Origin Energy Limited

Company Overview: Origin Energy Limited (ASX: ORG) is a leading integrated energy company in Australia that operates several energy businesses, including exploration and production of natural gas, wholesale and retail sale of electricity and gas, electricity generation and sale of liquIfied natural gas (LNG). The company mainly operates two businesses - Energy Markets and Integrated Gas. Origin has a 37.5% interest in Australia Pacific LNG, which is a significant supplier to both domestic and international LNG markets. The company continues to focus on delivering affordable energy by running its generation assets reliably and efficiently, bringing more renewable energy online and maintaining its competitive gas supply portfolio.

ORG Details

Well Placed for Long-Term: Origin Energy Limited (ASX: ORG) is Australia’s leading energy company that operates two strong cash generating businesses- Energy Markets and Integrated Gas. The company is focused on providing clean energy and intends to be a low-cost operator with a disciplined capital management capability. The company continues to work on improving affordability, adding more contracted renewables to its generation capacity, as well as investing to make its generation assets more flexible to support more wind and solar in the market. The company recently joined hands with a fast-growing United Kingdom retailer and emerging technology business Octopus Energy (Octopus) to transform its retail operations delivering radical improvement in customer experience, a material reduction in costs, and opening up future growth opportunities. Over the last five years, the company witnessed significant improvement in its underlying EBITDA and underlying ROCE. From 2015 to 2019, the company’s underlying EBITDA has increased at a CAGR of 20%.

Company Performance (Source: Company Reports)

In response to the current COVID-19 situation and the decline in commodity prices, the company has reduced its operating costs and capital expenditure to improve the resilience and to mitigate some of the impacts on its business. Going forward, the company will continue to pursue opportunities that will help it in delivering its strategy of improving customer experience, reducing the cost to serve and growing new revenue streams. Origin Energy Limited with its diverse business spanning energy retailing, power generation and natural gas along with exposure to future growth opportunities in renewable energy and new technologies, seems well placed for long-term growth.

FY19 Results Highlights: During the financial year 2019 or FY19, the company saw decent earnings from its Integrated Gas business, underpinned by cost efficiencies, higher effective oil price and stable production at Australia Pacific LNG. In the Energy Markets, the company witnessed moderately reduced earnings in electricity, mainly due to the continued impact of heightened retail competition, price relief measures provided to customers, and lower average customer numbers and usage.

For FY19, the company reported an underlying profit from continuing operations at $1,028 million, up 42% from FY18. Further, the company reported a statutory profit of $1,211 million for FY19. The underlying EBITDA from Energy Markets and Integrated Gas business stood at $1,574 million and $1,892 million, respectively. For FY19, the company paid a total dividend of 25 cents per share.

FY19 Performance Summary (Source: Company Reports)

H1FY20 Performance Highlights: For H1FY20, the company reported a statutory profit of $599 million and Underlying EBITDA was $1,590 million. Further, the company reported free cash flow of $680 million, up 22% on pcp. The strong free cash flow growth allowed the company to increase the interim dividend to 15 cents per share (fully franked), up 5 cps from pcp.

Over the period, Australia Pacific LNG delivered record production and higher revenue, underpinned a 7% increase in underlying EBITDA in Integrated Gas before non-cash accounting changes. The Integrated Gas delivered record production of 358 PJ during the half-year; a 5% increase compared to pcp. During the period, the company observed margin pressure in Energy Markets with the impact of price re-regulation, as well as lower volumes reflecting reduced energy usage and lower customer numbers.

As at 31 December 2019, the company had a sound balance sheet with the liquidity of $3.8 billion, consisting of $0.8 billion in cash and $3.0 billion in committed undrawn debt facilities expiring over FY2023 and FY2026.

H1FY20 Results Highlights (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 19.69% of the total shareholding. The Vanguard Group, Inc. and AustralianSuper hold maximum interest in the company at 6.02% and 5.01%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

A Quick look at Key Margins: In H1FY20, the company’s gross margin stood at 18.3%, slightly higher than the pcp. For the same period, the company reported a net margin of 8.9%, higher than the industry median of 8%. Further, the company has a Return on Equity (ROE) of 4.5%, higher than the industry median of 3.5%, demonstrating the company’s efficiency in handling shareholders’ money. The company has a quick ratio of 0.91x, higher than the industry median of 0.80x, demonstrating that the company is well-equipped to pay its immediate short-term obligations.

Key Metrics (Source: Refinitiv, Thomson Reuters)

March Quarter Performance: During the March quarter, Australia Pacific LNG delivered stable and reliable production. However, APLNG revenue declined by 12% on Dec-19 quarter with lower LNG sales partially offset by higher domestic sales. Over the quarter, the company saw some initial impact from the Coronavirus pandemic on electricity demand, which contributed to lower volumes compared to the March quarter of 2019. The retail volumes increased by 12% due to cooler weather in Victoria and higher customer numbers and usage.

Over the quarter, the company increased its interest in the Beetaloo Basin to 77.5% and agreed changes to the joint operating agreement, providing greater control over the timing, direction and budgets for future project activity.

March Quarter Production Results (Source: Company Reports)

Strategic Partnership with Octopus Energy: On 1^st May 2020, the company announced that it has established a strategic partnership with disruptive UK energy retailer and technology company, Octopus Energy, to transform its retail operations delivering radical improvement in customer experience, a material reduction in costs, and opening up future growth opportunities. ORG is going to acquire a 20% interest in Octopus and a licence in Australia to its market leading customer platform, Kraken. In the next 2 to 2.5 years, the company is going to transfer its 3.8 million retail electricity and gas customer accounts to the Kraken platform, delivering a step-change reduction in operating and capital costs. The company expects pre-tax cash savings of $70-80 million in FY2022. This will increase to $100-150 million annually from FY2024.

Non-cash Charges in FY20: In an update provided on 15 July 2020, the company informed that it expects to recognise non-cash post-tax charges in the range of $1,160 million to $1,240 million in FY20 results which are scheduled to release on 20 August 2020. These charges are related to updated year-end valuation estimates primarily driven by revised commodity price assumptions, the associated economic impacts of the COVID-19 pandemic, and the progressive transition to a lower-carbon energy supply.

Breakdown of the Expected Charges (Source: Company Reports)

Key Risks and Challenges: The company operates in a highly competitive retail environment which can result in pressure on margins and customer losses. Currently, there is some uncertainty about the extent of the short-term impact of COVID-19 on Energy Markets. Changes in energy demand driven by price, consumer behaviour, mandatory energy efficiency schemes, government policy, weather and other factors can create revenues uncertainty and impact future financial performance. The company’s future results are subject to any material increase in bad and doubtful debt provisioning associated with the changing economic conditions.

What to expect: Amid COVID-19 situation, the company has been able to maintain its energy supply operations, with customers continuing to receive reliable electricity, natural gas and LPG supply. The company has assured that it is not going to disconnect any residential or small business customers in financial stress.  The company’s action taken in the last three years to simplify the business, significantly reduce upstream costs at Australia Pacific LNG and materially reduce debt, has put us in a financially resilient position.

In the long run, the company seems to be well-positioned with a diverse business spanning energy retailing, power generation and natural gas which generates strong cash flow. Further, the company also has exposure to future growth opportunities in renewable energy and new technologies.

The company is expected to release its Q4 production volume update on 31 July 2020 and is scheduled to release its FY20 results on 20 August 2020. In Energy Markets business, the company expects its FY20 underlying EBITDA to be in the range of $1.4 - $1.5 billion, subject to any significant increase in bad and doubtful debt provisioning. From APLNG, the company expects the FY20 cash distributions to be in the range of $1.1 billion - $1.3 billion. In FY20, the company expects its capital expenditure to be 5%-10% lower than previous guidance of $530 million- $580 million. And in FY21, the company expects the capital expenditure to further reduce by 25% – 30% on FY20 previous guidance. The company recently recognized non-cash post-tax charges in the range of $1,160 million to $1,240 million for FY20.

Key Financial Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (illustrative)

EV/EBITDA Multiple Based Approach (Source: Refinitiv, Thomson Reuters)

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Stock Recommendation: The stock of ORG has corrected by 32.71% in the past six months and is currently trading slightly below the average of its 52-week band, offering a decent opportunity for accumulation. Going forward, the company will continue to work on improving affordability, adding more contracted renewables to its generation capacity, as well as investing to make its generation assets more flexible to support more wind and solar in the market. We have valued the stock using EV/EBITDA multiple based illustrative valuation method and have arrived at a target price with lower double digit-upside (in % terms). For the purpose, we have taken peers like AGL Energy Ltd (ASX: AGA), APA Group (ASX: APA), Woodside Petroleum Ltd (ASX: WPL), etc. Considering the company’s resilient performance amid COVID-19, its decent H1FY20 performance, FY20 guidance, and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $5.69, down by 1.557% on 22 July 2020.

ORG Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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