AGL Energy: Data Centres To The Rescue?

This story features AGL ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: AGL

Growth in electricity demand from the secular development in data centres could be the driving factor which tips in AGL Energy’s favour.

-AGL Energy’s FY24 performance well-received in August
-Decade ahead requires heavy investment
-Data centres to the rescue?
-Data centres power demand seems manageable up unti 2030

By Danielle Ecuyer

Australian electricity generators like AGL Energy ((AGL)) are tasked with a challenge; decarbonise generation capacity while balancing the transition from cheap fossil fuel contracts against the capital investment spend in replacement to renewables and firming capacity, against a backdrop of shifting demand dynamics.

Sounds challenging not only for AGL but also for investors, with varying drivers impacting on future earnings.

How did FY24 results stack up?

On balance, FNArena daily monitored brokers gave a thumbs up to AGL Energy’s FY24 results with the company reporting better than expected earnings. Underlying profit jumped 189% to $812m, surpassing the consensus estimate of $798.3m.

UBS noted the results were “solid” and up by 2%-3% above consensus estimates with management upgrading FY25 guidance by 5% at the mid-point.

Ord Minnett highlighted the results were boosted by improved electricity prices in May and June. The company achieved greater thermal power plant reliability and received a nine-month contribution from the Torrens Island battery in South Australia.

UBS also highlighted electricity margins are high enough for flexibility on Loy Yang and Bayswater power stations to allow output to migrate up or down intraday. Gas margins rose as the company moved to reduce its portfolio by 30PJ to lower margin commercial and industrial customers and increased exposure to the mass market.

Although brokers emerged from the FY24 results with an upbeat tone on AGL, both Macquarie and Barrenjoey have flagged concerns over the rising impost of capital investment against the loss of favourable gas and coal contracts as the company continues to transition.

Macquarie pointed to concerns over the “heavy” capex burden from FY27 as AGL invests to replace lost earnings from long-standing coal/gas contracts and large-scale generation certificates.

By way of context: an important part of AGL’s transition strategy entails selling renewable energy certificates to companies seeking carbon credits.

In September 2023, AGL announced “AGL Energy has signed a 15-year renewable energy certificate agreement with Microsoft. The agreement will provide Microsoft with renewable energy certificates from the Rye Park wind farm project in NSW, under AGL’s recently announced Power Purchase Agreement with Tilt Renewables.” 

AGL’s Climate Transition Action plan “aims to add around12 GW of generation and firming by the end of 2035 comprised of circa 6.3 GW of renewables and ~5.9 GW of firming.”, according to a company statement.

Morgan Stanley highlights this equates to around 5.5GW of on balance sheet development by 2035, costing between -$3bn-$4bn to FY30 and -$5bn-$6bn for FY31-FY36. 

UBS estimates funds from operations to net debt to remain in a range of 50%-75% from FY25-FY29 even with higher capex and lower electricity margins. From a ratings agency perspective, this is believed to provide “ample” room regarding Moody’s Baa2 downward rating under sensitivity analysis for electricity price changes and higher capex.

Macquarie notes household solar growing at 2GW p.a. and as grid scale renewables are added, there are risks of added volatility to AGL, although medium term the electrification of gas becomes an opportunity to grow versus replace earnings.

Running on the spot to stay still

Barrenjoey has been very much on the front foot when it comes to the impact from the roll-off of AGL’s legacy gas and coal contracts. The broker conducted an in-depth dive into the implications from the expiration of gas supply contracts with Queensland Gas Corporation in December 2027, and Wilpingjog coal supply contract which expires in December 2028.

The analyst estimates AGL is exposed to a decline in EBITDA of some -$300m from FY27 to FY30, a loss of -15%, which compares to market consensus only paring back forecast EBITDA by one-third of the estimated impact (-5%).

Offsetting the decline, the analyst forecasts $75m-plus EBITDA of Liddell battery earnings from mid-2026 based on a pre-tax return of 10%-15% on a -$750m investment. Considering other savings across operating expenditure and higher earnings from investments in reliability and flexibility, Barrenjoey forecast a net decline in EBITDA of -$105m from FY26 to FY30.

Some 20% of the company’s FY25 earnings are viewed as “finite”, meaning AGL needs a further circa -$1.8bn in investment, swapping out legacy fossil fuel generation for renewables and firming (battery) capacity, to keep earnings flat.

The implications from Barrenjoey’s analysis are that AGL Energy will need to invest over the next 10-years to stop its earnings retreating from what was achieved in FY24. 

Barrenjoey recently cut earnings forecasts by -8% to -13% for FY26/FY27 followed by a -30% decline in FY28 which includes impact of coal/gas supply contracts resetting higher, with assumptions of no growth in industry electricity demand before FY28, plus a delay in returns from the retail transformation and Liddell Battery.

Megatrend investment to the rescue

While Barrenjoey has been cogitating on the impact from re-priced gas/coal contracts, Morgan Stanley offers an alternative scenario for AGL.

Based on this broker’s most recent outlook for data centre developments and demand drivers, the potential uplift in electricity demand should be a potential boon for power prices.

Data centre demand in Australia is forecast to increase “exponentially” with over 2,300MW of new projects announced in 2024, year-to-date.

The broker expects the data centre market to advance by 17% p.a. compared to 13% p.a. previously. This equates to $31bn-$42bn in data centre investment over the next eight years, which underpins data centres to expand to 3,200MW from 2,500MW previously. The extra 700MW supply is based on Australian data consumption growing at 15% per annum.

Compared to the Australian Energy Market Operator’s forecasts for data centre electricity demand which were outlined in August, Morgan Stanley projects domestic data centre power usage at around 6TWh by FY30 as a base case and as much as around 33TWh in a bull case scenario.

These estimates represent around 2% to circa 12% of the market operator’s total power generation forecasts for FY30.

Forecast demand from data centre energy needs by Morgan Stanley are above the Australian Energy Market Operator’s estimates. Including existing, committed and prospective data centre developments, the broker estimates demand rising to 3% of total power generation in 2030 from 1% currently.

Morgan Stanley’s projections suggest data centre demand is manageable up unti 2030 but supply constraints thereafter could emerge as coal plants close.

Until then the additional demand from data centres underpins baseload electricity prices, which supports incumbent coal-fired generation. AGL has much more coal fired generation at 5GW compared to Origin Energy ((ORG)) at around 3GW and Energy Australia at circa 3GW with better “near-term coal reserves and contract positions”.

The analyst’s sensitivity analysis estimates show 3% growth in flat load, which represents consistent and steady demand over a 24-hour cycle, could result in a rise in baseload power prices of circa $6/MWh. This equates to around 10% EPS accretion for AGL, all things being equal, over a three-year period. This is highest sensitivity in the universe of stock coverage.

Demand for carbon neutral electricity for information and technology companies will also help drive renewable energy power purchase agreements, a la the 2023 contract with Microsoft.

The estimated investment opportunities in renewable energy are around $7bn to FY30, based on current power purchase agreements and policy targets, and up to a possible $31bn.

Amongst the FNArena daily monitored brokers, Morgan Stanley and Ord Minnett are Buy-equivalent rated with respectively target prices of $12.88 and $11.20.

Macquarie and UBS are Hold-equivalent rated with $11.28 and $11 target prices, respectively.

Not daily monitored Goldman Sachs is Hold-equivalent rated with a $11.50 target price and Barrenjoey has a  Sell-equivalent rating with an $11.20 target.

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