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Treasure Chest: Underweight On Origin

Treasure Chest | Jul 06 2022

This story features ORIGIN ENERGY LIMITED. For more info SHARE ANALYSIS: ORG

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Jarden initiates coverage of Origin Energy with an Underweight rating.

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Origin Energy ((ORG))

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Stockbroker Jarden has initiated coverage of Origin Energy with an Underweight rating and $5.30 target price, citing uncertainty over the availability of up to 60% of coal supplies for the company’s Eraring power station. The sudden loss of supply comes at a time of record coal, gas and electricity prices, the broker notes, and thus not a good time to be short generation.

Within its valuation, Jarden’s below-consensus forecast for FY23 electricity profits more than offsets an above-consensus view for gas profits, and a positive outlook for distributions from Origin’s 27.5% owned APLNG project.

Otherwise, highly elevated commodity prices are supportive of most of Origin’s activities – oil, gas and LNG – into the medium term, the broker notes, and for electricity, Jarden expects strong futures prices to flow into retail revenue over time, as do other analysts covering the sector.

However, with up to two-thirds of the company’s supply portfolio partly or wholly exposed to very high coal and electricity prices, the market could be materially underestimating the cost to cover Origin’s short electricity position, Jarden warns.

Origin management’s recent decision to withdraw previous FY23 energy markets earnings guidance of $600-850m highlights the current challenges in forecasting earnings from this segment. Jarden estimates anything between an $880m profit and a -$240m loss are possible depending on coal costs, market hedges and Eraring output.

Last month, in the east coast freeze, Eraring power station — the biggest in Australia — had reported difficulties in securing sufficient supplies from its main coal mine after heavy rains during the autumn had disrupted mine operations. It was also not clear whether powers could be used to divert coal supplies that were otherwise destined for export.

That was when the Australian Energy Market Operator was forced to jump in.

If Origin were to execute electricity market hedges with perfect foresight, and were able to secure coal well below spot prices, then Jarden suggests the upper end of its earnings forecast range is possible. But the broker takes a more cautious stance, assuming minimal advantages in securing spot coal and assuming the east coast electricity squeeze was not anticipated by management.

Origin’s current strategy to replace Eraring’s generation after its optional FY26 closure leans towards low-capital options, such as power purchase agreements (PPA), which include paying for solar installation in return for the electricity at low cost, and hedging. To replace capacity, Origin is looking at batteries and “virtual power plants”, which use smart technology to direct power to where it’s needed from a “loop” of batteries.

This capex-light approach could allow for higher shareholder returns now that Origin has finally paid down its APLNG debt, but recent energy market volatility could force the company back to capex-intensive options such as building its own renewable plants.

Jarden is not one of the six FNArena database brokers who cover Origin, who between them currently have four Hold (or equivalent) ratings and two Buy.

Updating in mid-June, Macquarie saw downside risk to Origin's FY22 guidance given no management update due to uncertainty in energy markets, and as high coal prices continued to weigh upon generation at Eraring. Macquarie upgraded APLNG earnings estimates to reflect strong oil futures pricing and retained its Outperform rating.

Late in June, UBS lifted its forecasts for east coast contract gas prices due to few sources for material new gas supply and expected medium-term gas demand to remain resilient as coal-fired capacity retires. With Eraring by then back to full capacity, the broker saw Origin as best-placed to benefit from rising domestic gas prices. UBS has a Buy rating.

Hold ratings are to a large part reflective of Origin’s -13.5% share price during the two-week east coast power crisis.

The database consensus target is $6.54, suggesting 13.5% from the current price, and compared to Jarden’s $5.30.

Shares in Origin Energy peaked around $15 during the recovery from the GFC in 2010, but have never managed to revisit that level ever again. Over the past two years, the shares have temporarily traded below $4 but they bounced higher on sharply rising energy prices over the past months.

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