Origin Energy Releases The Kraken

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Retail platform Kraken is expected to improve Origin Energy's customer relations, although brokers suggest implementing the licence is not without risk.

-Substantial cost reductions expected from FY24
-Main issue is whether Kraken gives the company an "unassailable lead"
-Balance-sheet capacity not considered an issue
 

By Eva Brocklehurst

Origin Energy ((ORG)) has secured the assistance of Kraken, a retail billing platform that is expected to transform the customer experience, making it more transparent and personalised.

The company has acquired a 20% stake in UK-based Octopus Energy, which owns Kraken. Origin Energy will have an almost exclusive license in Australia for Kraken, as Hanwha Energy acquired the license in April 2019 and established its presence in NSW, South Australia and Queensland.

Origin Energy has committed to a staged consideration over four years of $507m. Kraken is expected to deliver pre-tax cost savings of $70-80m in FY22, increasing to $100-150m annually from FY24. Morgans assesses the company is taking a bold step, despite tighter cash flow, and upgrades to Add on the back of the cost reductions likely to emanate from the investment.

Yet Macquarie points out these cost savings come with execution risk and the Kraken platform relies on uptake of smart metres to unlock the full value addition. This is a hidden cost as new smart metres are more expensive.

There is also transition risk, because moving to new technology is a significant step-change for the company, despite Kraken having an operating presence in Australia. Origin Energy expects to become the lowest cost service provider in the Australian market but Macquarie expects other major energy suppliers will seek to realise similar cost benefits.

Replication

UBS interprets the stake as a "package" that came with the Kraken licence and therefore not indicative of plans to grow materially in the UK, calculating the consideration is expensive relative to recent UK transaction multiples, as Octopus Energy is currently making a loss. Still, provided risks are managed and the platform cannot be easily replicated, the transaction should be accretive, although not positive for free cash flow until FY24.

The main swing factor for Citi is replication and whether Origin Energy can attain an "unassailable" position in its cost to serve the Australian energy retailing market. This may be possible initially, but not forever and the broker assumes synergies are offset by margin implications as other retailers improve capabilities over time.

Returns could also be jeopardised by poor implementation, with Citi calculating a $100m cost increase and one-year delay would reduce the valuation uplift to 7% from 9%.

There could be other upside opportunities besides the cost savings. The equity interest, UBS points out, could provide contracted licensing revenue and/or retail revenue along with additional revenue from new products supported by the Kraken platform.

Balance Sheet

While Origin Energy has the balance sheet capacity to fund the partnership, UBS notes stresses could arise if oil prices stay below US$30/bbl in FY21. Origin Energy has indicated asset recycling can support the balance sheet if necessary.

UBS expects non-core assets will be the focus, although sales within APLNG could be considered, while Citi doubts a buyer exists for a minority interest in APLNG and suggests non-core asset sales in energy markets are more likely.

Citi is not concerned about the company's creditworthiness, expecting existing liquidity can repay the $1bn maturity in November, also assessing Origin Energy could refinance at a lower cost of debt if necessary.

The broker assumes Origin Energy raises $1bn in new debt in the first half of FY21, given the acquisition and a period when APLNG will probably be in cash lock-up. Moreover, investors should be encouraged that names such as Transurban ((TCL)) APA Group ((APA)) and Telstra ((TLS)) have raised substantial amounts in eurobonds in recent weeks, a market which Origin Energy has previously tapped.

FNArena's database has five Buy ratings and two Hold. The consensus target is $6.64, signalling 19.4% upside to the last share price. The dividend yield on FY20 and FY21 forecasts is 4.8% and 4.4% respectively.

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