Update

A Stock to Position Against Rough Times

I must confess, this pandemic has rocked much of what I used to hold dear. You see, I’m a defensive investor mostly. Some occasional speculative bets. But also a focus on preserving family and client capital. While delivering income (via dividends) and some macro or sector growth.

So, when a pandemic comes out of nowhere and rocks property-based stocks — stocks that previously returned 10-30% each year on dividends and valuation gains — you can understand how I feel.

The world got jolted. And everything we used to take for granted is now questioned.

Well, the good news is those property stocks are starting to grow again. Albeit with dividends suspended. You’ll see them in our portfolio recommendations here.

One of the reasons for this is that Gordon Gekko’s ‘greed is good’ mantra is now coming back to the table.

There’s barely a day that goes by when I’m not speaking to someone who is now looking to buy discounted assets. Shares. In one case, direct property.

All this bargain-hunting is pushing the markets back up from their floor on March 23^rd.

The societal concern is that, as with the GFC, the rich will get richer. All over again. But I’m talking to people taking this responsibility seriously. Supporting the less fortunate. Helping family members into housing.

My job here is to analyse and monitor the best opportunities we can see in the markets to grow your wealth.

Today, I’m following a more defensive line. And following the money.

In particular, I’m looking for healthy balance sheets to ride out this storm.

Idea: Large-Cap Utility, COVID-19 Income Hedge?

Bayswater power station, New South Wales. Source: Guardian/Ian Waldie

If I had to make an elevator pitch on the potential of today’s stock, it would go like this:

AGL Energy Ltd [ASX:AGL] is Australia’s largest energy provider. What makes AGL special is its history. It has been around in Australia since 1837.

The company is currently buying back its own shares with excess funds. It’s on track to increase the bottom line by optimising operations and reducing costs by FY2021. A very attractive projected dividend of around 8% is currently targeted.

Let’s take a more detailed look why we’re commencing guidance on AGL.

The good

AGL operates Australia’s largest private electricity generation portfolio. Total capacity is 10,413 MW. This accounts for about 20% of the total generation capacity within Australia’s National Electricity Market.

The company has about 3.7 million customer accounts across residential, business, and wholesale customers.

As an essential service provider, AGL’s generation sites continue to operate as usual to ‘keep the lights on’.

The bad

Like most companies exposed to the cliff-jump shutdown of much of the business community, AGL’s revenues are under some threat.

The company is now operating a COVID-19 Customer Support Program. This enables customers experiencing financial stress to delay payments. Disconnections for non-paying customers are also suspended until July 31^st.

Well, this is good for customers under the circumstances! But it will have an impact on AGL’s revenue.

Meanwhile, the company was already facing a very competitive wholesale electricity market. Alongside government initiatives to lower utility bills.

The ugly

AGL has cost advantages due to its gas and coal-fired power stations.

Let’s make no bones about it. AGL is Australia’s largest coal power generator. These days, coal is climate-dirty.

Recent sources suggest AGL is around 60% reliant on coal production, with less than 20% from renewables.

It’s important to point out that in a big, dry country like Australia, this is not unusual. In fact, they may be outperforming as a company in the cleaner renewables area if you consider overall generation:

Source: ‘Energy in Australia’ study, Origin Energy.

When renewable sources struggle due to drought or other seasonal factors, Australia’s grid relies more heavily on fossil fuels. As a cheap and reliable power source.

This has put AGL in the firing line of environmental activists, shareholder activists within the company, and potential government climate-change regulation.

Which is why it’s the price it is.

But before you accuse me of being a coal-bagging profiteer who will eventually meet drawdown in a decarbonised world, let me point out that AGL is working to transform its business.

Here is the company’s own promise:

‘Our aim is to prosper in a carbon-constrained world and build customer advocacy as our industry transforms. That’s why we have committed to exiting AGL’s coal-fired generation beginning in 2022 and ending in 2048, why we will continue to develop innovative solutions, and why we’re investing more than anyone else in building new supply to bring more affordable, reliable and sustainable energy to our customers.’

This is not merely planting some trees around power plants. AGL appears to have the size, scale, and capitalisation to make a meaningful go of such plans. Although the cost advantages of coal are difficult to replace, it’s important to realise that all generators will need to compete in a decarbonised world. And those with the greatest scale will likely have the lead in doing so.

You can learn more about AGL’s decarbonisation plans here.

Perhaps most potent is their launch of the ‘Powering Australia Renewables Fund’ (PARF) — a $2-3 billion fund ‘to invest in ~1,000 MW of large-scale renewable projects, providing an opportunity for investors to finance a portfolio of renewable assets to diversify risk and reduce costs.’

The trends

The reason we’re commencing monitoring on AGL now is due to its defensive balance sheet.

Here are our views on some of the trends we see:

• After lockdown, electricity usage should increase again.
• Looking even further out, continued electrification of transport may further boost revenue.
• AGL’s revenues will increase with population growth expected in Australia.
• The company is in a strong position to potentially take advantage of soft asset prices and acquire value-added concerns.
• Over the past few years, AGL has been increasing dividend payout ratios, and lately, it has been buying back its own shares.
• Australia will likely need more electricity, not less. And AGL is ready to capture increasing demand.

The buy-backs

AGL Energy has been building up a war chest of cash for acquisitions. The company hopes to find opportunity to combine energy with data. And to ramp up generation projects.

Last year, it was bidding to buy cash-strapped broadband firm Vocus [ASX:VOC], but the deal fell apart on price.

Although it recently announced weaker outlook for 2020, it appears AGL has still been unable to deploy much of that excess cash.

Over the past month, the company has been buying back significant quantities of its own shares. This helps to underpin the value of the stock. And works to return value to shareholders.

Buy-backs are not without controversy.

In some cases, management get accused of using them to bolster the share price.

But when a company has been unable to find any opportunity to deploy excess cash, it is not unreasonable to return value to shareholders in this way. And it may further point to the financial strength of this business.

The fundamentals

Source: Interactive Brokers TWS figures as at 21 April 2020

The risks

• AGL experiences revenue decline due to COVID-19, increasing competition and regulation.
• Revenue decline will negatively impact the share price and ability to sustain dividends.
• The company is unable to meet decarbonisation targets and faces climate-change sanction.
• Decarbonisation targets reduce revenue and competitiveness.
• The share price may fall once buyback support tails off.

Portfolio update

Charter Hall Infrastructure REIT [ASX:CQE] pays the last quarter dividend distribution as follows:

• Distribution Amount: A$ 0.04175 (per share)
• Ex Date: Monday March 30, 2020
• Record Date: Tuesday March 31, 2020
• Payment Date: Tuesday April 21, 2020

Given recent guidance, this may be the last distribution for a while.

Kina Securities Limited [ASX:KSL] delivered a pleasing annual report for the financial year ended 31 December 2019.

• Total deposits grew 87%
• Funds under management up 7%
• Total loans up 65%
• Net interest income up 31%
• Revenue up 27%

Yet the market did not respond with any boost to the share price. This seems to be due to the 2020 outlook within Papua New Guinea:

• The PNG economy is facing lower levels of activity.
• The PNG government is targeting reductions in public service expenditure.
• The proposed large-scale on-shore gas field development P’Nyang appears to have fallen through in the negotiations phase, removing an otherwise certain boost to investment in the country.
• The company expects foreign exchange shortages will continue to be an impediment to businesses in PNG throughout 2020.

So, we have a business taking ground. But remaining in a high-risk position due to the surrounding environment in PNG, now exacerbated due to COVID-19.

Unfortunately, in the last week, the country confirmed 5 new coronavirus cases, bringing the total to 7. Although this number is thankfully tiny, any escape of the virus into an underdeveloped nation like PNG could be devastating.

Kina remains both a promising but speculative investment subject to significant macroeconomc risk.

Here is our current portfolio with updated guidance:

 Current as of 21 April 2020 at 10pm GMT.

We are seeing some gradual improvement in prices.

Last week, some commentators expressed dismay that stocks are rising while US unemployment rockets.

Source: MarketWatch

The above screenshot got tagged, ‘Everything that is wrong with America.’

But, like much in the mainstream media, this might be inaccurate and unfair.

The rational market is not looking at today’s immediate circumstance, with shocking unemployment as the case may be.

Experienced investors are trying to price 6 to 12 months in advance. Warren Buffett and his ilk are looking for discounted businesses they may seize and ‘hold forever’.

Develop and keep a steady view on your long-term goals. That will help your investing mindset. The way is clear for those with knowledge.

Regards,

Simon Angelo

Editor, Lifetime Wealth Investor

Important disclosures

Simon Angelo owns shares in AGL Energy Ltd [ASX:AGL].