Genex Power showing upside potential despite sector challenges: Morgans

Falling electricity prices are having a dampening effect on the outlook for Australia’s power companies in the coming year. Morgans announced changes to their power company ratings last week off the back of the softer outlook. In its report, it cited a milder Australian summer, the growing market share of renewable energy, along with government intervention as factors behind price falls.

Morgans upgraded Genex Power (ASX: GNX) to a SPECULATIVE BUY and downgraded AGL Energy (ASX:AGL) to HOLD. It maintained HOLD ratings on Origin Energy (ASX:ORG) and LGI (ASX: LGI).

A softer outlook for power companies

Morgans’ outlook on the coming year for the industry suggests prices will remain subdued and remain at more ‘normal’ levels across the year.

Electricity spot prices for NSW and QLD settled at around $120/MWh in the last quarter, below the forecasts above $200MWh set by baseload futures contracts. Futures prices have correspondingly fallen as shown in the chart below.

NSW baseload electricity futures for Jan-Dec 2022. Source: Morgans

Similarly, spot prices for gas have fallen below the price cap of $12/GL. There are several reasons behind the falls.

• A milder summer has meant lower demand for cooling in key states of QLD and NSW and supported lower prices.

• Renewable energy is also growing in dominance. Solar output jumped in particular during daylight hours. Development and use of renewables is also being incentivised.

• Proposed Australian Federal Government intervention into gas and coal prices has placed higher risk on power companies and subdued prices.

Morgans still anticipate we may see a short-lived rally for electricity prices. This comes back to the process for default electricity tariff benchmarks. These are set based on average contract prices over a two-year period. As prices were so high across the last year, tariffs are likely to still jump significantly. You may wonder why the rally will be short-lived and the simple answer is the proposed government intervention to lower costs. If the intervention is successful, it will end the rally.

As a result of both the falls and likelihood that lower prices will be sustained through intervention, Morgans sees little upside potential for most power companies in the coming year.

Except for Genex Power

Genex Power was upgraded to a SPECULATIVE BUY and is the only of the four rated power companies to sit outside of HOLD rating.

Given its exposure to spot prices, this may come as a surprise to some investors.

Morgans believe recent falls in the share price of Genex Power have ignored the value of the hydro project and estimates for the solar farms. This means Genex Power have exposure to the increasing market share of renewable energy. Assuming it is able to deliver on its projects successfully, Morgans have revised its price target up by 35%.

It comes with significant risks though.

Morgans still has 18 months of construction activity to complete leaving it vulnerable to any financial challenges its contractors may face. It has also had cost increases flowing from the Main Access Tunnel (MAT) workarounds).

Further to this, Morgans has revised its earnings forecasts downwards to account for weaker electricity pricing along with low solar volumes this year.

AGL Energy downgraded to HOLD

Off the back of the soft outlook for electricity and gas prices, Morgans downgraded its rating for AGL. It views it as unlikely we’ll see another energy shortage which AGL could benefit from and government intervention will interfere with market signals that AGL needs to be monitoring to understand where and how to build capacity.

Morgans has also revised its price target for AGL downward by 11%.

Ratings unchanged for Origin and LGI

Morgans maintained its HOLD ratings on Origin and LGI.

In the case of LGI, it notes that the firm has limited its downside potential using sales of derivatives to lock in prices. LGI’s All-gas generation fleet is flexible too for conditions. Its forecasts for LGI remain the same.

Origin has remained on HOLD due to the prospect of a takeover bid from Brookfield and EIG. Morgans also believes Origin might benefit from government intervention as lower fuel costs could lift energy earnings.

Final sector views

Morgans believe that tariffs will still increase significantly this year given the way they are calculated, though government intervention is likely to minimise the impact.

“For the rest of the decade, we think that the intervention will only add to investment uncertainty for both new generation and fuel supply. New policies are being proposed to incentivise non-fossil fuel storage and firming capacity, but we still see an increasing likelihood of supply constraints as coal plants retire,” says Morgans analyst Max Vickerson.

It’s not all bad news though, with Vickerson adding, “Companies with a greater degree of integration and long term fuel supply will be less vulnerable to market shocks, all things being equal.”