Does a 60% earnings upgrade get you excited? If it was not for the Brookfield recommended takeover, we would have expected the ORG share price to be up >20% today.
The spectacular earnings improvement is chiefly due to ORG’s fast-growing UK business Octopus, which has benefited from more stable operating conditions over the UK winter and shoulder period.
Lower coal and gas prices have helped improve the profitability of domestic businesses. This would likely continue into FY24E.
With the takeover by Brookfield (BN.CA) being the key determinant of the ORG share price, we expect a muted response from this large earnings upgrade.
Earnings improvement reinforces Brookfield’s view on ORG, despite the noise around government intervention and caps on domestic gas prices. Whilst there is limited noise at present from investors, there may be some frustration that ORG is being sold too cheaply.
For investors, should the Brookfield transaction fail to get all the required approvals, we now see limited downside to the share price given the earnings improvement. ORG’s FY23 earnings guidance is now >30% higher relative to the November market estimates for FY23.
Investment View
So where to from here for ORG? Brookfield is very motivated to acquire Australian utility and infrastructure assets after passing on AGL Energy (AGL) last year, ORG is now firmly in its sights.
In our view, the ~$9.00 price is a knockout price for ORG, despite the three earnings upgrades the company has pushed through since December. The Federal Government’s proposed legislation to influence gas project returns (significantly watered down in April 2023), has the potential to impact the impact the cash flows from ORG. Despite this risk, Brookfield and EIG are fully committed to acquiring Origin Energy.
Various approvals need to be secured before going to a shareholder vote later this year. Approvals from the ACCC and FIRB remain the most contentious.
We would not be surprised to see the ACCC require some small asset divestments to gain approval, whilst FIRB approval remains a little bit of a lottery. On balance, with Brookfield’s promise to accelerate energy transition expenditure, we expect FIRB will approve.
Using a 0.68 AUDUSD rate, and assuming the deal is closed before November 2023, the Brookfield’s Offer is valued at $9.06. This assumes a 75% franked second-half dividend. This equates to gross total return in the high single digits. A ticking fee of $0.045 per month is payable after November, should the approvals remain outstanding. We downgrade our Rating on ORG from Buy to Hold.
Risks to Investment View
The key near-term risk would be the failure of the Brookfield takeover to be approved by the various regulatory bodies including FIRB. Proceeds from Brookfield include a portion of USD cash proceeds, which introduces a level of FX risk to the investment in ORG.
If commodity prices fall and consumer demand for electricity and gas declines, ORG’s earnings would decline. Government intervention in energy markets would present a risk to earnings, as does the oncoming transition to renewable energy for ORG's core business.
