Investment Matters

Origin Energy: Powering ahead

Origin Energy is an integrated energy provider that is involved in power generation, energy retailing and the exploration/production of gas and oil.

It has 4.2m electricity, gas and LPG customers, produces 7,000 MW of electricity and supplies 281 petajoules of gas to customers around Australia [1].

Origin consists of two business segments: Energy Markets and Integrated Gas.

The company’s Energy Markets' business primarily provides gas and electricity to retail (households and businesses) and wholesale (other retailers) markets. Gas and electricity is sourced directly from its generation portfolio as well as contracted generators/producers.

The Integrated Gas business primarily refers to its 37.5% stake in Queensland’s APLNG project. The project (a joint venture between Sinopec, Origin and ConocoPhillips) is a major gas producer and exporter of LNG to Asia (with contracts to supply 8.6mtpa of its 9 mpta capacity for the next ~17 years). It has been able to capitalize on the increasing demand for natural gas, which is forecast to represent a greater part of the future global energy mix.

The following graph was included in Origin Energy’s Investor Day presentation late last year.  It shows the positive demand outlook for LNG in coming years:

Future LNG Demand graph

Performance to date

Origin was first purchased for client portfolios in October of 2015.

At the time, its share price had fallen considerably due to a depressed oil price, as well as the high level of debt taken on to fund the APLNG project. This culminated in the suspension of dividend payments and a capital raising in which we participated after assessing that its share price at the time attributed no value to its 37.5% stake in the APLNG project.

Since 2016, an increase in production and recovery in oil prices has seen the APLNG project become a substantial cash generating asset (with underlying operating earnings increasing from $386m in 2016 to $1.3 billion in 2018). In addition to this, its Energy Markets division experienced significant profit growth (with underlying operating earnings growing from $1.33 billion to $1.8 billion over the same period).

Over the period, the company implemented several measures to improve performance, including the divestment of non-core assets (such as Contact Energy and Lattice Energy) and a significant reduction in operating costs (including reducing the cost to serve customers, headcount, ceasing geothermal activities as well as unnecessary exploration and development). It has also made significant progress in reducing and refinancing its debt. It has reduced its leverage significantly (with its adjusted Net Debt/EBITDA reducing from 5.4x to 3.1x in 1H-19) as well as its net debt (adjusted net debt falling from $13.1 billion in 2015 to $6.0 billion in 1H-19) and is on track to reach its gearing target (2.5x - 3.0x Net Debt/EBITDA) soon.

As a result, Origin has been able to reinstate dividend payments this year, for the first time in three years. Furthermore, this week credit rating agencies S&P and Moody’s upgraded the company’s credit rating (from BBB- to BBB and Baaa2 from Baaa3, respectively).

This as a testament to the significant turnaround that management has instituted since our initial investment.

Outlook for the future

We anticipate that the APLNG project will continue to generate stable, substantial cash flows into the future. Demand is assured through long-term contracts (and there is a favorable outlook for future LNG market demand), while we assess that the project’s substantial reserves (the highest 2P reserves of any Queensland LNG exporter) positions it favorably relative to its peers, in terms of surety of supply. Furthermore, the company continues to drive cost improvements that will reduce the project’s operating breakeven and distribution breakeven costs and ensure its long-term profitability/competitiveness.

While Origin’s Energy Markets business is facing increasing competition as well as regulatory and policy uncertainty, we assess that much of this uncertainty has been factored into the company’s share price. We believe that the potential upside from its stake in the APLNG project outweighs short term challenges to its Energy Markets business.

Furthermore, Origin has several options for growth, including the highly prospective Beetaloo Basin project (a potential multi-decade opportunity) which provide additional upside potential.

As Origin draws closer to its target debt level, we assess that it will be able to pay materially higher dividends in the future as well as fund further value additive growth options.

[1] Figures as at end of FY-18 and for the period of FY-18.

 - Paul Grace