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Morningstar | Higher LNG Prices Drive Good 1H for Origin

No-moat-rated Origin Energy had a good first half, with underlying EBITDA up 20% to AUD 1.7 billion and underlying profit up 53% to 592 million, mainly on stronger LNG export prices and lower interest expense. EBITDA in the utility business, known as energy markets, was flat, while integrated gas EBITDA jumped 43%. Headwinds will intensify in the second half, and full-year profit growth is unlikely to be as strong. We increase our earnings forecasts for the integrated gas division on the recent improvement in the oil price and a faster than expected improvement in domestic gas prices. Our fair value estimate increases 4% to AUD 7.80 per share. At current prices, the stock is fairly valued.

Origin’s earnings can be highly volatile because of its exposure to oil prices and high fixed costs. We’d prefer it used more hedging to lock in prices in coming years to ensure financial leverage continues to fall towards appropriate levels. Net debt/adjusted EBITDA including dividends from APLNG was 3.1 times at December 2018, down from 5.6 times a year ago and closing in on management’s target of 2.5 to 3.0 times. Financial strength has improved hugely but further improvement is needed. To put in perspective, AGL Energy has net debt/EBITDA of around 1.1 times and much more stable earnings. We forecast Origin’s net debt/EBITDA falls to appropriate levels around 2 times in 2021, though this could be derailed if the oil price falls sharply. An improving financial position should translate to ongoing interest savings as more debt, including expensive hybrids, can be refinanced at cheaper rates.

Dividends were reinstated, with AUD 10 cents per share fully franked in the first half and management guiding to the same again in the second half, in line with our prior expectations. At the current price of AUD 7.65, Origin offers a paltry 2.6% yield but there is plenty of upside to payout ratio, which is around 33% in fiscal 2019, as financial health improves.

Energy markets EBITDA rose 2% to AUD 852 million in the first half as lower electricity earnings were offset by sharply high gas earnings. The full-year guidance range of AUD 1.5 billion to 1.6 billion is unchanged. Electricity gross profit fell 7% to AUD 719 million on lower volumes and lower average retail prices. Downward pressure on retail prices stems from measures to help alleviate concerns from the 2018 government electricity price review, including extending discounts to more customers and offering relief for hardship customers. Electricity earnings should fall further in the second half on price relief measures, nonrepeat of renewable energy credit trading gains and continued intense competition. Focus is on reducing costs to serve customers and improve customer experience by investing in IT and digital platforms.

Still in energy markets, gas gross profit increased 24% to AUD 398 million on higher prices for large business customers. These customers sit on multiyear contracts, so there’s a lag in pushing through higher wholesale gas prices. Additionally, gas earnings benefited from diverting gas from its own power stations and instead selling the gas to wholesale customers. Guidance is for second-half gas earnings to be flat on the previous corresponding period, or pcp.

The integrated gas division, mainly consisting of the 37.5% stake in the APLNG export business, was again the star performer, with EBITDA up 43% to AUD 900 million. The good result was mainly driven by a 40% increase in realised LNG prices, which are linked to oil prices with a few months lag. First-half earnings also benefited from higher average prices for domestic gas sales, though prices received remain well below spot prices because of long-term, low-priced contracts. We expect further upside to earnings as these domestic gas contracts end over the longer term. Costs rose on higher royalties, gas purchases, and price hedging.

Guidance is for full-year APLNG production of 665 to 685 petajoules; our forecast is close to the midpoint. APLNG’s focus remains on reducing costs to drill and operate wells. Its fiscal 2019 distribution breakeven guidance is broadly unchanged at USD 39 to 42 per barrel of oil, while Brent oil prices sit today around USD 66 per barrel. This suggests strong free cash flows at APLNG and dividends paid to Origin will continue, despite the sharp fall in oil prices late last year.

Origin recently sold its undeveloped Ironbark gas field for AUD 231 million to APLNG, which, due to proximity to existing infrastructure, will develop it more efficiently. Origin continues to progress its other, large undeveloped gas field Beetaloo in the Northern Territory, with results from production tests expected later this year.