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Morningstar | Origin’s Recover Rolls On; Dividends Restarted

No-moat Origin Energy maintained its fiscal 2019 earnings and production guidance at its December investor day. We maintain our fiscal 2019 earnings forecasts but make some minor adjustments to medium-term assumptions. We remain comfortable with our AUD 7.50 per share fair value estimate, with the stock currently trading at an 8% discount.

In the utility side of the business, Origin estimates the cost of the government enforcing a default retail electricity price to be around AUD 120 million per year. In response, the firm is targeting cost savings of AUD 100 million by fiscal 2021 by investing in IT systems to increase automation of operations and customer interactions. It will also be simplifying its offers and focusing on targeted advertising and data analytics. We don’t expect competition to erode the benefit of cost savings as pressure on prices is coming from regulation, not competition, and all the major players will be looking to offset reduced pricing.

On the generation side, management discussed the huge amount of new wind and solar farms being developed and how this will bring wholesale electricity prices back down, at least when the wind is blowing and the sun is shining. Focus is on developing a more flexible generation portfolio to fill in the gaps left by intermittent renewable energy, such as expanding capacity at its pumped hydro station in the Shoalhaven and upgrading the Eraring coal-fired power station to make it more flexible. However, management has some justified reservations about investing in the sector given heightened levels of government intervention.

In the LNG export business, APLNG, management hopes to further reduce distribution breakeven--the oil price needed for APLNG to pay dividends to investors--to USD 35 per barrel by reducing costs via productivity improvements. Refinancing debt will also help by reducing the mandatory debt repayment schedule under the original debt facilities.

Interestingly, one customer has elected to defer delivery of 30 cargos over six years from 2019 to 2024. The customer will pay for the cargoes as per the original schedule and take delivery six years later for no further payment. As APLNG can sell the original cargoes on the spot market, there will be a boost to revenue in the medium term with an offsetting reduction in the longer term. We view this positively, as it’s better to get more money now rather than later, particularly as this will help get financial leverage under control quicker. Assuming an equal spread of five cargoes per year, that is around 20PJ, or 3% of APLNG's production, per year.

Dividends have been reinstated at AUD 0.20 per share in fiscal 2019, in line with our prior expectations. We previously thought dividends would increase to AUD 0.35 in fiscal 2020 as more comfortable financial leverage would allow strong free cash flows to be diverted to dividends. But management appears to be prioritising capital expenditure in the utility business and progressing the large undeveloped Beetaloo gas project. Thus we reduce medium term dividend forecasts. Eventually, dividends could go much higher, potentially to more than AUD 0.50 over the medium term. Focus is also on refinancing debt and securing lower interest rates as financial leverage improves. Ironbark, the other large undeveloped gas project, is likely to be sold.