Origin Energy Limited

Company Overview: Origin Energy Limited (ASX: ORG) is a leading energy company that sells electricity, natural gas, LPG, and green power products to Australian homes, businesses and industrial customers. The company mainly operates two businesses - Energy Markets and Integrated Gas. ORG has a 37.5% interest in Australia Pacific LNG, which is a significant supplier to both domestic and international LNG markets. The company is focused on providing clean energy and intends to be a low-cost operator with a disciplined capital management capability.

ORG Details

Improving Bottom-line: Origin Energy Limited (ASX: ORG) is a leading Australian energy retailer, with a low-cost, customer-centric delivery model. The company operates several energy businesses, including exploration and production of natural gas, wholesale and retail sale of electricity and gas, electricity generation and sale of liquefied natural gas (LNG). The company owns 37.5% interest in APLNG, which is a 9Mtpa integrated LNG project, backed by JV partners ConocoPhillips and Sinopec. The company intends to maximise the value of its existing business and pursue growth by expanding its customer scale through low-cost position and platform business model and by pursuing opportunities in renewable fuels. From 2016 to 2020, the company has witnessed significant improvement in its bottom-line, rising from a net loss of $628 million in FY16 to a profit of $83 million in FY20.

Five-Year Financial Summary (Source: Company Reports)

Looking ahead, the company is focused on improving its customer experience, targeting a market-leading cost position and growing new revenue streams. For its Energy Markets division, the company is focused on growing its customer scale through low cost position and by selling a broader suite of products and services. In its Integrated Gas division, the company is pursuing opportunities to leverage unique capabilities to lead in commercialisation of renewable fuels. 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 decent cash flow.

Improved Operational Performance in FY20: For the year ended 30 June 2020, the company reported an underlying profit of $1,023 million and an underlying EBITDA of $3,141 million, despite facing significant challenges caused by bushfires, drought, and the ongoing COVID-19 pandemic. During FY20, Australia Pacific LNG (APLNG) delivered record production of 265 PJ (ORG share) and made record cash distributions to ORG of $1,275 million. Over the year, APLNG executed new contracts for over 100 PJ of gas sales to domestic customers starting in the calendar year 2020. Driven by record production by APLNG and a record cash distribution, the company’s free cash flow increased by $105 million to $1,644 million in FY20, compared to FY19. Notably, the company reduced its net debt by $773 million during the year to $4,644 million. For FY20, the company has paid an unfranked final dividend of 10 cents per share, taking the total full-year dividend to 25 cents per share, in-line with the prior year, and representing 27% of free cash flow.

FY20 Results (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 23.11%. AustralianSuper and The Vanguard Group, Inc. hold the maximum interest in the company at 8.39% and 6.02%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Metrics: The company’s gross margin and EBITDA margin for FY20 stood at 18.4% and 8.9%, respectively. Current ratio for FY20 stood at 1.01x, compared to 1.07x of industry. The company’s debt to equity multiple for FY20 stood at 0.54x, slightly lower than 0.58x in FY19.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Strategic Partnership with Octopus Energy: In FY20, the company acquired a 20% interest in UK company Octopus Energy, and an Australian licence for the Kraken customer platform. The company’s strategic partnership with Octopus Energy is delivering a radical improvement in customer experience and driving a material reduction in costs. It is also making progress in customising the Kraken platform for the Australian market and is on track to migrate its first customer cohort by the end of CY2020. The company is targeting pre-tax cash savings of ~$70 million -$80 million in FY2022, and $100 million-$150 million from FY2024.

September 2020 Quarter Highlights: For the September 2020 quarter, the company’s Integrated Gas segment reported stable production of 64.2 Petajoule (PJ), compared to 64.5 PJ in June 2020 quarter. Integrated Gas’s revenue for the quarter $373.9 million, down by 39% on the previous quarter due to lower realised prices. From Energy Markets segment, the company reported electricity sales of 8.7 Terrawatt hour (Twh), up 11% on the previous quarter. The Retail volumes during the quarter were 5% higher than pcp, mainly due to increased residential demand, a cooler winter and higher customer numbers (0.2 PJ). Further, the Natura gas volume stood at 72 PJ, up 7% on the previous quarter. During the quarter, the company re-commenced its operations in the Beetaloo, after pausing activity in March 2020 due to COVID-19.

Q3FY21 Performance Summary (Source: Company Reports)

Key Risks: The company is exposed to the risks related to the changes in energy demand, driven by price, consumer behaviour, mandatory energy efficiency schemes, government policy, weather and other factors that can create revenues uncertainty and impact future financial performance. 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.

Outlook: The company is progressing well with the exploration in the Beetaloo and has recently completed fracture stimulation which paves the way for extended production testing. The company is also making progress on the Kraken roll out, with a small team of energy specialists trained in the platform and ready to service the first cohort of 50,000 customers that are targeted to be migrated by the end of 2020.  Spot LNG prices are expected to recover in Q2 FY2021 with LNG spot prices now above US$6.50/mmbtu for December deliveries.

The company is progressing with plans to customise Octopus’ unique technology platform, Kraken, and adopt its globally distinctive retail operating model, with the aim of delivering a superior customer experience at market-leading cost. For FY21, the company expects Energy Markets’ underlying EBITDA to be in the range of $1.15 billion -$1.3 billion. The company expects strong demand for long-term contracts for the calendar year 2021. As a result, it has increased FY21 production guidance of APLNG (100%) to 675–705 PJ, from the previous guidance of 650–680 PJ. The company has also reduced distribution breakeven guidance to US$25-29/boe, from prior guidance of US$27-31/boe. FY21 free cash flow yield is expected to be between 12%-15%, reflecting resilient businesses with low-cost operations and limited near term investment required.

FY21 Guidance (Source: Company Reports)

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

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

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

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

Stock Recommendation: The stock of ORG has provided a return of 26.93% in the last one month and is currently trading below the average 52-weeks price level band, offering a decent opportunity for accumulation. On the technical analysis front, the stock has a support level of ~$4.569 and resistance of ~$6.465. We have valued the stock using an EV/EBITDA multiple based illustrative relative valuation method and have arrived at a target price of a low double-digit upside (in % terms). For the purpose, we have taken peers like AGL Energy Ltd (ASX: AGL), Santos Ltd (ASX: STO), Ampol Ltd (ASX: ALD), etc. Considering the company’s stable production performance in Q1FY21, growth in expected energy demand, APLNG’s FY21 production guidance, ORG’s long-term fundamentals, and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $5.090, down by 1.738% on 02 December 2020.

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

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