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Morningstar | Origin Posts Strong FY18; Guidance Disappoints

No-moat-rated Origin Energy's underlying EBITDA increased 36% to AUD 2,947 million, driving a 110% increase in fiscal 2018 underlying NPAT to AUD 838 million. The result was good, but a little below expectations because of higher corporate costs and a slightly weaker-than-expected result from the integrated gas divisions. The utility business was in line with expectations and guidance. Forward guidance disappointed, with EBITDA in the utility business to fall around 6% in fiscal 2019, mainly because of competitive pressure. Considering medium-term headwinds from government policy to improve utility bill affordability, it is hard to see where earnings growth will come from in this division. The other negative surprise was an outlook for higher maintenance capital expenditure at Origin's LNG export business than we previously assumed. We downgrade our near-term earnings forecasts in line with guidance but remain comfortable with our AUD 8 fair value estimate. We continue to think the stock is modestly overvalued, despite falling 6% after releasing its financial results.

Energy markets--the utility business--underlying EBITDA increased 21% to AUD 1,811 million, in the middle of the guidance range and in line with expectations. Growth was driven by stronger wholesale electricity and gas prices, as well as stronger gas sales volumes as major peers faced gas supply constraints. Electricity sales volumes fell 5% on customer losses, milder weather and ongoing improvements in energy efficiency. The firm upped efforts to defend market share amid intense retail competition, pushing costs to acquire and maintain customers higher. Underlying EBITDA guidance disappointed, coming in at just AUD 1,500 to 1,600 million. This is 14% lower than fiscal 2018, part due to tough retail competition and part due to a change in the treatment of electricity hedge premiums.

The latter suggests this division was overstating earnings in prior years, a corporate governance concern and highlighting the risk of relying on unaudited management adjusted earnings numbers, particularly when companies are facing financial difficulties, as Origin was.

Integrated Gas, which primarily comprises the 37.5% stake in the APLNG LNG export business, reported underlying EBITDA of AUD 1,251 million on stronger prices for LNG and domestic gas and ramp up of LNG production. LNG prices are based on oil prices, which have more than doubled since early 2016. The Brent oil price is currently USD 73 per barrel, 22% higher than our long-term forecast of USD 60. Domestic gas prices have also risen strongly in recent years because of export pricing parity caused by LNG export and domestic supply shortages, though most of the APLNG's sales are under low-priced contracts. Earnings should strengthen as these contracts progressively roll off.

Balance sheet continues to improve. Gearing reduced to 35% from 42% last year, and debt/EBITDA fell below 3.5 times from close to 5 times in fiscal 2017. While the firm remains much higher leveraged than peers, gearing is getting close to management's target and dividends are likely to be reinstated in fiscal 2019.