Is Origin Energy Oversold?

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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

-More clarity on costs needed
-Gas remains the bright spot
-S&P assuages debt concerns
 

By Eva Brocklehurst

The market remains fixated on the potential start up of the Australia Pacific LNG (APLNG) project, in which Origin Energy ((ORG)) has a 37.5% interest. The company delivered some insight in its December quarter production report, as the project gears up for first cargoes mid year.

APLNG is 88% complete, with all major upstream fields ready to produce from the 1019 wells drilled. Downstream commissioning activities have commenced. The project does not need to be 100% complete for first gas, given the staggered nature of the start-up. Morgan Stanley observes the project requires oil prices at US$48/bbl to generate positive cash flow to Origin. The broker retains an Overweight rating, noting elsewhere in the energy sector the company has made significant investments in unconventional and undeveloped gas but these are long dated and will likely require substantial capital to move to commercial status. The broker considers a review of the options may be prudent.

Citi continues to expect a modest cost over-run at APLNG of about 5.0% but, given there was no update as yet, expects this will be clarified at the first half result. The broker also expects to hear more about cost savings generally, expecting guidance on possible opportunities on that front given Santos ((STO)) has reduced its GLNG 2015 capex estimate by $50m, largely emanating from service costs.

Another broker has highlighted the fact that Origin dispensed with its tradition of providing detailed guidance back in 2013, even at its full year result, and suspects it unlikely this will change at the interim results. Continued steady ramp up at APLNG and GLNG should help to de-risk the projects, as potential delays and cost blow-outs remain a niggling concern.

There may be justifiable concerns but Morgans considers the sell-off in the stock is overdone. The broker cities the long-term nature of the company's contracts and the fact that APLNG does not fully ramp up for 9-12 months. The stock offers an attractive yield, and on this basis Morgans retains an Add rating. There are risks, the broker acknowledges, and these include lower oil prices, capex increases and adverse currency movements, as well as lower electricity prices.

Investors are now focused on how much revenue will be forthcoming now the start date for APLNG is nearing. UBS observes there are few expectations for near-term profit at APLNG and considers this both good and bad. March and June quarters will be key to how smoothly commissioning is progressing and the broker holds off on making a definitive call on start-up. Gas profits will largely depend on how much "ramp up" gas was bought and sold to the retail customer base. There is likely to be some recognition of the value in the stock from first LNG at APLNG, providing the cash flow to service debt, in Macquarie's opinion.

Gas remains the bright spot for the company, with a hopes of a colder winter and the repricing of the retail market in NSW and Victoria, reflecting anticipation of higher prices for LNG even though this is yet to occur. Discounting in Origin's retail segment remains significant, increasing in both NSW and Victoria. Demand is also decreasing. Macquarie notes a shift in the generation mix with the ramp-up of Eraring. Internal energy generation has increased 37%, principally from Eraring, which bodes well for improved profitability, although hedging and ongoing discounting could erode these efficiency gains. Similarly, LPG profitability is potentially challenged by a falling oil price.

Macquarie considers the stock represents value, but its diversification has currently encompassed the worst of both falling oil prices and the structural changes in electricity usage. Beyond APLNG start up, a higher oil price is needed to drive confidence. On the back of Macquarie's forecasts the stock remains attractive and an Outperform rating is retained.

JP Morgan notes the next few years should be better for energy retailers operating in a deregulated market, although the performance to date in FY15 has been marred by weaker energy consumption. Of comfort to the broker is the news that Standard & Poor's has reaffirmed its view on Origin, given there were questions regarding the company's debt situation with the decline in oil prices. S&P maintains that, for Origin to lose its investment grade credit rating, the debt/earnings ratio over a three-year average would have to be a full 100 basis points higher than current expectations. In other words, JP Morgan calculates its oil price forecasts would need to reduce by US$22/bbl across the next three years for the credit metrics to be stressed to the point where S&P would act.

On FNArena's database Origin Energy has seven Buy ratings and one Sell (Credit Suisse). The consensus target is $13.62, suggesting 24% upside to the last share price. Targets range from $12.00 (Credit Suisse) to $15.40 (Morgan Stanley). The dividend yield on FY15 and FY16 forecasts is 4.6% and 4.8% respectively.
 

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