When asked for a strong investment idea on Livewire's Buy Hold Sell, Matt Williams offered up Origin Energy (you can see it here). So, for Livewire's 2018 season of Christmas Crackers, Matt expands on our investment case for this compelling opportunity in the ASX Top 20.
First up, what is Origin Energy?
Origin (ASX:ORG) is an integrated energy company with broadly two parts:
1. Gas exploration, production and conversion to LNG (via its interest in the APLNG project in Gladstone QLD)
2. Power generation and energy retailing. The firm has renewable energy investments including wind and solar.
5 reasons to own Origin
A material change in financial strength. Is entering a phase of significant free cashflow generation driven by their interest in the APLNG project in Qld, leading to rapid deleveraging of the balance sheet and reinstatement of the dividend in FY19
A large and profitable electricity and gas utility business that provides steady cashflow and earnings that should prove resilient in any broader economic downturn.
Cost out opportunity at the APLNG project which means this asset is not solely reliant on the prevailing oil price. Origin and its partners are confident of attaining a 10-15% reduction in operating costs by June 2019. This further lowers the oil price at which the project is cash break-even.
Group cost out opportunity – At last Friday’s investor day, management announced a broader company-wide cost out opportunity in excess of $150m… which is circa 10% of NPAT.
The Origin valuation is compelling, trading at ~10x FY19 P/E. On our estimates in the FY20, Origin could comfortably fund a 60cps dividend out of free cashflow whilst still investing in its utility business. This would provide shareholders with a dividend yield of almost 9% at the current share price.
Note that this 60cps assumption is based on an oil price and exchange rate broadly in line with the current spot price which we note has been sold down significantly over the last 1-2 months. It could also incorporate a 10-15% decline in utility earnings due to short-term regulatory risks, which we discuss below.
Two risks to consider
The government has targeted the electricity retailing industry following material price rises over the last 2 years. While there are several factors that have driven the rise in electricity prices, the Morrison government is intent on reducing prices ahead of any election in 1H2019. The risk that government intervention into the pricing of electricity leads to reduced earnings in the order of 10-15% is a possibility, however, we would expect the industry would be able to mitigate some of these effects.
Origin as a large and vertically integrated energy provider is well placed to deal with the current volatility in the industry. We believe this volatility is providing an opportunity to buy the stock at an attractive valuation on a medium-term view.
More insights from Airlie
Airlie is a specialist Australian equities fund manager which brings together some of Australia’s most experienced industry participants. You can read more of our team's insights here.