EUR 850.00 For Business Accounts Only

Morningstar | Sharp Oil Price Fall Hurts Earnings Outlook; Trimming FVE to AUD 7.50

The Brent oil price has fallen 28% to USD 62.5 per barrel from USD 84 in early October 2018. Lower oil prices detract meaningfully from no-moat Origin's earnings via its stake in APLNG, though we never baked in peak prices. We reduce our near-term oil price assumptions, resulting in our fiscal 2019 and 2020 net profit after tax forecasts falling by around 7%. We also slightly trim longer-term growth assumptions, and reduce our fair value estimate to AUD 7.50 per share from AUD 8. The stock is trading 13% below our new valuation, though this isn’t quite a big enough discount to consider Origin cheap given higher risk than other utilities because of its leverage to volatile oil prices, combined with high financial leverage.

APLNG is a major producer of gas and exporter of liquefied natural gas, with LNG prices linked to oil prices. In fiscal 2019, it requires an oil price around USD 40 per barrel to cover its operating costs, maintenance capital expenditure and meet its financial liabilities. As such, its free cash flows--which can be used to accelerate debt reduction or pay dividends to investors--at USD 80 per barrel are double what they would be at USD 60 per barrel. This operating leverage explains most of the volatility in Origin's share price in the past few years.

The other key driver for Origin is conditions in electricity markets. While underlying conditions remain favourable because of high wholesale gas and electricity prices, government pressure will limit the ability of Origin and peers to pass high prices through to end users via retail price increases. With the Labor government likely back in power in Canberra next year, the risk of government intervention will only rise. Management guided to a mid-single-digit percent fall in EBITDA in its utility division in fiscal 2019, which it likely remains on track to achieve.