This week we continue our examination of utility markets. Last week we looked at prices and what has been driving them higher, this week we look to one company in the sector that has also been all over the headlines, AGL (AGL.ASX).
See last week's article: Utility Prices: An Economic Issue Bungled Over a Decade
By now we’re quite sure that most investors would be somewhat familiar with the AGL story, a story that has now led to the resignation of four board members and the CEO while leaving the company in a state of flux. This security offers up a number of different narratives; a prime example of management incompetence, an illustration of the rather messy transition in the broader energy markets and finally perhaps even an opportunity.
We can only describe the strategy and activities undertaken by the now previous management as a painful bungle. Last week we described some of the challenges that are inherent in the sector both from a regulatory and operational perspective. AGL, a business encumbered with legacy coal power generation assets and thus significant greenhouse gas emissions (i.e. 10% of the nation’s total), was always going to be a tough proposition for any management team to navigate. Fundamentally, the business needs to address two issues. First, to ensure reasonable cost of capital given the lack of investor appetite for fossil fuels based exposures going forward and, the second, to transition towards a more sustainable portfolio mix. Given the majority of AGL’s energy mix is coal based and the declining profitability of the sector, speed being of the essence may also be considered a third factor.
So, how did AGL perform?
The business seemed to have a plan to begin with, hiring an outsider in the form Andy Vesey. He formulated a plan to address the everchanging business conditions but apparently that was where it stopped. He was ousted pre-emptively with a helping hand from the nation’s Treasurer at the time, Fryndenberg. Vesey was replaced by Brett Redman who seemed to move the company in the other direction, doubling down on the existing coal exposure and extending the life of the producer plants. In our overview of the market last week, we did mention that this is one sector that continues to have outsized political influence. This begs the question of the rationale for matching a potentially multidecade strategy to suit the requirements of stakeholders with a much shorter warranty. Nevertheless, we look to the results.
Through all this, management continued to fail to invest meaningfully in the next phase of the industry. Coal may have been cheaper but was it the future?
AGL posted a record $2.27bn hit to the bottom line in February 2021 with the cherry being an unprecedented shareholder revolt, 55% supporting a motion to set climate targets in line with the Paris Climate Accords. Management shortly thereafter came up with an innovative solution which was to split away the coal assets from the retail business. Supposedly refocusing the business and make the transition easier. Going back to our dual targets and lowering the cost of capital, this was to apparently make it easier to ascertain liquidity for the retail business which could then focus on shifting toward renewables. That is, since it would no longer be encumbered by coal assets it was reasoned that bankers would be more amenable to injecting liquidity. Unfortunately for management, shareholders took a similar view to us on the idea of duplicating functions and dispensing with the potential of using cashflows from the retail business to help with the transition. All this and shareholders continued to see the pain. The board continued to disregard concerns around the proposed demerger and kept on its path.
Despite the continued and relentless fall in both profits and shareprice, the only statement of note from management was that, according to CEO Brett Rodman, there was and continues to be ‘considerable uncertainty’ of the company’s operations. If shareholders were not content on that statement, Peter Botten, then the Chair, graciously admitted that leadership had not been able to factor in the sheer scale and speed of the changes that have occurred in the sector.
It is within this context that Mike Cannon-Brookes made his initial failed bid for the business. His ideas were clear, he was intent on speeding up the transition away from fossil fuels and he made a play for one of the largest of the lot. While we disagree with what can only be considered a ridiculously low offer, the silver lining was to put a decidedly incompetent management team and board on the backfoot. Despite shareholders consistently voicing concerns about the direction of the company and the decisions being made, the previous board and CEO showed a blatant contempt for the owners of the business they work for. There isn’t really another way to describe it.
After the initial rebuff and much ado, Cannon-Brookes took an alternative route to shaking up the business. He effectively became the largest shareholder in the company and convinced his fellow investors, both institutional and retail alike, to oppose the de-merger while at the same time collecting some scalps in the form of four directors, the Chair and the CEO.
After providing us with a perfect example of management incompetence and the broader bungled energy transition, what Cannon-Brookes will actually seek to do next with AGL is still a question for the market. Herein lies the potential opportunity. We’ll have to wait and see.
Disclaimer: TAMIM currently holds AGL (AGL.ASX) in a number of income-focussed individually managed account portfolios.
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