Upgraded Reserves Sparks Valuation Upgrade For Origin

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This story features ORIGIN ENERGY LIMITED, and other companies.
For more info SHARE ANALYSIS: ORG
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

What price Origin Energy ((ORG))? That is the question most in the market are asking after the company last Friday turned down a revised takeover offer of $15.50 per share from UK group BG, citing as its reason for rejecting the offer the fact it didn’t reflect the value of its gas reserves and resources.

Just to highlight this the company at the same time announced a significant increase in its coal seam gas reserves, increasing those in the 3P (proved, probable and possible) category by 121%. This has driven significant upgrades to broker valuations on the stock, as the recent spate of deals in the sector and in particular the Santos ((STO))/Petronas deal means the market is willing to ascribe much higher values to such gas reserves than was previously the case.

As examples Credit Suisse analysts now have a price target on the stock of $20.00 compared to $16.33 previously, JP Morgan has bumped its target up to $18.00 from $14.70 and Citi has lifted its target almost 50% to $23.70. These changes have pushed the average price target according to the FNArena database to $16.67, up from $13.79 previously.

But what is Origin’s future now? According to Credit Suisse there is not much chance BG will return with a sweetened offer, the broker suggesting the most likely outcome is Origin does a deal similar to the Santos/Petronas deal and sells down a portion of its equity in its coal seam gas fields, with something in the order of a 20-40% selldown considered a possibility.

The multiple a partner/suitor is prepared to pay for these reserves becomes the main valuation yardstick for the company, with Credit Suisse suggesting on its previous methodology of risk weighting 3P and contingent reserves and using an oil price of US$85 dollars per barrel it is possible to come up with a valuation of more than $20.00.

JP Morgan points out if BG were to return as a bidder and offer the same multiple for the group’s gas reserves as other recent transactions in the industry it would imply an offer price of something in the order of $26.29 per share.

The broker does make the point this price assumes no valuation discount for the integrated nature of Origin’s current business structure or the fact the company isn’t developing an LNG project for the gas itself. A reasonable discount in its view would be in the order of 25%, meaning BG would need to pay a price approaching $22.00 per share.

Whether such a price would be enough depends on the actual size of the company’s gas reserves, as while the revised numbers indicate 3P reserves of more than 10,000PJ Citi notes an independent consultant’s report suggests contingent reserves could see this number more than double in the future.

The size of the reserve upgrade leads Citi to suggest there is also strategic value in the reserves given the race to build an LNG project in Queensland, ABN Amro taking the view there is now something of a race between BG and Santos/Petronas to see who will be able to lock Origin’s reserves into their project first. This may not be necessary though, as according to UBS it now appears there is enough gas that Origin could sell to both the Santos/Petronas project and to the BG project if it so desired.

With management having revealed some third party interest in the assets Citi points out any deal will monetarise the value of the reserves, so there is scope for anything from a joint venture to asset sales or a de-merger of the coal seam gas assets.

With the market clearly having under-appreciated the worth of the group’s gas reserves, ratings have been upgraded to reflect the new valuation multiples being applied to reserves, such that the FNArena database now shows Origin as being rated as Buy five times, Accumulate once and Hold three times compared to two Buy ratings for the stock last week. While one of the brokers to upgrade the stock to a Buy rating today ABN Amro does highlight taking a medium-term view the market appears to be getting a little excited and is underestimating the risks associated with establishing an LNG project.

Shares in Origin today are slightly stronger despite a weaker overall market and as at 1.00pm the stock was up 23c at $15.83.

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