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Why the AGL Energy Ltd (ASX:AGL) share price is crashing today

The share price of AGL Energy Ltd (ASX: AGL) crashed this morning even as management posted a better-than-expected profit result and threw substantially more dividends at shareholders.

But it’s hard to find love as a power utility stock these days as politics has made the sector a hot potato (not to mention the fact that rising bond yields are also a drag on the sector).

You can thank poor policy settings for the surge in AGL’s FY18 earnings and blame them for its disappointing outlook for the current financial year.

As listed companies are always measured by their next results, AGL took a 5.1% blow to its share price in early trade, which slumped to $20.89 when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index rose 0.1%.

AGL is the worst performing stock on the top 200 benchmark and I think the sell-off ignores a few key positives for the stock – but I’ll get into that later.

The meltdown in the shares comes despite the fact that the integrated energy company posted a 30% jump in underlying earnings per share (EPS) to $1.56 for the financial year ended June 30, 2018, and it increased its total dividend for the year by 29% to $1.17 per share.

The underlying EPS is 4% above consensus while the dividend puts the stock on a yield of around 7% if you included the franking credits (its dividend is 80% franked).

If you included fair value adjustments to AGL’s investments, statutory EPS in FY18 would have surged 201% as the jump in wholesale electricity prices lifted its bottom line and the value of its assets.

But AGL’s chief executive Andy Vesey is quick to point the finger elsewhere to explain the surge in the wholesale price that has enabled the company to pocket a big profit increase. Energy prices have become a public relations nightmare for the government and power generators.

Vesey said that the spike in electricity bills is primarily driven by the closure of non-AGL-owned power plants like Hazelwood in 2017 and Northern in 2016, as well as the rising costs of coal and gas.

He has also thrown his support behind Prime Minister Turnbull’s National Energy Guarantee (NEG) scheme – and why wouldn’t he? The NEG will push part of the responsibility of having a reliable source of electricity on retailers.

AGL and Origin Energy Ltd (ASX: ORG), being the largest players in the industry, are better able to meet the new obligation.

But AGL shareholders should brace for a consensus profit downgrade though. Analysts polled on Reuters were tipping a 9% increase in underlying EPS for FY19. This stands in contrast to AGL’s guidance for underlying net profit to stay roughly flat at between $970 million and $1.1 billion.

This includes $120 million in cost cutting, so organic growth is more than likely slipping backwards!

One key reason for the downbeat outlook is that wholesale power prices are easing. The NEG should add further downward pressure on electricity prices (assuming Turnbull can get the state governments to play ball).

But the sell-down is an over-reaction. Even with little to no growth, the stock is trading on attractive valuations.

AGL’s FY19 price-earnings (P/E) is now sitting under 13 times – and that’s the lowest it’s been over the past five years and it’s around a 20% discount to the market.

That seems like a very reasonably price to pay for what is a defensive stock, particularly if you consider its decent yield, which should appeal to income investors.

I think the market will better appreciate AGL’s qualities later this year as I am predicting that growth stocks (a hot favourite with investors at the moment) will lose their gloss as value and quality defensives come back into favour.

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Motley Fool contributor Brendon Lau owns shares of AGL Energy Limited. 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 Scott Phillips.

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