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AGL Energy Ltd and ERM Power Ltd – should you buy?

Many investors in the energy sector have recently been focussed on both the price of oil which has spiked higher in response to concerns over the stability of Iraq and the price of LNG. With so much increased supply of LNG about to hit global markets including production from PNG LNG which is part owned by Oil Search Limited (ASX: OSH) and Santos Ltd (ASX: STO), a number of energy analysts have begun querying how sustainable current LNG prices are.

While oil and LNG are certainly ‘hot spots’ for investors right now, ultimately energy demand is determined by the end user. Given Australia’s growing population it’s a near certainty that more electricity will be required and consumed in the future, although the source of that electricity is certainly up for debate. While roof top solar generation is a threat to energy retailers there would also appear to be plenty of scope for the following two companies to still grow their respective earnings significantly in coming years.

AGL Energy Ltd (ASX: AGK) recently received confirmation from the Australian Competition Tribunal that it could proceed with its $1.5 billion acquisition of Macquarie Generation. As the single largest producer of electricity in NSW, the acquisition of MacGen provides a major boost to AGL. MacGen’s assets include the Bayswater and Liddell black coal fired power stations as well as a contracted supply of 110 million tonnes of coal.

Losing out in the bidding for MacGen was ERM Power Ltd (ASX: EPW). This was an unfortunate loss for ERM as AGL’s acquisition further narrows the NSW retail market to three main players namely AGL, Origin Energy Limited (ASX: ORG) and the unlisted Energy Australia. Despite this missed opportunity, there are reasons to be optimistic about ERM’s future. ERM boasts electricity generation capacity of approximately 1.4% of the total Australian grid and is the fourth-largest retailer of electricity by volume. ERM has also differentiated itself from the competitive household customer market by choosing to focus on selling electricity to business and government customers.

Deciding whether to add either AGL or ERM to an investment portfolio at current prices will depend on your risk profile. AGL is an $8.7 billion blue-chip, market-leading company that is trading on a very reasonable looking 13.6x next year’s earnings and offering a forecast fully franked dividend yield of 4.3%.

Meanwhile ERM’s share price has fallen 28% in the past year, the company is a relatively small fish in a bid pond with a market capitalisation of just $425 million, but is trading on an attractive looking forecast PE of 12.7 and a forecast fully franked yield of 7.1%.

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Motley Fool contributor Tim McArthur owns shares in Origin Energy Ltd.

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