Two energy stock recommendations for SMSFs

Investment Committee, Switzer Dividend Growth Fund
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Energy is a core theme for a portfolio; there is no doubt about that. Exposure to the sector can be via many listed entities, but both AGL Energy and Origin Energy are two core exposures that should be considered for your self-managed super fund (SMSF).

AGL Energy

AGL Energy tends to be a little more defensive than Origin Energy as it has a low beta (around 0.65) versus the broader ASX200 Index. It is more likely to feature in a defensive income portfolio. This should be no surprise given the core business model is to sell and distribute gas and electricity to both wholesale and the largest retail client base in the local market.

Despite being a defensive stock for your portfolio, AGL Energy did underperform the utility sector in 2011 due to a number of factors, including softer electricity demand and some poor hedging that impacted earnings. Missing out on electricity privatisation in NSW was another.

A positive in the longer term was the Loy Yang A Power acquisition (AGL Energy’s bid to acquire 100% stake of Victoria’s largest brown coal station), which would clearly secure generating capacity in the decades ahead at a price that appears competitive versus previous valuations (just ask previous long-term equity owner Tokyo Electric).

While the regulator requires more information on this acquisition, it remains the most likely outcome (and consistent with other acquisitions in recent years). However, if there is a significant delay, then this would have an impact.

The key going forward for investors is that the company’s retail customer base is growing and that ultimately, the earnings tend to be defensive with the stock outperforming when the broader equity market is soft. They do, however, need to maintain their margins from both their retail and wholesale businesses while maintaining costs. The strong performance of the cyclical sectors of the market year-to-date may suggest becoming a little more defensive again. In short, AGL Energy ticks the right boxes.

Origin Energy

Origin Energy is a little different. It is an integrated oil and gas producer, electricity and renewable power generator, energy retailer and a large producer of coal seam gas locally. Broadly, it has less exposure to a retail customer base and has a larger capital expenditure requirement in its business versus AGL Energy.

Origin Energy’s business is a little less defensive as a consequence. Origin Energy has a beta closer to one, well above AGL Energy’s 0.65. So it is a little more volatile over the cycle, and offers a lower dividend yield versus AGL Energy, but it does have a greater leveraged upside in earnings. Therefore, Origin Energy would be suitable for a more growth orientated SMSF than AGL Energy.

The chart below shows the performance of AGL Energy, Origin Energy and the broader equity market (ASX300 Accumulation) over the past year. This compares performance versus levels a year ago. One can clearly see the most defensive – AGL Energy – has outperformed both the more cyclical Origin Energy and the broader equity market. This should be no surprise given that defensive stocks generally performed well in 2011.

In summary

AGL Energy is your defensive/income exposure for 2012 and Origin Energy can add that little more leverage to future earnings and be part of your higher conviction energy exposure. You get the best of both with these two stocks.

George Boubouras is the Head of Investment Strategy & Consulting at UBS Wealth Management.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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