AGL: Short Term Pain, Long Term Gain

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AGL Energy was swiftly derated post its FY25 result release, but while the near term outlook is uninspiring, longer term, the battery-powered future looks bright.

-AGL Energy disappoints on FY25 numbers and FY26 guidance
-Earnings forecasts and price targets reduced
-Batteries to replace coal-fired earnings
-Longer term electricity demand outlook drives broker upgrades

By Greg Peel

The market wasted no time in trashing AGL Energy’s ((AGL)) share price on the release of the gas and electricity provider’s FY25 results. The apparent “sell first, ask questions later” attack was underpinned by FY25 underlying profit missing consensus forecasts by -5%, and FY26 profit guidance missing by -11%. The dividend was also a slight miss. The stock fell -13% on the day.

The FY25 miss is blamed on lower power generation availability from planned and unplanned outages over the second half at its Bayswater plant in NSW and Loy Yang in Victoria, leading to higher electricity procurement costs.

The underwhelming guidance reflects electricity and gas portfolio margin compression that builds over the next three years as cheap legacy gas and coal supply contracts expire and are replaced with higher cost fuels, plus the drag of depreciation and interest.

Higher depreciation reflects higher near-term sustaining capex required to keep the ancient coal-fired power stations alive well past their “best before” dates, which was well flagged by management, on top of the step-change in battery capex.

And therein lies the twist. With a bit of a prod, or perhaps wake-up call, in billionaire Atlassian co-founder Mike Cannon-Brookes’ attempt to take over the company in 2022 and turn it a dark shade of green, battery investment will be the driver to replace the earnings gap caused by the end of the gas and coal supply contracts.

Cannon-Brookes failed, but he remains AGL’s largest shareholder.

BESS and Less

Despite the consensus miss, AGL’s FY26 guidance implies improved generation availability year on year. While UBS expects this is achievable, reliability will remain an ongoing risk. Clearly, one cannot provide unplanned outage guidance.

The expiration of legacy gas and coal supply contracts and replacement with higher cost fuels is now factored in, but UBS echoes a consensus analyst view that increased costs can be “entirely overwhelmed” by new earnings from AGL’s accelerated investment in grid-scale batteries.

AGL has stated it is confident in “more than offsetting” earnings impacts from coal and gas re-contracting in FY28 from current sanctioned investment in “flexible” assets, with potential for further sanctions to deliver earnings growth.

Barrenjoey notes the implication from the circa $300m earnings contribution from some -$1.8bn investments in Battery Energy Storage Systems (BESS), is that battery earnings are above target 7-11% post-tax returns, reducing capital intensity needed to replace earnings.

AGL has, however, painted a picture of flat profit in the near-term given increasing D&A, but Barrenjoey believes the non-cash nature enables a higher dividend payout ratio going forward.

In other words, there will be lag in profitability as AGL ramps up its BESS investment, but down the track the cost of replacing gas/coal-fired power diminishes.

Citi’s investment case remains unchanged, supported by a robust BESS development pipeline with 900MW of additional financial investment decisions (FID) expected before end-FY27 and attractive long-term earnings potential through an increasingly volatile mid-cycle transition.

Citi expects the stock to re-rate along with increasing visibility into the quality of BESS earnings when Liddell comes on in early 2026 (which remains on schedule). AGL shut down its 52 year-old coal-fired power station in the NSW Hunter Valley in 2023, and is building a BESS on the site.

Ord Minnett concedes near-term earnings prospects are being hurt by increased costs, but the longer-term outlook has improved, with greater visibility over the impact of coal and gas contract rollovers and a growing –-and stronger than expected-– earnings contribution from the BESS operations, albeit with execution risk.

Growing Demand

It’s a bit of a no-brainer that electricity demand is set to grow in the age of increasing electrification.

AGL highlighted National Energy Market (NEM) system electricity demand is forecast to grow 44% over the next ten years. This provides a source of structural support to incumbent owners of capacity assets, including AGL, that UBS believes is not factored into longer-term consensus earnings forecasts.

UBS expects the next iteration of the Australian Energy Market Operator’s (AEMO) Integrated System Plan to highlight materially higher system demand, including from AI and data centre load growth.

UBS’ new, higher wholesale electricity price outlook recognises delays to key electricity transmission interconnectors, slowing renewable FIDs, and higher costs to build new generation across the NEM together pointing to wholesale prices needing to rise further into the medium term.

Macquarie notes upside for investors will come from better electricity prices, traditionally in base, but now with batteries, a return to normalised generation, a restoration of retail gross margins, and a step-change in the cost base from Kaluza (digital billing platform).

Capex ex wind farms should peak in FY27 or FY28, Macquarie suggests, before quickly moving to being relatively low, as AGL progressively becomes capital light.

The balance sheet is progressively being utilised and does not look stretched to Macquarie without wind farm projects being funded on-balance sheet, which is not AGL’s intention. AGL has also flagged the potential sale of its 20% stake in the Tilt renewable energy financing fund, which is 40% owned by the Futures Fund.

The outcome of this is dividend growth is likely to be moderate, Macquarie notes, with the payout at the lower end of the range. However, combined with the rebasing of the share price post the result, the outlook gives Ord Minnett confidence AGL can maintain a fully franked dividend yield of circa 5–6%, increasing its investment appeal.

Upgrades

There is no denying AGL delivered a downside surprise with its FY25 result and FY26 guidance. While analysts have moved to cut earnings forecasts and price targets in response, the general view is the share price thumping on the day was unnecessary.

Five brokers monitored daily by FNArena cover AGL. Two have retained existing Buy or equivalent ratings post result and two have upgraded to Buy from Hold (or equivalent).

Having traded -13% lower on the day, AGL was trading at 4x FY26-27 forecast earnings, compared with Origin Energy Markets ((ORG)) implying greater than 10x, UBS notes, and implied a 5% net dividend yield (fully franked), which together supports UBS’ upgrade to Buy.

AGL has capacity to pay higher dividends, UBS suggests, and offers a defensive utility exposure, leveraged to energy transition upside via higher electricity demand and prices. Origin Energy nonetheless remains this broker’s ’ most preferred Australian utility, followed by AGL, with APA Group ((APA)) least preferred.

As noted earlier, combined with the rebasing of the share price post the result, the outlook gives Ord Minnett confidence AGL can maintain a fully franked dividend yield of circa 5-6%, increasing its investment appeal. With an expected total 12-month return of almost 30%, Ord Minnett upgrades to Buy.

Macquarie is in agreement, and Citi labels AGL’s valuation as inexpensive.

Only Morgan Stanley remains cautious. This broker fears the company’s capital intensity and FY28 earnings uncertainty will weigh on AGL’s trading multiple in the near term, and retains Equal-weight (Neutral/Hold in layman’s lingo).

The consensus target among the five brokers has fallen to $11.60 from $11.70.

Despite confidence in the longer-term outlook, Barrenjoey notes the near-term earnings profile is almost entirely underpinned by Energy Markets and ageing thermal assets, exposed to a resetting of default market offer (DMO) prices, and carries less certainty, with execution risk on the battery roll-out.

But Barrenjoey now sees AGL’s outlook as fair on a relative basis, and upgrades to Neutral from Underweight, with its target reduced to $11.00 from $12.00.

RBC Capital, nevertheless, remains downbeat.

RBC now expects AGL’s earnings and dividend growth to be limited over the next two years, and has difficulty seeing material upside catalysts following the FY25 result. RBC struggles to see increased FY26 Customer Market earnings growth (excluding the recent acquisition of Ampol’s ((ALD)) electricity supply business), and FY27 could have a weaker Default Market Offer (DMO).

New AGL FY26 guidance implies higher operating costs, tighter margins from gas and coal contract rollovers, plus higher D&A and finance costs. RBC sees this being only partially offset by increased firming capacity, following the start-up of the Liddell and Tomago batteries.

RBC downgrades to Sector Perform, cutting its target to $10.00 from $13.00.

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