Fundamental Analysis of AGL Energy and Origin Energy in the Energy Industry of Australia

The report provides a fundamental analysis of AGL Energy and Origin Energy in the energy industry of Australia. It includes top-down analysis of macroeconomic factors and bottom-up analysis of financial ratios for evaluating their current and future growth prospects.

Principles of Financial Management
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Executive Summary
The report has carried out fundamental analysis for the two ASX listed companies within
Australia for identifying the macro and micro factors that can impact their performances in the
future context. The companies selected for the purpose are AGL Energy and Origin Energy
operating within the energy industry of Australia. The top-down analysis has gain an analysis
into the impact of the macro-economic factors on the future performances of the two companies.
In this context, the factors analyzed are specifically interest rate, inflation rate, business cycle of
economy and GDP growth rate. The bottom-up analysis has examined the micro economic
factors impacting their performances. This has been done by carrying out financial ratio analysis
to gain an examination of the current and future performances of these companies.
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Introduction
It is very essential for the investors to gain an analysis of the macro and micro economic
factor that can impact the performance of an entity. In this context, fundamental analysis is a
technique used by the investors for identifying the factors that may cause directional changes in
the value of a company and its share prices. It adopts the use of both top-down and bottom-up
analysis for developing an insight into the macro and micro factors that may impact the
performance of an entity. Top-down analysis is usually carried out by initially examining the
macro-economic factors and then conducting a more specific sector analysis. On the other hand,
bottom-up analysis emphasizes on evaluation of the key performance indicators of a firm such as
its financial performance. The report has carried out an evaluation of the two ASX listed firms
for carrying out fundamental analysis with the use of both top-down and bottom-up analysis for
evaluation of their current and future growth prospects on the behalf of the investors. The
companies selected for the purpose are Origin Energy and AGL Energy Limited operating in the
energy industry of Australia.
Top-down Analysis
Top-down analysis of the selected companies is conducted by evaluation of the overall
economic environment of Australia. This will help in forecasting the changes in the economic
fundamentals and their impact on the selected company’s performance operating in the energy
industry of Australia. The analysis is carried out by an evaluation of the following macro-
economic factors of Australia as follows:
Interest & Inflation Rate
The interest rate within Australia is maintained at very low level by the Reserve Bank of
Australia (RBA) at 1.5 per cent since the year 2016. This has been done by the RBA for
promoting the economic growth within the country that has been struggling since the past few
years. This has promoted RBA to curb the interest rates at low level to foster development in the
economy of the country. The low interest rate will help in reducing the level of inflation and
decreasing the rate of unemployment. RBA has even gain success in restoring the economic
growth by reducing the rate of interest by having a control over the level of inflation. The central
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bank of the country is still emphasizing to maintain the interest rates at very low level for
promoting wage growth. The wage growth within the country is still maintained at 2 per cent that
is same as the rate of inflation. As such, the RBA is maintaining the interest rates at low level
because an increase in the interest rate with lower growth of wages could negatively impact the
economic growth by raising debt level within the country (Murphy, 2018).
(Source: https://tradingeconomics.com/australia/interest-rate)
Current Value of $AUD
The value of Australian dollar (AUD) is subjected to fluctuation in relation to the other
currencies across the world. Its current value is recognized to be 75 US cents by the end of the
year 2018 and is expected to further decline and reach 77 US cents by the end of the year 2019.
The major reason for the decline in the value of AUD can be regarded as the increasing gap
between the interest rates of the US and Australia (Reserve Bank Of Australia, 2018). Also, the
movement in its value is fluctuated by the downward pressure resulting from the global growth
forecast of the country. The increased volatility in the Aussie market is causing a relative fall in
the value of Australian dollar as it is losing value in relation to the value of foreign currencies
that have more financial stability. Moreover, its value fluctuates largely because the variability in
the prices of commodities. Australia is a major exporter of natural resources and thereby the
decrease in the price of commodities such as iron ore and coal have caused the relative decline in
the prices of Australian dollar. This has caused a reduction in the demand of the currency and a
significant decline in its value in the recent years (What makes the Australian dollar move,
2018).
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(Source: https://www.rba.gov.au/mkt-operations/ex-rate-rba-role-fx-mkt.html)
GDP Growth Rate
The Australian economy has recorded an annual growth rate in GDP up to 3.40 per cent
in the year 2018 which is higher than the previous annual growth rate of 2017. The strong
increase in the domestic demand by 0.6% that is driven by 0.7% growth in household spending
has lead to a strong increase in the GDP. The increase in the level of consumer spending due to
low level of interest rate maintained with the country has caused a rise in the sales of food,
recreation and culture, furnishing and household equipment (Janda, 2018). There is increase in
the rate of household consumption by 3% accompanied by rising wages and salaries growth by
0.7% that id riven by increase in the employment rate. It has been stated by the Australian
Bureau of Statistics data has revealed that commodities exports are the main driver of economic
growth at present within the country. The mining boom within Australia has caused a rise within
the exports of mining commodities as the sector output has recorded a growth to about 2.9 per
cent supported with increase in coal, iron ore and production of LNG. Thus, the rise in GDP
growth of the country is supported by the rise in mining exports and removal of restriction in the
trade policies. These all factors are contributing to a sharp increase in the GDP growth of the
country and as such it is expected to have faster rate of annual expansion that is expected to
continue in future because rising export level supported by weakened Australian dollar
(Hutchens, 2017).
Business Cycle of Economy
Australia is regarded to be presently in a developing phase of economy with a rapid
increase in the economic growth supported by low interest and inflation level. There is an
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expected increase in the wage growth due to reducing rate of unemployment within the country.
The increased consumer spending and the rising profits realized by the government due to net
rise in the exports is causing a direct increase in the economic growth (Murphy, 2018).
Impact on the Performances of Companies
The strong GDP growth within the country supported by sharp increase in process for
energy-related commodities due to mining boom is supporting the growth and development of
the energy companies such as AGL and Origin Energy within Australia. This has caused a rapid
increase in the job opportunities within the energy companies and therefore leading to a
reduction in the unemployment rate. The low level of inflation is further causing an increase in
consumer spending to buy energy products. The weakening Australian dollar is causing a high
demand of energy products overseas and thereby leading to an increase in the production of
energy products is helping them to realize economies of scale and thus reducing their operational
cost. Therefore, it can be said that the overall economic condition of Australia is providing a
favorable environment within Australia promoting the growth of the energy companies in the
future context (Roarty, 2010).
Bottom up analysis of Energy Industry of Australia
Bottom up analysis is part of fundamental analysis that aims to evaluate the company
from various perspectives such as financial performance, quality of management, product or
service, and industry comparison. So in contrast to top down approach, bottom up approach will
evaluate the fundamentals of company whereas top down information on market trends. It
compares individual company within the sector with any other company in same section to know
the industry performance. In this section, energy sector of Australia has been examined through
conduction fundamental analysis of Origin Energy and AGL Energy.
Profitability Performance of both the selected companies
Profitability performance aims to evaluate the ability of company to turn the available
resources to the revenue. It can be performed through conducting the ratio analysis that evaluates
the profitability performance.
Profitability Ratios AGL Energy Origin Energy
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2017 2016 2017 2016
Net Profit Ratio 4.28% -3.65% -16.29% -5.37%
Return on Equity 7.12% -5.13% -19.47% -4.37%
(AGL Annual Report, 2017 and Origin Annual Report, 2017)
Net profit margin: This ratio is an important profitability ratio and it can be vital for comparing
profitability performance of companies in same industry. If any company has higher net profit
margin ratio it means that company is performing well and is successfully converting sales in net
profit.
Formula: Profit (after tax)/Revenue (Schlichting, 2013)
2017 2016
-20.00%
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
Net Profit Ratio
Percentage
On the basis of calculation it has been found that profitability performance of Origin Energy was
much weaker than AGL Energy. In year 2016 both companies has suffered the loss. In year
2017, the net loss percentage of Origin was further increased while AGL Energy has able to
maintain net profit at 4.28%.
Return on Equity: This ratio reveals the net income earned by the company as the percentage of
shareholders equity. It means percentage of net profit that company has earned on total
shareholders’ equity invested by the company.
Formula: Net Income After tax/Shareholder’s Equity (Arnold, 2013)
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2017 2016
-25.00%
-20.00%
-15.00%
-10.00%
-5.00%
0.00%
5.00%
10.00%
Return on Equity
Percentage
The above graph clearly shows that Origin Energy has failed to keep up with the
profitability performance as it has suffered with major loss in both the years in review. On the
other hand AGL Energy has able to earn positive return on equity of 7.12% in year 2017 but
suffered a loss of 5.13 in year 2016.
Overall profitability performance of industry seems to be weaker in year 2016 as both the
selected companies has suffered a net loss but in year 2017 there has been some improvement in
profitability performance of industry.
Solvency Position of both the companies
Solvency position is also referred as the leverage position as it aims to analysis the debt
capital held by the company. The solvency ratios aim to analyse the financial health of the
company. It measures the ability of the company to pay the liabilities as and when it falls due.
Solvency Ratios
AGL Energy Origin Energy
2017 2016 2017 2016
Debt to Equity ratio 90.89% 84.25% 120.70% 105.58%
Interest Coverage ratio 4.17 -1.08 -3.16 0.09
(AGL Annual Report, 2017 and Origin Annual Report, 2017)
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Debt to Equity Ratio: It is an important financial ratio that helps to analyse the financial
leverage position of the company. It means it measures the financial ability to the company to
bear the debt obligations.
Formula: Total Liabilities/Shareholder’s Equity
2017 2016
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
120.00%
140.00%
90.89% 84.25%
120.70%
105.58%
Debt to Equity Ratio
Percentage
On the basis of analysis it has been found that debt to equity position of both the
companies it not satisfactory as they both hold same portion of debt as their equity which is a big
concern for these energy companies. The comparison of both the companies shows the debt of
equity position of AGL Energy was better than the Origin Energy. However there has been sharp
increase in the debt position of both the companies from year 2016 to 2017.
Interest Coverage ratio: This ratio measures the ability of company to meet the interest
payments arising on debt capital. Interest payments reflect the charge on the profit of the
company so it important to earn sufficient profits that can help to pay the interest on time.
Formula: Earnings before interest and tax /Interest expenses (Ross, Jaffe and Kakani, 2008)
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2017 2016
-4.00
-3.00
-2.00
-1.00
0.00
1.00
2.00
3.00
4.00
5.00
Interest Coverage Ratio
Times
The interest coverage ratio of AGL Energy and Origin Energy was worst in year 2016 as
they are not capable to bear the interest expenses through the profits earned by them. Moreover
in year 2017, the position of Origin Energy has become even more worse as they have suffered
with huge losses while AGL Energy had improve its financial performance in year 2017 that
makes the interest coverage ratio to 4.17 times.
The overall solvency or debt position of energy sector was not satisfactory in year 2016
as well as in year 2017. It is because many big companies have increased their debt liability
which in turn has increased the burden of interest payment that has impacted the profitability
performance the industry sector.
Market Performance of energy industry of Australia and selected companies
Market performance can be measured through performing the market value ratios
analysis of the company selected and comparing them with the performance of whole industry.
The market value ratio evaluates the current share price of the company that has been traded on
the stock exchange. The market value ratios help the potential investors to find out whether
market value of equity shares is over-priced or under-priced. Some of the important market value
ratios are earnings per share, P/E ratio, Price to book ratio etc (Ross, Jaffe and Kakani, 2008).
Market Performance of AGL Energy and Origin Energy with comparison to
industry averages (Market performance is for current year)
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Companies
EP
S
P/E
Ratio
P/B
Ratio
P/E
Growth
Dividend
Yield Mkt. Cap.
AGL Energy 0.64 8.66 1.5 0.00% 6.04% $12,710 M
Origin Energy 1.24 18.7 1.2 1.58% 0.00%
$ 14,005
M
Energy
Industry 0.91 23.00 1.42 1.88%
(Source: AGL: Investsmart, 2018 and ORG: Investsmart, 2018)
The above table critically analysis the market performance of both selected companies in
current year i.e. 2018. All the information has been gathered from the well-known source called
as Investsmart. Based on information gathered above it can be said that market performance of
Origin Energy was quite better than AGL Energy in current year. The earnings per share (EPS)
of Origin Energy was almost twice the earnings per share of AGL Energy in year 2018 that
convey that there has been significant improvement in the profitability performance of Origin
Energy in year 2018 as and when compared to 2017. The price to earnings ratio reflects that
market price of Origin Energy is trading at higher level as compare to AGL Energy. When the
market performance of both the companies has been compared with industry average it has been
found that both companies have weaker position as compared to many other companies in
similar industry (AGL Annual Report, 2017 and Origin Annual Report, 2017).
Summary & Recommendations
It can be stated from analysis of the macro-economic condition of Australia that the
overall economic environment favors the growth and development of the energy sector within
the country. The low inflation rate, developing phase of economy, strong annual growth rate of
gross domestic products and weakening value of Australian dollar are all supporting the growth
of the energy companies. The bottom up analysis of AGL Energy and Origin Energy has
revealed that financial performance and position of both the companies was not satisfactory due
to change in regulatory reforms in the energy sector and increase in leverage capital over the
year. The current market performance of Origin Energy was satisfactory as compared to AGL
Energy. In this context, it is recommended to the investors to wait and analyze the future
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performance of the companies as forecasted economic fundamentals can lead to an increase in
their financial performance.
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References
AGL Annual Report. 2017. AGL Energy Limited. [Online]. Available at:
http://agl2017.reportonline.com.au/annualreport#1 [Accessed on: 25 September, 2018].
AGL: Investsmart. 2018. AGL Energy. [Online]. Available at:
https://www.investsmart.com.au/shares/asx-agl/agl-energy-limited [Accessed on: 25 September,
2018].
Arnold, G., 2013. Corporate financial management. Pearson Higher Ed.
Hutchens, G. 2017. Australia's economy hits 3.4% annual growth rate, exceeding expectations.
[Online]. Available at: https://www.theguardian.com/business/2018/sep/05/australias-economic-
growth-exceeds-expectations-at-34 [Accessed on: 25 September 2018].
Janda, M. 2018. Australian economy beats expectations with 3.1pc annual GDP growth.
[Online]. Available at: http://www.abc.net.au/news/2018-06-06/gdp-economic-growth-data-
abs/9840308 [Accessed on: 25 September 2018].
Murphy, J. 2018. We just got a glimpse of Australia’s future — and it is not good. [Online].
Available at: https://www.news.com.au/finance/economy/australian-economy/we-just-got-a-
glimpse-of-australias-future-and-it-is-not-good/news-story/bcc95c134c2f78d1878c6ca58f39a06d
[Accessed on: 25 September 2018].
ORG: Investsmart. 2018. Origin Energy. [Online]. Available at:
https://www.investsmart.com.au/shares/asx-org/origin-energy-limited [Accessed on: 25
September, 2018].
Origin Annual Report. 2017. Origin Energy Limited. [Online]. Available at:
http://agl2017.reportonline.com.au/sites/agl2017.reportonline.com.au/files/
full_financial_annual_report.pdf [Accessed on: 25 September, 2018].
Reserve Bank Of Australia. 2018. The Exchange Rate and the Reserve Bank's Role in the
Foreign Exchange Market. [Online]. Available at: https://www.rba.gov.au/mkt-operations/ex-
rate-rba-role-fx-mkt.html [Accessed on: 25 September 2018].
Roarty, M. 2010. The Australian Resources Sector its contribution to the nation, and a brief
review of issues and impacts. [Online]. Available at:
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https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/
pubs/BN/1011/AustResources [Accessed on: 25 September 2018].
Ross, A., Jaffe, J. and Kakani, R.K. 2008. Corporate Finance. Pearson.
Schlichting, T. 2013. Fundamental Analysis, Behavioral Finance and Technical Analysis on the
Stock Market. GRIN Verlag.
What makes the Australian dollar move. 2018. [Online]. Available at:
https://www.commbank.com.au/guidance/economy/what-makes-the-australian-dollar-move--
201605.html [Accessed on: 25 September 2018].
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Appendix
Financial data AGL Energy Origin Energy
2017 2016 2017 2016
Amount in $ million
Net Profit
$
539.00
$
(407.00)
$
(2,223.00)
$
(615.00)
Net revenue
$
12,584.00
$
11,150.00
$
13,646.00
$
11,456.00
Shareholder Equity
$
7,574.00
$
7,926.00
$
11,418.00
$
14,060.00
EBIT
$
988.00
$
(256.00)
$
(1,746.00)
$
47.00
Interest Expenses
$
237.00
$
236.00
$
553.00
$
548.00
Total Debt
$
6,884.00
$
6,678.00
$
13,781.00
$
14,845.00
(Source: AGL Annual Report, 2017 and Origin Annual Report, 2017)
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