Is AGL Energy Ltd a buy at today’s share price?

Is AGL Energy Ltd (ASX: AGL) an opportunity today, with a share price of $24.66, and 3.7% dividend yield?

The company has been a market-beater in recent years, although returns prior to that have been mediocre:

source: Google Finance

I think I first wrote about AGL three years ago, when it was priced at $12-something and raised a billion dollars by selling new shares at $11 per share to fund its MacGen coal asset acquisition. At the time I thought the company was a clear bargain, although to my chagrin I a) did not purchase any shares and b) have persistently and incorrectly thought the company was overvalued every year since. I tell you this to give you some context, because I’m about to suggest the time is coming where AGL could be a sell.

The reason I’ve been wrong is simply that the company has earned far more than I thought it capable of, given mediocre customer numbers and a competitive environment (like many utilities). Rising energy prices have propelled earnings higher, and AGL is now being priced like a fast-grower rather than a stodgy old utility. Mostly this is due to rising electricity prices, although to be fair the company also has several genuine growth opportunities, including renewables.

However, there’s a downside. Total debt is increasing, up $420 million to $3.2 billion. It’ll probably go higher as AGL invests in growth. Second, the company has been buying back shares at ~$20 apiece just three years after issuing millions at $11 to finance an acquisition. Third, the electricity market is probably close to the point at which new competition enters and/or the government intervenes.

Thanks to changes in the supply-demand relationship, AGL is earning cracking profits that show no signs of abating. New electricity can’t be conjured from thin air (there is a lead time to construct supply) and the impact of regulation is an open question. If you’re a shareholder, you don’t want to sell AGL too soon and miss your opportunity to really cash in.

Still, over the next 2-3 years, there is potential for big changes to the national electricity market. Electricity prices are a political hot potato, and cannot rise too high or many businesses become unviable. If I saw AGL’s share price around $36 or above – i.e., 24x next year’s forecast profits of ~$1 billion – I would strongly consider selling. For now I think that shareholders should enjoy the ride.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. 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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