A new research note from Macquarie has outlined the potential downside of the government's push to cap electricity prices for utilities stocks.
According to the broker, the government's DMO review continues a 5-year trend of cutting allowed retail profits.
The DMO review refers to the Australian government's review of the Default Market Offer (DMO) .
It is a regulated electricity price set by the Australian Energy Regulator (AER). It is for households and small businesses in NSW, South Australia, and south-east Queensland.
If the DMO becomes stricter, it may lower electricity prices for consumers.
For energy retailers like AGL Energy Ltd (ASX: AGL), it could mean lower margins and profits on their default customers. That is unless they find other ways to cut costs or grow revenue (e.g., via batteries or solar).
What does this mean for AGL shares according to Macquarie?
According to Macquarie's report, the government's DMO review continues a 5-year trend.
Since the first DMO/VDO in FY20, there has been an ongoing round of tightening on the allowed retail returns. AGL retail GM in FY19 was 12.4%, 11.6% in FY24, and now 10.4% in 1H25.
We think ~$35m is at risk, i.e., no margin recovery. We see the maximum downside risk is ~$0.55, i.e., 4.8%.
Not time to panic yet
Despite the regulatory headwind, Macquarie maintains an outperform rating due to future growth from batteries, which will help replace lost income from gas and renewable certificate declines.
Batteries remain the source of income to replace EBITDA lost from the gas contract ending, and LGC prices falling. Government policy to support retail batteries is positive. This retail review is a drag, albeit the driver of value is from wholesale.
According to the broker, only 69% of the retail book is impacted, and of that, only 10% of customers are on the DMO are directly affected. The residual is offset by reduced discounting, reduced marketing spend and an intense cost focus.
Importantly, Macquarie has also kept its target price unchanged at $11.47.
From its current share price of $10.08, this still indicates an upside of 13.79%.
Foolish Takeaway
Macquarie has painted a clear picture of the downside that exists for AGL shares pending the result of the government's continued DMO review.
Regulatory tightening is a risk, but AGL is adapting, and growth from batteries should support the share price.
