* As a component of Part II of our Themed Essentials we examine potential merger and acquisition activity in the Utilities sector including the ability, likelihood and impact for companies under our coverage acquiring assets.
Impact
* As part of this themed essentials piece we have reflected on the prospect of M&A in the Utilities sector. We note the following themes across the sector:
* The two large Integrated Energy Retailers, Origin Energy ( ORG AU , A$ 16.11 , Outperform , TP: A$ 19.30 ) and AGL Energy ( AGK AU , A$ 15.38 , Outperform , TP: A$ 14.85 ) , have solid balance sheets which would appear to provide both businesses with acquisition capacity. However, with the delay to the NSW electricity assets privatisation, any near-term M&A activity would appear to us to be unlikely for the two large stocks in the sector.
* Of the regulated asset vehicles under our coverage, we believe that Spark Infrastructure Group ( SKI AU , A$ 1.26 , Outperform , TP: A$ 1.38 ) presents the most likely takeover target given Cheung Kong Infrastructure's ( 1038 HK , HK$ 29.20 , Neutral , TP: HK$ 30.00 , Wei Sim ) appetite for further investments in this market coupled with its undergeared balance sheet.
* ORG has by far the strongest Balance Sheet in the sector following the sale of 50% of its Queensland coal seam acreage to ConocoPhillips in 2008. Management noted recently that its A$1.4bn of balance sheet capacity and access to A$3.7bn in cash and undrawn, committed debt facilities. This is likely to have increased given ORG recently refinanced a syndicated bank loan for A$2.3bn and US$200m together with an A$100m bilateral bank guarantee facility. The syndicated facility was launched with a targeted size of A$1.8bn and US$200m, following strong demand from ORG's existing bank group, as well as from new banks, the facility was closed significantly oversubscribed and ORG accepted A$500m of over subscriptions.
* The AGK Balance Sheet is in probably the best shape it has been in for a number of years. At the recent 1H10 results conference call, management noted that it has around $600m of balance sheet capacity assuming that S&P continue to include its off balance sheet wind farms into its rating calculations. This has the potential to increase by a further $600m if the S&P agrees with AGK's assessment of its wind farm financing.
Outlook
* While both AGK and ORG have strong balance sheets, in the absence of a NSW privatisation we see little prospect of M&A among the two large cap stocks under coverage given the in-house opportunities available to both companies. AGK has its renewable options and ORG has the potential to develop coal seam gas to LNG with its APLNG JV with ConocoPhillips.
* At the smaller end, we think that SKI is the business most exposed to a takeover and continue to have an Outperform recommendation on that name.
AGK Price at posting:
$13.61 Sentiment: Buy Disclosure: Held
