-up, 5.9%)
FY21 price/earnings ratio: 18.5 times earnings
Analysts’ consensus valuation: $6.42 (Thomson Reuters), $6.36 (FN Arena)

AGL’s fellow gentailer Origin Energy is one of Australia’s leading energy retailers, a low-cost gas producer – it is the leading gas producer in Australia – and it also has substantial operations in electricity generation and storage. Origin owns the biggest power station in Australia, the Eraring coal-fired power station in New South Wales, and 12 others in a 6 GW-capacity portfolio – within this, the company operates a range of renewable energy projects, such as wind and solar panel farms. Origin has also been buffeted by the same headwinds as AGL, as lower wholesale electricity prices eat into profits and the oil price crash flows through to sales of liquefied natural gas (LNG) – Origin is the upstream operator for the Australia Pacific LNG (APLNG) project, of which it owns 37.5%. Origin is responsible for the development of its CSG fields in the Surat and Bowen basins and the main transmission pipeline that transports the gas to the LNG facility on Curtis Island near Gladstone.

In August, Origin reported that full-year profit had plunged by 93%, from $1.2 billion to $83 million, as COVID-19 slammed energy prices, and increased the risk of bad debts from customers unable to pay their bills. However, Origin’s underlying profit – stripping out one-off costs – was largely unchanged from the previous year’s result as a record cash distribution ($1.275 billion) from the APLNG project offset lower retailing earnings.

However, weaker oil and LNG prices caused a write-down of up to $770 million to the value of APLNG. The final dividend fell by one-third, to 10 cents, but for the full-year, it was held at 25 cents.

FY21 guidance wasn’t great, with Origin flagging that earnings from the core electricity and gas retailing business would fall by up to 21%, or $309 million, to a range of $1.15 billion–$1.3 billion this year, compared to $1.46 billion in 2020, as the business deals with lower wholesale prices, higher network costs and lower gas profit as legacy contracts expire. APLNG production is also projected to decline by as much as 8%, due to weaker demand in the face of the Asian LNG glut.

Origin also held back on expected investment in its renewables portfolio, saying it would wait for improved market prices and greater government policy certainty.

In September, Origin’s Beetaloo Basin gas fracking project in the Northern Territory was designated as a strategic basin as part of the Federal government’s “gas-led recovery,” increasing its chances of reaching production, although Origin (which owns 70%) faces opposition from both environmental and traditional owner groups. Beetaloo is estimated to hold 6.6 trillion cubic feet of gas.

The Origin share price has almost halved in 2020, and like AGL, the stock has been a wasteland for investors in recent years. But ORG is very cheap right now, for investors prepared to accept that the required recovery in both electricity prices and oil/gas prices won’t happen overnight, but it will happen. As might be expected after halving, Origin looks to be outstanding value at these prices.

3. Santos (STO:ASX)

Market capitalisation: $10.6 billion
One-year total return: –30%
Three-year total return: +9.8% a year
Five-year total return: +0.9% a year
FY21 (December) forecast yield (current exchange rates): 1.9%, fully franked (grossed-up, 2.7%)
FY21 price/earnings ratio: 16.1 times earnings
Analysts’ consensus valuation: $6.47 (Thomson Reuters), $6.50 (FN Arena)

Santos is one of Australia’s largest oil and gas companies, owning and operating one of Australia’s largest portfolios of oil and gas fields, connected by extensive pipelines and processing facilities. Santos is Australia’s biggest domestic gas supplier with operations in Cooper Basin, Surat Basin, Bowen Basin, Carnarvon Basin and gas assets in Timor-Leste and Papua New Guinea.

The company uses the calendar year as its financial year, but in the June 2020 half-year it lifted hydrocarbon production by 4% on the June 2019 half, to a record 38.5 million barrels-of-oil-equivalent (boe), but with lower prices driving revenue 16% lower, to $US1.668 billion ($2.4 billion), and earnings before interest, tax, depreciation and amortisation (EBITDA) 21% lower, to US$995 million ($1.4 billion).A write-down that Santos had already announced, of US$756 million ($1.1 billion) on the value of its GLNG export project in Queensland in the wake of lower oil prices, helped take the bottom-line to a net loss of US$289 million ($419 million).

There was only one way for revenue and profit to go, given that Santos’ average realised oil price fell by 34% to US$47.83 a barrel, and the average realised LNG price dropped 14%, to US$8.57 a million BTUs (British Thermal Units).

But Santos was helped by the lower prices and uncertain outlook for oil demand in another part of its business, its purchase of the majority interest in the Bayu-Undan and Darwin LNG projects from ConocoPhillips, for which it will now pay $US1.265 billion ($1.8 billion), a discount to the $US1.39 billion ($2 billion) price announced last October. These will help boost 2020 production and cash flows: Santos expects to produce 83 million boe–88 million boe during 2020, well above the 75.5 million boe reported in 2019, which was up 28% on 2018, and a company record.

Santos’ Barossa project is planned to backfill DLNG and extend its life for more than 20 years. A final investment decision on Barossa was planned for the first half of 2020, but was deferred until business conditions improve given the uncertain economic impact of COVID-19 combined with lower oil prices.

Last month, the company also got good news, with the NSW Independent Planning Commission (IPC) approving development of the Narrabri Gas Project, with certain conditions, removing the last major hurdle for the controversial project to proceed. Narrabri is a coal seam gas (coal-based methane) project, where gas production will be sourced from coal seams without extracting coal. Gas wells will be drilled to prolific coal seams, initially extracting the first formation water and then coal seam gas. Santos has already spent nearly $1.5 billion on appraisal and development of gas assets, and total cost of the project is estimated to be $3.6 billion. The project is a 100 per cent domestic gas project, that Santos says can provide the lowest-cost source of gas for NSW customers, and could meet half of the state’s needs. But it won’t make the final investment decision until 2022.

Santos also has a 30% interest in the GLNG project in Queensland, which produces LNG for export to global markets (and domestic sales) from an LNG plant at Gladstone, and a 13.5% interest in the PNG LNG project, which produces LNG in Papua New Guinea for export to global markets.

Santos has a swelling portfolio of growth assets, and is positioned well to benefit from recovering pricing. Analysts are bullish on the stock and at this price, it looks to be really good-value exposure to the energy sector. However, it is not a yield stock.

4. Woodside Petroleum (WPL:ASX)

Market capitalisation: $17.5 billion
One-year total return: –37.7%
Three-year total return: –9.5%a year
Five-year total return: –6.7% a year
FY21 (December) forecast yield (current exchange rates): 3.9%, fully franked (grossed-up, 5.6%)
FY21 price/earnings ratio: 20.4 times earnings
Analysts’ consensus valuation: $23.79 (Thomson Reuters), $22.93 (FN Arena)

Woodside is the largest independent oil and gas producer in Australia, with its two flagship LNG operations on the North-West Shelf (NWS), where WPL is the operator and owns an equal 16.7% stake with its six partners), and Pluto (where WPL is the operator and holds a 90% interest). In 2019, Woodside’s total production was 89.1 million boe, split across LNG (73%), oil and condensate (17%), natural gas (6%) and LPG (liquefied petroleum gas), at 4%.

It hasn’t been a great year for Woodside, with the pandemic hitting energy demand and slamming oil and gas prices, which were already facing a damaging price war between Saudi Arabia and Russia, to 17-year lows (and the amazing spectacle of “negative” prices in oil futures, in March.) In March, Woodside temporarily shelved its major LNG expansion projects, Browse, Scarborough and the Pluto-2 LNG expansion, taking a $53 billion decision to effectively keep valuable gas in the ground until the market improves. The 2020 target for final go-ahead decisions on the $US11.4 billion ($16.3 billion) Scarborough and Pluto-2 LNG expansion has been pushed back into 2021, while the late 2021 target for a final investment decision on the $US20.5 billion ($29.3 billion) Browse project has been dropped, with no revised target set.

Longer-term, these are all likely to go ahead. What Woodside is doing is using its very strong balance sheet (the gearing ratio of 19.4% as at 30 June 2020, at the lower end of the company’s target range of 15%–35%) to ride out tough times in oil and gas, “parking” big projects until the market improves. Some brokers think the company’s financial strength means it could withstand oil prices as low as US$10 a barrel for 2020 and US$15 a barrel throughout 2021, without risking debt covenants. Right now, spot oil has recovered to levels just above US40 a barrel – and quite frankly, that is more representative of where Saudi Arabia and Russia need it to be, for their pressing budgetary needs.

In the meantime, the Sangomar offshore oil project in Senegal (Woodside 35%) is going ahead (Woodside is targeting production in 2023). Other growth projects include the $1.9 billion Greater Enfield project in Western Australia; the stalled Greater Sunrise project, which straddles Australian and East Timorese maritime borders, NWS “tolling” (in which the NWS joint venture shifts from processing its own natural gas offshore in Western Australia to processing gas owned by other companies): a deep-water gas development in Myanmar; and the Kitimat LNG project in British Columbia on Canada’s Pacific coast, a project that was written-down by US$720 million ($1.1 billion) in February.

Woodside is still profitable, although the June half-year (Woodside is a calendar-year reporter) saw underlying net profit (stripping out the US$3.9 billion [$5.6 billion] in asset-value write-downs) fall 28% to $US303 million ($433 million). Revenue was down by 15.9%, to US$1.9 billion ($2.7 billion) but the company actually hit its highest-ever first-half production levels, producing 55.1 million boe. Shareholders got a fully franked interim dividend of 26 US cents a share, down from 36 cents a share a year ago, at an 80% payout ratio. Woodside said it was on track to meet its 2020 production forecasts, but full-year underlying earnings will come in less than in 2019.

Longer-term, if you think that renewable energy is going to replace Woodside’s oil and gas, you won’t want to own the stock – because its assets will be “stranded.” But if you’re sceptical of renewable energy’s ability to power the massive energy requirements of the likes of China and India, you might see an unavoidable long-term role for hydrocarbons, at the very least as the back-up that renewable energy requires. If you’re in that camp of thinking, WPL looks to be very good long-term value at the current price.