ASX Utility stocks: Broker views and James Gerrish’s top pick

A major class of regulated infrastructure assets (alongside user-pays assets such as motorways), investors typically prize utilities for their defensive characteristics. But Australia’s already complex energy markets have become more complicated still since Russian tanks rolled into Ukraine 12 months ago. Power prices have soared and the Federal Government’s mini-budget in October tipped a 56% jump in retail electricity prices over two years.

A “reasonable pricing” regime is being rolled out by the government, including price caps on local power companies. And additional changes are expected to further ruffle feathers, with the ACCC and the Federal Government set to release an industry code of conduct later this month.

What does all this mean for the biggest ASX-listed utilities and their shareholders? In the following article, I look at how the broker community regards some of these companies. I also talk to James Gerrish of the online investment advisory service Market Matters and a Shaw and Partners portfolio manager.

ASX 200 Utilities

APA Group (ASX: APA)

Natural gas and electricity infrastructure firm APA Group, a more than $12 billion company, is Australia’s largest utility in terms of market cap. And with new CEO Andrew Watson at the helm and more than $1.4 billion of projects in the pipeline, it has big plans to cash in on the energy transition.

Macquarie re-added the company to its coverage list on 7 November, with a NEUTRAL rating and a $10.13 price target.

CLSA downgraded APA to a SELL from Underperform on 25 August, analyst Daniel Butcher cutting his price target to $10.06 from $10.12.

And Jefferies rated the company a HOLD when it initiated coverage on 3 June, analyst Anthony Moulder setting a $10.30 price target.

APA Group’s share price closed at $10.88 on Friday, roughly in line with where they opened at the start of the year.

Origin Energy (ASX: ORG)

Juggling a takeover offer from a North American consortium and landmark regulatory shifts closer to home, Origin Energy CEO Frank Calabria fielded multiple questions during the half-yearly earnings call on 16 Feb. The company’s share price of $9 at that point was its lowest since the first approach by Brookfield and EIG Partners in November.

CLSA on 17 February downgraded Origin to UNDERPERFORM from Outperform. Analyst Daniel Butcher reduced his price target to $6.80 from $7.85.

A month earlier, Morgan Stanley lifted its rating to OVERWEIGHT form Equal Weight on 16 January. Analyst Rob Koh increased his price target to $8.88 from $6.35.

J.P. Morgan also lifted its rating, to OVERWEIGHT from Neutral on 11 November. Analyst Mark Busuttil increased his price target to $9 from $6.

Origin shares closed at $8.08 on Friday, up 6% in the year so far and 40% above their 9 November price of $5.80.

Mercury NZ (ASX: MCY)

Based in Auckland, New Zealand, Mercury NZ is an electricity generation and utility retailer of electricity, gas, broadband and mobile telephone services. While not widely known within Australia, it’s one of New Zealand’s five largest utilities, which provide 95% of the nation’s power and are majority-owned by the NZ Government. Mercury NZ is the fourth-largest ASX-listed utility, with an $8 billion market cap.

Mercury NZ was downgraded to UNDERPERFORM from Neutral by broker Forsyth Barr on 17 August. Analyst Andrew Harvey-Green cut his price target to NZ$5.40 from NZ$5.70.

The company also copped a downgrade Craigs Investment Partners, who dropped it to NEUTRAL from Overweight on 12 August. Analyst Cameron Parker also cut his price target to NZ$6.49 from NZ$7.01.

And Jarden’s latest rating change for Mercury NZ came on 21 March, when it upgraded the stock to BUY from Neutral. The price target was also lifted to NZ$7.15 from NZ$6.68.

Mercury NZ shares closed at $5.74 on Friday, up 9.5% in the year so far.

Meridian Energy (ASX: MEZ)

Another of the big five Kiwi power firms mentioned above, Meridian is in the same business as Mercury NZ and is also 51% owned by the New Zealand Government. One of the biggest contributors of power to New Zealand’s grid, Meridian also claims to use 100% renewable sources. It operates seven hydroelectric power stations and five wind-farms across New Zealand’s North Island and South Island.

Forsyth Barr on 8 February downgraded its rating for Meridian Energy to UNDERPERFORM from Neutral. But analyst Andrew Harvey-Green lifted his price target to NZ$5.05 from NZ$4.85.

Just a couple of days earlier, on 6 February, UBS downgraded the company to SELL from Neutral. Analyst Vignesh Nair cut his price target to NZ$5.05 from NZ$5.25.

Last year, Jarden upgraded Meridian to OVERWEIGHT from Neutral. But analyst Grant Swanepoel reduced his price target to NZ$5.24 from NZ$5.35

Meridian Energy shares closed at $4.91 on Friday, in line with were they opened at the start of 2023.

"Sentiment can change quickly”

Though each company needs to be weighed on its individual merits, Gerrish emphasises the value of utility companies, particularly their, “irreplaceable asset bases” and huge pools of customers.

And though the sector has found itself on the receiving end of negative attention - particularly AGL, which owns the lion’s share of Australian coal-fired power stations, consumer sentiment can turn on a dime.

He points to the intense activity that’s occurring within the energy space currently, with both AGL and Origin in the crosshairs of bidders last year. “And AGL, more recently, seems to me is still in play,” he says.

Gerrish refers here to the approaches by Mike Cannon-Brookes’ Grok Ventures and Brookfield Asset Management last February, when the shareholder and Canadian investment firm effectively tried to scupper the board.

The key metric to watch

Gerrish believes the most important consideration for AGL and its shareholders is improving its earnings. He believes it is widely understood that the company has value in its underlying assets and a 4.5 million-strong customer base - as validated by the recent bidding activity. And with the consortium having bid $8.25 a share for AGL, which is now trading at under $7, Gerrish believes they’re still well and truly on the share register.

“Obviously it’s had some short-term earnings issues because of some unfortunate short-term contracts from which they get poor margins, but they roll off,” Gerrish says.

“In FY2023, the consensus is they generate about $250 million in profit. In FY2024, if consensus is right, they’ll do around $560 million,” Gerrish says.

He’s also closely watching to see if management can deliver on the earnings growth the market is now factoring in for the outer years, as the company’s legacy positions roll off.

“The story they can tell around being pivotal in the decarbonisation process, and self-funding a huge move into that space –that’s a company whose perception could change very quickly,” Gerrish says.

Australia’s dominant energy infrastructure firm

For APA Group, Gerrish emphasises the lack of locally-listed competitors in the natural gas energy infrastructure space.

“It’s now fairly expensive, but I look at it as an income stream over and above bond yields. So, the big question is am I getting enough return to compensate for the risk?”

Normally, it trades at a premium of around 2.4% to 10-year bond yields, but is currently only around 1% above the yield.

During its interim earnings call on Thursday, management reported a 2.5% increase in benchmark profit and an anticipated 3.8% increase in dividends this year.

“We did own it but have since sold out because, at this level, it’s not compelling value. APA is a great company that probably deserves to have a smaller spread to 10-year yields,” Gerrish says.

“Its earnings are linked to inflation, so all APA’s energy tariffs rose. Everyone talks about their debt but their earnings are also linked to CPI, and much of it to US CPI.”

Gerrish's pick of ASX Utilities

For Gerrish, AGL is his overwhelming favourite in the sector.

“You’ve got an asset base there, you’ve got someone on the register who thinks there’s more value than the market’s ascribing to it. And they’ve got this decarbonisation push,” he says.

“And it’s a business that in 2024 and 2025 will see its earnings improving a lot, and will see better times than it has in the last couple of years.”