A combination of weak retail demand, a significant acquisition in the context of soft wholesale power markets and the repeal of Australia’s carbon tax has sunk the share price of AE Portfolio Conservative Holding AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY).

After closing at AUD13.95 on the Australian Securities Exchange (ASX) on Sept. 11, 2014, AGL is now down 9.5 percent from its 2014 peak of AUD15.41, established on May 13. And it’s 12.3 percent below its AE-era peak of AUD15.91–it’s high since we included it among the first eight Portfolio recommendations in our debut issue–in March 2013.

But even accounting for this weakness AGL is still in the green on a US-dollar total return basis in 2014 at 3.2 percent and has generated a gain including dividends of 13.3 percent in the nearly four years we’ve held in the Portfolio.

But there’s no question AGL has lagged the broader market since March 2013, the primary factor in its struggles a steady decline in power demand in Australia.

Fiscal 2014 retail results were weighed down by a relatively warm start to the winter Down Under that impacted electricity and gas demand.

Management estimated that weaker volumes hit operating earnings before interest and taxation (EBIT) by AUD82 million, with half of the demand destruction attributable to weather, the remainder to a fundamental change in consumption.

Retail segment EBIT for the 12 months ended June 30, 2014, was AUD318 million, down 10.7 percent from fiscal 2013.

Management is tightening its retention focus to higher-margin customers. Rather than focusing exclusively on growing customer numbers, the emphasis will be on growing AGL’s relative share of the retail gross profit pool.

Management believes that it has the capability to target the retention of more profitable market share rather than market share alone.

Merchant operating EBIT was actually up 5.4 percent year over year to AUD899 million, helped by increased wholesale gas sales in Queensland and higher wholesale electricity generation volumes and improved margins. These positives offset a decline in overall consumer volumes.

AGL posted a 3.9 percent decline in underlying net profit after tax (NPAT) to AUD562 million, as revenue dipped 1.8 percent to AUD9.543 billion. Underlying earnings per share (EPS) were AUD1.01, down 5.2 percent.

Gearing–which AGL defines as net debt as a percentage of net debt plus equity–ticked up by 1.9 percentage points but remains well within the “Very Safe” range as defined by the AE Safety Rating System.

On a positive note, AGL did boost its final dividend by 4.4 percent to AUD0.33 per share, bringing the full-year dividend to AUD0.63. That’s 62.5 percent of underlying earnings.

Analyst attention has turned to AGL’s AUD1.505 billion acquisition of the New South Wales state-owned power generation and related assets collectively known as Macquarie Generation (MacGen), which was completed on Sept. 2, 2014.

The company also announced a AUD1.2 billion entitlement offer and a AUD350 million debt facility to fund the acquisition.

Completing the deal adds approximately 4,640 megawatts of generation capacity via the Bayswater and Liddell power stations.

Over the long term AGL will be able to benefit from operating cost improvements, with most upside following the expiration of the current four-year enterprise bargaining agreement, as well as improved reliability and availability that will result from a four-year, AUD400 million capital expenditure program at the two power plants.

Most of the spending will be focused on improving fuel processing at Bayswater (AUD330 million) and fixing boiler issues at Liddell (AUD70 million).

There are re-contracting issues, but management has a flexible plan that will ensure both plants, Liddell in particular, are operating at ideal capacity with cash-flow certainty.

AGL has demonstrated its ability to turn acquired assets around, most recently with the Loy Yang A brown-coal plant in 2012.

But management, in light of weak wholesale power market conditions, pushed back its assumption on payback of the cost of the deal from a prior estimate of seven years to nine years. At the same, time management expects the deal to be accretive to earnings in fiscal 2015.

In July AGL management noted that the negative AUD200 million impact on EBIT of the repeal of Australia’s carbon tax and the shutdown of its Kurnell liquefied petroleum gas extraction plant would be “largely offset” by strong growth in other parts of its business, including additional gas sales to Queensland liquefied natural gas (LNG) projects.

And it expects MacGen to add AUD75 million to underlying net profit after tax (NPAT) during the current fiscal year.

AGL will provide formal guidance for fiscal 2015 at its annual general meeting on Oct. 23, 2014.

AGL’s upstream ambitions are further out on the realization timeline than Aggressive Holding Origin Energy Ltd’s (ASX: ORG, OTC: OGFGF, ADR: OGFGY), for example, which could be part of the explanation for the latter vertically integrated utility business’s outperformance on the ASX since mid-July.

Origin’s Australia-Pacific LNG project–on track to ship its first cargoes in mid-2015–will begin generating substantial cash flow beginning in fiscal 2016. AGL’s Gloucester gas project isn’t even slated for a final investment decision until the fourth quarter of calendar 2015, with first production expected during the third quarter of calendar 2017, assuming management gives the go-ahead.

Gloucester is a key part of AGL’s long-term strategy to develop and source long-term gas supplies to support its existing generation assets as well as its wholesale and retail operations.

Origin, meanwhile, posted a 6.2 percent decline in underlying profit to AUD760 million, as its Energy Markets unit, experiencing reduced volumes on lower electricity sales to domestic mass market customers, suffered a 21 percent decline in underlying earnings before interest, taxation, depreciation and amortization (EBITDA) to AUD1.05 billion.

Origin’s result, like AGL’s, reflects a reduction in average consumption and an historically mild yea weather-wise that reduced overall household energy consumption.

Origin’s Exploration & Production unit generated a 23 percent increase in underlying EBITDA to AUD487 million, providing some offset to Energy Markets’ slump.

Contact Energy, the New Zealand power generator in which Origin holds a 51 percent stake, reported a 9 percent increase in underlying EBITDA to NZD587 million.

Growth was driven by an increased proportion of energy produced from hydro generation displacing more expensive thermal generation and the receipt of NZD43 million of compensation relating to the delay in start-up of the Te Mihi Power Station.

We recommend AGL Energy in the Conservative Holdings because it generates reliable and steadily growing income.

Origin Energy is an Aggressive Holding because of its exposure to energy exploration and production as well as the fact that management has held the annualized dividend rate at AUD0.50 per share since August 2011, with no plans to change the payout policy until AP LNG begins producing and generating cash flow.

The upside of AP LNG is promising, and with the backing of a solid utility business Origin is well placed to support required investment in its E&P business and sustain the current dividend level.

Origin Energy is a buy on the ASX using the symbol ORG and on the US over-the-counter (OTC) market using the symbol OGFGF under USD15.

Origin also trades on the US OTC market as an American Depositary Receipt (ADR) under the symbol OGFGY. Origin Energy’s ADR, which represents one ordinary, ASX-listed share, is also a buy under USD15.

AGL has of course suffered a long decline since peaking in March 2013 near AUD16 per share on the ASX. Since then it’s been a standout underperformer.

The strategy we advocate is to build wealth over time by collecting dividends, benefiting as well from dividend growth and concomitant capital appreciation.

Tactically, we focus on high-quality, easily understood businesses, primarily in essential-service industries, with clearly identifiable cash flows.

When we buy a company we intend to stick with it for the long term, conceiving of ourselves as small business owners, with the type of commitment to stick it out through cycles.

We use the AE Safety Rating System to establish quality, buy-under targets to establish value.

From time to time we’ll take profits off the top of positions, maintaining our original investment, in order to generate funds to establish new positions for diversification purposes or for other uses that suit your particular needs.

It’s a “broad front” approach, as opposed to quick, concentrated  methods such as day trading, seeking out hot momentum stocks or piling into initial public offerings.

AGL faces near-term challenges, primarily a weak wholesale power market. In time, however, it will benefit from the ongoing deregulation of Australia’s power markets as well as the tightening of wholesale generation markets.

AGL continues to invest in asset growth, extend market dominance, fine-tune customer-retention efforts and establish a basis for long-term earnings and dividend support and growth.

Reflecting market reality, we are reducing our buy-under target.

AGL Energy is a buy up to USD16 on the ASX using the symbol AGK and on the US OTC market using the symbol AGLNF.

AGL Energy also trades on the US OTC market as an ADR under the symbol AGLNY. AGL’s ADR, which is worth one ordinary, ASX-listed share, is also a buy under USD16.

Where to Get Results

Note that key earnings details for the following Portfolio Holdings are included in the “Comment” section of this month’s How They Rate table:

• AGL Energy Ltd (ASX: AGK, OTC: AGLNF, ADR: AGLNY)
• Amalgamated Holdings Ltd (ASX: AHD, OTC: None)
• APA Group (ASX: APA, OTC: APAJF)
• Australia & New Zealand Banking Group Ltd (ASX: ANZ, OTC: ANEWF, ADR: ANZBY)
• BHP Billiton Ltd (ASX: BHP, NYSE: BHP)
• Cardno Ltd (ASX: CDD, OTC: COLDF)
• DUET Group (ASX: DUE, OTC: DUETF)
• GrainCorp Ltd (ASX: GNC, OTC: GRCLF)
• M2 Telecommunications Group Ltd (ASX: MTU, OTC: MTCZF)
• Oil Search Ltd (ASX: OSH, OTC: OISHF, ADR: OISHY)
• Origin Energy Ltd (ASX: ORG, OTC: OGFGF, ADR: OGFGY)
• Ramsay Health Care Ltd (ASX: RHC, OTC: RMSUF)
• Spark Infrastructure Group (ASX: SKI, OTC: SFDPF)
• Sydney Airport (ASX: SYD, OTC: SYDDF)
• Wesfarmers Ltd (ASX: WES, OTC: WFAFF, ADR: WFAFY)
• Woodside Petroleum Ltd (ASX: WPL, OTC: WOPEF, ADR: WOPEY)
• WorleyParsons Ltd (ASX: WOR, OTC: WYGPF, ADR: WYGPY)

Important financial and operating data for the following Holdings are detailed in the August 2014 How They Rate table:

• Australand Property Group Ltd (ASX: ALZ, OTC: AUAOF)
• GPT Group (ASX: GPT, OTC: GPTGF)
• CSL Ltd (ASX: CSL, OTC: CMXHF, ADR: CMXHY)
• Crown Resorts Ltd (ASX: CWN, OTC: CWLDF, ADR: CWLDY)
• JB Hi-Fi Ltd (ASX: JBH, OTC: None)
• Mineral Resources Ltd (ASX: MIN, OTC: MALRF, ADR: MALRY)
• Rio Tinto Ltd (ASX: RIO, NYSE: RIO)
• Telstra Corp Ltd (ASX: TLS, OTC: TTRAF, ADR: TLSYY)
• Transurban Group (ASX: TCL, OTC: TRAUF)

We get deeper into the Crown Resorts story in one of this month’s Sector Spotlights.

The stock trades on the Australian Securities Exchange (ASX) under the symbol CWN and on the US over-the-counter (OTC) market under the symbol CWLDF.  It also trades on the US OTC market as an American Depositary Receipt (ADR) under the symbol CWLDY. The ADR is worth two ordinary, ASX-listed shares.

Crown Resorts is a buy up to USD16.50 on the ASX using the symbol CWN and on the US OTC market using the symbol CWLDF. Crown Resorts’ ADR is a buy under USD33.

Replacing Australand Property Group in the Conservative Holdings is fellow Australian real estate investment trust (A-REIT) Stockland (ASX: SGP, OTC: STKAF), which owns, operates and invests in a diversified portfolio of residential, retail, office industrial and retirement but is primarily focused on housing.

We have more on Stockland–another of our top ideas for new money this month–in a Sector Spotlight, where we discuss the A-REIT’s fiscal 2014 operating and financial results.

Stockland is a buy on the ASX using the symbol SGP and on the US OTC market using the symbol STKAF under USD4.

Loose Ends

It’s time to sell Conservative Holding Australand Property Group (ASX: ALZ, OTC: AUAOF) if you haven’t already done so.

The final “allowed distribution” under its deal with Frasers Centrepoint Ltd (Singapore: FCL)of AUD0.0263 per security has been paid, and the A-REIT trading at the offer price of AUD4.48 on the ASX.

Our total return on Australand from its March 16, 2012, addition to the Conservative Holdings through Sept. 11, 2014, is 77.4 percent versus 24.9 percent for the Standard & Poor’s/Australian Securities Exchange 200 Index, 35.2 percent for the S&P/ASX 200 A-REIT Index and 50.1 percent for the S&P 500 Index.

Use proceeds from the sale to buy new Conservative Holding Stockland.

Fellow A-REIT and Conservative Holding GPT Group (ASX: GPT, OTC: GPTFF) is also a viable alternative. GPT, with one of the strongest balance sheets in the A-REIT universe and currently yielding 5.3 percent, is a buy under USD4.

Official quotation of Envestra Ltd (ASX: ENV, EVSRF) has been suspended on the ASX as of the close of trading on Friday, Sept. 12, 2014.

Envestra last traded at the AUD1.32 per share acquisition price offered by a consortium including Cheung Kong Infrastructure Holdings Ltd (Hong Kong: 1038, OTC: CKISF, ADR: CKISY), Cheung Kong Holdings Ltd (Hong Kong: 0001, OTC: CHEUF, ADR: CHEUY) and Power Assets Holdings Ltd (Hong Kong: 0006, OTC: HGKGF, ADR: HGKGY).

It too has paid its final dividend. Investors should by now have received the AUD0.035 per share payment agreed to as part of the Cheung Kong deal.

One of the “Seven Wonders from Down Under” that made up the original AE Portfolio, Envestra generated a US dollar total return of 132.5 percent from Sept. 26, 2011, through Sept. 11, 2014, versus 54 percent for the S&P/ASX 200 Index, 57.7 percent for the S&P/ASX 200 Utilities Index and 83.2 percent for the S&P 500.

Alternatives for conservative, income-focused investors, include, of course, but are not limited to Stockland.

More like-for-like alternatives include the remaining three Portfolio Holdings that derive most of their revenue and cash flow from fee-generating energy infrastructure assets.

APA Group (ASX: APA, OTC: APAJF), also one of the original eight Portfolio Holdings, is trading right at its USD7 buy-under target as of this writing. With Sept. 12, 2014, trading on the ASX already open APA last changed hands at AUD7.69, equal to AUD6.99 based on prevailing Australian dollar-US dollar exchange rates.

APA Group, which is yielding 4.7 percent, is a buy under USD7.

DUET Group (ASX: DUE, OTC: DUETF) is trading just above its buy-under target as of this writing. DUET, which is yielding 7 percent, is a buy under USD2.20.

Spark Infrastructure Group (ASX: SKI, OTC: SFDPF) is trading at AUD1.83 on the ASX at this hour, equal to USD1.67 based on prevailing exchange rates. Spark Infrastructure, which is priced to yield 6.1 percent, is a buy under USD1.80.

Conservative Update

M2 Telecommunications Group Ltd (ASX: MTU, OTC: MTCZF), an August 2014 “best buy” recommendation, pushed out to a 52-week high on the ASX on Sept. 11, 2014, of AUD8.08.

M2 has posted a 12.4 percent rally in US dollar terms since Aug. 15, spurred by a solid fiscal 2014 earnings report that included a 45 percent dividend increase. That boost exceeded our forecast of a 25 percent to 35 percent increase.

Results for the year ended June 30, 2014, were supported by 8 percent organic growth in services in operation, with 121,000 post-paid services added, including 70,000 new broadband customers and 137,000 new customers for its stepped-up energy offering.

M2 also continued the successful integration of recently acquired properties, including Dodo, and the introduction of new services.

Revenue for the period grew by 50.4 percent to AUD1.024 billion, while EBITDA were up 48.1 percent to AUD160.1 million. Underlying NPAT was up 59.8 percent to AUD93.3 million, and statutory NPAT was up 53.2 percent to AUD67.1 million.

Underlying EPS were AUD0.52, while statutory EPS were AUD0.374.

A final dividend of AUD0.145 per share brings the full-year payout to AUD0.26. Total dividends paid and payable were AUD46.8 million, up 39.3 percent from fiscal 2013. The payout ratio based on underlying NPAT was 50.2 percent, 69.7 percent based on statutory NPAT.

M2 Telecommunications is a buy under USD7 on the ASX using the symbol MTU or on the US OTC market using the symbol MTCZF.

Aggressive Update

Like M2, Woodside Petroleum Ltd (ASX: WPL, OTC: WOPEF, ADR: WOPEY) also announced a significant dividend increase along with its financial and operating results for the first six months of 2014.

The oil and gas producer will pay an interim dividend of USD1.11 per share, up 28 percent versus the prior corresponding period, on Sept. 24, 2014, to shareholders of record as of Aug. 29.

Woodside’s half-year report including several company records.

Management reported NPAT of USD1.105 billion for the first six months of the year, up 27 percent to establish a new standard, as revenue grew by 24 percent to USD3.551 billion, also a new mark. Underlying NPAT was up 33 percent to USD1.136 billion, also a record.

Profit was helped by higher realized prices due to the transition to the new Pluto pricing regime, no impairment losses, lower exploration and evaluation expenses. Sales volumes surged on an entire half of Vincent production, which came back online during the fourth quarter of 2013, and increased reliability at Pluto and North West Shelf.

Production was a record 46.5 million barrels of oil equivalent.

Woodside generated free cash flow of USD1.825 billion, up 158 percent versus the first half of 2013. The company now has USD2.7 billion in cash and USD1.6 billion in undrawn facilities available to fund growth and therefore color in one of the few open spots in an otherwise healthy picture.  

Opportunities abound as rivals step up asset sales and competing bidders dwindle.

Woodside has resisted making acquisitions over the past two years, as prices were too high. But CEO Peter Coleman recently noted there were now attractive opportunities as companies including Royal Dutch Shell Plc (London: RDSA, NYSE: RDS/A) and Apache Corp (NYSE: APA) offload assets.

At the same time, competitive bidding is likely to ease, Mr. Coleman said, as state-owned oil companies including China’s CNOOC Ltd (Hong Kong: 883, NYSE: CEO) and PetroChina Co Ltd (Hong Kong: 857, NYSE: PTR), are no longer chasing deals after making expensive acquisitions over the past few years.

Woodside has said it is looking for growth prospects worth around USD5 billion.

Among other opportunities, Woodside is looking at assets that Apache wants to sell, including LNG stakes in Australia and Canada.

Woodside is feeling some pressure to make an acquisition to spur growth ahead of the development of its next big project, most likely the Browse floating LNG project, after scrapping a deal to buy a 25 percent stake in Israel’s massive Leviathan gas field earlier this year.

Canadian opportunities would fit with Woodside’s plan to develop an LNG export plant in British Columbia.

Woodside Petroleum is a buy under USD42 on the ASX using the symbol WPL and on the US OTC market using the symbol WOPEF.