Leaner and meaner AGL Energy Ltd is heading higher: Should you buy?

An update by AGL Energy Ltd (ASX: AGL) has thrown up a few surprises and shareholders could be enjoying big capital returns over the next year or two.

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Gas and electric utility company AGL Energy Ltd (ASX: AGL) is the second best performer on the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) in late morning trade after promising shareholders it will be leaner and meaner.

Shares in AGL surged 5.8% to $16.38, and it is only second to iron ore miner Fortescue Metals Group Limited's (ASX: FMG) 10.6% rally on the back of fresh takeover speculation.

AGL's advance is less headline grabbing, but its outlook is far more exciting in my opinion.

The utility released a "strategic roadmap" that would suggest big capital returns to shareholders over the next few years.

First, AGL is looking to sell $1 billion in non-strategic and underperforming assets by the end of 2016-17.

Second, AGL will need less capital to run its leaner business –around $200 million less, according to management.

What's more, a further $170 million in savings is being targeted through improved operational efficiencies, which will bolster the stock's return on equity that stands around 7.5%.

It is also noteworthy that AGL is moving quickly to embrace change with "decentralised power generation" threatening the business model of the sector.

It's predicted that households will be increasingly power independent through the use of solar panels and electricity storage technologies.

AGL seems to have learnt the mistakes of traditional media companies who have buried their head in the sand when confronted with the online threat, and is positioning itself to be an early mover into this space.

It is the first major energy retailer to offer a battery storage product for homes even though this is likely to eat into its traditional revenue stream of selling electricity to households.

AGL knows it can't change where the market is heading and shareholders should be pleased that management is capitalising on emerging trends.

Fellow utility Origin Energy Ltd (ASX: ORG) has gas and oil projects to offset this risk, but it will be interesting to see how other rivals like AusNet Services (ASX: AST) and Spark Infrastructure Group (ASX: SKI) will respond to this future threat.

AGL has reaffirmed its 2014-15 full year net profit guidance of $575 million to $635 million and management is tipping that it will deliver earnings that are closer to the top end of that range.

This is likely to prompt analysts to upgrade their forecasts as consensus is targeting the middle of the range.

I think AGL is heading higher on the back of a possible profit upgrade and capital return. That makes the stock a "buy" in my opinion.

Motley Fool contributor Brendon Lau has no position in any stocks mentioned. Follow me on Twitter - https://twitter.com/brenlau The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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