Australia | Oct 16 2007
By Greg Peel
The interesting outcome stemming from AGL Energy’s ((AGK)) shock announcement yesterday is that broker responses were split between downgrades and upgrades this morning. It all comes down to both their ratings going in to the profit announcement, and whether they think a 17% share price dumping was a bit too much regardless. But one thing brokers were unanimous in suggesting is that they, and the market, have lost all confidence in management.
Last month, AGL management reiterated previous guidance, suggesting FY08 profit would test the top of the range of $380-400m. Yesterday, with little or no development in the energy market in the meantime, that figure was slashed to $330-360m. Analysts were furious. What Macquarie describes as “the scary part” is that CEO Paul Anthony seemed in the conference call to be just as surprised as everyone else. Citi analysts suggested they “remained at a loss” as to what could have changed in seven weeks.
Not unsurprisingly, management’s earnings growth guidance of 15% is now “under review”. This didn’t exactly appease analysts either. The review is expected to be presented at the company’s AGM on November 8. Suffice to say, in the meantime analysts have slashed earnings forecasts across the board, the magnitude depending on just how caught out they really were. The net changes are reflected in the change in the average target price in the FNArena database, which has fallen this morning from $16.86 to $15.22. This includes a reduction from Deutsche Bank all the way from $17.90 to $12.50.
Management suggested the problem lay in rising wholesale gas prices and lower than expected demand from industrial and business customers. It also reduced its forecast earnings from gas produced in PNG. Deutsche Bank’s response was “Today’s events highlighted serious issues concerning management’s understanding of operational issues and customer requirements, with little transparency or comfort that measures have been put in place to address them”.
In terms of ratings however, the B/H/S ratio remained at 4/4/2, which might seem surprising. But only three brokers actually maintained their existing ratings. The spread of changes from other brokers is arguably the most extraordinary FNArena has ever experienced.
Of the four Buys in place before the downgrade only one – JP Morgan – survives. Citi and Aspect Huntley both downgraded to Hold, while Deutsche went straight to Sell. Merrill Lynch and GSJB Were both kept Holds, while ABN Amro and UBS shifted from Hold to Buy. Credit Suisse shifted all the way from Sell to Buy, and Macquarie kept Sell.
Why the amazing differences? The answer lies in yesterday’s market reaction. In falling 17% from $15.63 to $13.03 AGL suffered its biggest percentage fall since the ’87 crash. Hence the question is: has the share price fallen enough, or even too far?
For starters, it has to be remembered that some brokers’ ratings methods involve a set model that compares share price to target price and acts accordingly. This, for example, explains Credit Suisse’s double-whammy upgrade. For even Credit Suisse suggests, as do most analysts, that we haven’t yet heard the last of the downgrades. However, other upgraders are largely suggesting 17% was simply enough of a drubbing. The downgraders tended to suffer the biggest shock, and cite ongoing uncertainty as the reason they have simply thrown up their hands in disgust.
It will now come down to not just the review at the AGM, but the outcome of that review. JP Morgan (the stoic Buy) suggests no earnings certainty is likely for the rest of 2007, while any positive outcome from vertical integration will not become apparent until probably the first half of FY09. Citi wonders aloud whether, following the share price fall, AGL would now be in play, but the analysts can’t think of any likely suitors.
AGL has now clearly become a longer term proposition for investors. Contrarian traders may see an opportunity to pick up an energy stock at a good price and put it away, while shorter term players should be wary of potentially more bad news ahead. Once some of the analysts get over the initial shock, it is likely some deeper analysis will be forthcoming.
One boost of confidence may be provided if the AGM brings about a change of management – a very real possibility.