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Why AGL is underperforming

Gas and electricity supplier AGL Energy (ASX: AGK) is a well-known and widely owned stock that controls a number of strategic energy production assets and has an entrenched position in the retail market. Despite this, AGL’s business is facing certain headwinds that have just forced management to lower profit guidance for full-year 2013.

To understand exactly why AGL is underperforming requires gaining a deep understanding of the intricacies of energy pricing and the supply and demand dynamics of the domestic energy industry. So while there are a lot of factors at play, the direct explanation for the drop in underlying net profit after tax “to be in the lower half of the guidance range of $590 million to $640 million” was increased retail competition, coupled with soft wholesale prices and higher costs.

AGL stated that the increased retail competition has led to unprecedented customer churn rates. The soft wholesale prices are being caused by a combination of increased household solar penetration, weaker demand and significant over capacity.

While AGL’s outlook is somewhat cloudy and not helped by the elephant in the room – the carbon tax – AGL does have a number of things going in its favour. They include the recent purchase of the Loy Yang generator, which has increased the company’s scale and improved its coverage of retail load with owned and controlled generation, the recent SA government deregulation of electricity pricing and AGL’s positioning as one of Australia’s largest renewable energy generators.

The increased competition within the retail market and question marks over energy pricing, along with certain company specific issues, has flowed through to AGL and competitors Origin Energy (ASX: ORG) and Australian Power and Gas Company (ASX: APK), leading them all to significantly underperform the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) over the past 12 months.

chartagl

Source: Google Finance

Foolish takeaway

The beauty of utility stocks is that consumers don’t really have any choice but to purchase gas, electricity and water. However industry dynamics can change, including regulations, putting pressure on business models. Therefore investors need to be as vigilant as ever in assessing a utility company’s sustainability.

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More reading

The Motley Fool’s purpose is to help the world invest, better.  Click here now  for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Tim McArthur owns shares in Origin Energy.

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