Origin Energy: inexpensive large cap growth company
Origin Energy is much better known to long term clients of First Samuel.
Origin Energy is one of Australia’s largest producers (and sellers) of energy. It has 4.3m electricity, gas and LPG customers (that represent 29% of the National Electricity Market (NEM)), produces 6,000 MW of electricity and produces and transports 147 petajoules of gas to customers around Australia.
As clients will know we acquired shares in Origin in February 2008 (firstly for $8.46ps) and were richly rewarded selling them at a considerable profit by 2013 (last price $11.97ps), which also included many strong dividends along the way. The key driver and feature during our ownership being the original investment by Conoco Phillips (which sharply rerated Origin) and then the start of building the APLNG plant in Gladstone, Queensland. We elected to sell for a number of reasons, but concern over the oil price (which was at that point >$120/barrel) and risk around development at APLNG.
Since that time the decline in oil prices has put significant pressure on the economics of APLNG, and given the debt taken on to build it started to put real pressure on Origin's credit rating. Whilst Origin was never in any risk of not paying its interest, the credit rating was essential as it is required to be able to do business in the NEM. As a result Origin elected to raise money via a $2.5b entitlement offer. And now, along with reprioritising its capital and operating spending for the next two years, it is in a very strong position to ride out any further weakness in oil that may occur.
As a result we saw the current price as an excellent opportunity to capitalise on the appearance of distress in what is a large (top 50) company, but that has strong quality cash flows and growth potential.
At the price we paid Origin's core business (Australian gas production, electricity production & retailing) it is trading on a prospective net cash flow return of 11.3%pa (or P:Cashflow of 8.9x). This is after all capex required to stay in business (but before dividends). This is a very strong cashflow return and compares very favourably to AGL on 7.7%pa (13x), and Woodside 9.3% (10.7x) and Oil Search 7.2% (13.9x). AGL is probably the best comparison for this part of the business, and a comparative price would see Origin worth $8ps). We acquired our shares for ~$5.50 on average.
This cash flow valuation puts no value on the 37.5% of the $24.7b (cost price to build) APLNG business. Whilst oil prices (which directly relate to LNG export prices) may batter this business for some time (it is still cash flow positive operationally at oil prices 50% below the A$ price today) at current A$ oil prices it should generate $0.28ps of distributable cash to Origin per year (from 2017) which means it is unlikely the business is worthless! APLNG is a long-term cash producing asset, in time this will be recognised by the market.
So whilst we are not sure (nor ever are) what will happen to the market and Origin's share price in the short-term, we are very confident that at these levels, Origin will represent a great investment for clients in several years’ time.