Origin Energy Limited (ORG)

BUY

Ugly duckling becomes swan?

2Q22 production

4 Feb 2022

Sector: Energy

Need to know:

FY23 Energy Markets guidance of $600-850m is achievable
Low risk oil exposure through APLNG, even post sell down
Free cash flow yield finally becomes meaningful

Origin’s change of fortune is a slow moving event, but redemption is in the offing. Rising oil and gas prices certainly help, but balance sheet improvement and a more meaningful free cash flow yield are pointing the stock price in the right direction.

There is no hiding the sustained poor performance of ORG’s Energy Markets division with 4 years of downgrades and falling earnings. The market has been sceptical that FY23f EBITDA guidance of $600-850 million can follow a (hopefully) nadir of $450-600 million in FY22f. Aside from on-going coal prices hampering the benefit of ~A$85/MWh NSW wholesale electricity futures price in FY23f, the gas book has 120PJ of fixed price supply and meaningful upside pressure on wholesale gas prices to enjoy.

Electricity sales volumes edged higher in the December quarter as lower retail demand was offset by higher commercial volumes thanks to some new customer wins. Oddly, the reverse situation occurred in gas as retail volume increased 14% but business volume fell 17%.

ORG’s sale of a 10% stake in APLNG in October 2021 for $2.12 billion leaves the company with 27.5% of the business which has now shipped its 700th cargo. ORG received $555 million in cash distributions from APLNG in the 6 months to December 2021.

Investment view

A smaller holding in APLNG obviously lowers earnings from now on (ORG remains the upstream operator) but the benefit to the balance sheet is an adjusted net debt to EBITDA ratio of about 1x in FY23f at an oil price of US$75/bbl. At that gearing level, a 10-11% free cash flow yield becomes very meaningful and would be about 15% at spot oil prices and AUD levels.

The business risk remains with Energy Markets but there is an evolving environment that finally looks to be less detrimental to earnings and even potentially positive.

The combination of a repaired balance sheet and the potential for improved earnings in the Energy Markets division is sufficient for us to lift our recommendation to Buy. We acknowledge the on-going risks with this division but we argue that more attention should be given to ORG’s low risk exposure to rising oil prices.

Key Properties

Forecasts

Share Price

Company Description

Origin Energy is a leading energy retailer and power generation company. ORG explores for natural gas reserves and is increasingly using renewable technologies in its portfolio.

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