Andrew Lewandowski

Origin Energy (ORG) is an Australian energy company with two key divisions: Energy Markets, an Integrated Utility business that generates electricity and sells electricity and gas to household and business customers; and APLNG, a high‑quality liquified natural gas project in Queensland. ORG has a market capitalisation of $13 billion.

 

 

ORG delivered a half-year profit result ahead of market expectations, with both of its divisions delivering solid results. 

The critical aspect for ORG investors is it is generating extremely strong free cash flow (>$2bn per annum) and reducing its debt levels significantly. We expect Origin will be within its target gearing range by the end of FY19. We believe this will lead to a substantial increase in dividends from FY20.  

For the first time in many years, ORG announced a dividend of 10 cents per share with its half-year result (full-year guidance: 20 cents per share).  Even more importantly, Origin will be able to comfortably increase dividends to >45 cents per share in FY20 on our estimates, representing a dividend yield of >6%.

Underpinning our expectation for rising dividends is a 15% free cash flow yield at current oil prices on our estimates.  This is a significant anomaly given the quality of ORG’s asset base. As an increasing portion of cash flow is returned to shareholders via higher dividends, we expect ORG to trade up to over $9.00 per share over the next 12 months. We believe the strength of Origin’s free cash flow is more than enough to provide a large “margin of safety” ahead of any potential future regulatory changes in the Utility sector.

Importantly, we believe Origin has many levers at its disposal to further grow free cash flow into the future (under current oil prices):

  • $100m cost-out program in its Energy Markets business, to help offset retail margin compression
  • Reducing costs in its APLNG liquified natural gas business by over 10% (from US$39‑42/bbl to a target of US$35/bbl), representing a $150m per annum boost to ORG’s free cash flow
  • Reduced hedging costs. With Origin’s balance sheet rapidly de-gearing, ORG can now reduce its reliance on expensive hedging contracts over oil and LNG prices. In FY19 alone, Origin has guided to c.$200m in oil and LNG price hedging costs. 
  • Potential to refinance its EUR1bn hybrid debt from Sep 2019, which could reduce annual interest costs by $50m per annum

Over the last few months, Origin’s share price has lagged the performance of both oil & gas pure‑plays (e.g. Santos) and integrated utility pure-plays (AGL Energy). We believe this is primarily due to its conglomerate structure – with investors seeking oil price exposure gravitating towards oil & gas pure-plays, while AGL has been the beneficiary of investors seeking Integrated Utility exposure.  We think this is a short-term market inefficiency that will resolve over the months ahead, particularly as investors gain an appreciation for Origin's strong dividend paying potential from FY20.

 



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