Dividend May Resuscitate Origin Energy

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This story features ORIGIN ENERGY LIMITED.
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Several brokers have found it hard to become positive about Origin Energy amid the challenges in the energy market and sizeable reductions to FY19 guidance.

-De-leveraging considered no longer enough amid weaker guidance
-APLNG expected to break even on costs in FY19
-Management indicates dividends to recommence in FY19
 

By Eva Brocklehurst

The outlook for Origin Energy ((ORG)) is now materially softer and brokers suggest the company will have its work cut out in the months ahead to restore confidence. A resumption of dividends, as promised, may help.

Energy market earnings were $1.8bn in FY18, at the upper end of guidance and underpinned by a very strong performance in gas. APLNG sales were driven by mix of commodity price increases, higher LNG cargoes and a delay in supply coming online.

Yet the company has guided to FY19 energy market earnings of $1.5-1.6bn, which implies a decline of -6% year-on-year. The majority of the difference is a change to the accounting treatment of certain hedging contracts which were previously excluded from underlying results.

Moreover, Origin Energy indicated, in the integrated gas operations, a fair-value adjustment of $75-85m in FY19 as well as oil put options that add up to $150m. Adding these adjustments together results in a sizeable downgrade to operating earnings (EBITDA) forecasts for Ord Minnett, of -32% in FY19 and -21% in FY20. Thus, the broker finds it difficult to remain positive, given the scale of the downgrades and reduces its recommendation to Hold from Accumulate.

Citi's forecasts are also now materially weaker than previously modelled. Negative features include weaker growth in gas margins, higher capital expenditure, weaker cash conversion and delays to cost reductions. The broker downgrades to Neutral from Buy. 

Credit Suisse believes the de-leveraging is no longer enough and the magnitude of the challenges cannot be ignored. Guidance is well below prior forecasts and the broker becomes another one to downgrade to Neutral.

As the company is guiding to a modest increase in gas earnings, flat procurement costs and an increase in commercial prices, Credit Suisse suspects it is retail margins that are the weak link in guidance and does not expect any near-term improvement. Morgan Stanley is more positive about the APLNG outlook but reduces its valuation of the stock on re-based energy market earnings as well as a reduced margin for safety.

On a more positive note, UBS finds evidence the company is retaining and winning new customers, as retail customer numbers were up 1%. The broker considers the company well-positioned in an increasingly volatile electricity market as the generation business creates a natural hedge to volatile pricing.

Meanwhile, a combination of rising oil prices, increasing APLNG output and higher National Energy Market (NEM) electricity prices has improved the balance sheet. UBS believes the market has oversold the stock and maintains a Buy rating.

The company has factored in little impact from digitisation benefits into guidance, which could provide momentum from FY20 onwards, although Macquarie suspects this is at risk of being competed away.

Energy Markets

Origin is now recognising around $160m in annual insurance premiums within its electricity hedging portfolio as operating expenditure. The hedging portfolio is expected to evolve over time but Morgan Stanley does not consider the investment thesis that positive at present. Regulatory uncertainty and policy is manageable, nonetheless, and the broker expects cost reductions and falls in wholesale electricity costs will mitigate gradual losses of market share.

Structurally, Macquarie finds the energy market business attractive as the company's large short position in base-load generation allows it to capture falling electricity prices in its costs, while its gas plants, even though not being utilised, gain by selling gas and obtaining firm premiums in electricity.

APLNG

The company has reaffirmed a target for APLNG to break even in FY19 and has hedged around 73% of its share of contract LNG volumes. Despite success in reducing break-even costs to US$39/boe Morgans considers Origin Energy late to the party in view of the aggressive cost reductions that have already been completed by its peers.

The broker expects realised prices to continue trending higher for APLNG, with lagged oil-linked LNG prices. This should be partly offset by higher FY19 break-even guidance – US $39-44/boe – as exploration/appraisal expenditure recovers and infrastructure expenditure rises.

UBS anticipates a continued increase in distributions from APLNG as a result of higher prices and the focus on cost reductions. This should allow Origin Energy to achieve a net debt/operating earnings ratio of 2.5-3x by the first half of FY19 and this could lead to a reinstatement of the dividend.

Dividend

Origin Energy did not provide a final dividend, despite being well below its FY18 debt target of $7bn and amid strong operating cash flow from APLNG and energy markets. Subject to board approval, the medium-term outlook supports a recommencing of dividends in FY19, the company said. Still, Macquarie suspects it may take time to ramp up to a 60% pay-out.

FNArena's database shows three Buy ratings and four Hold. The consensus target is $9.54, indicating 10.7% upside to the last share price. This compares with $10.32 ahead of the results. Targets range from $8.80 (Citi) to $10.08 (Morgan Stanley).

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