Origin Energy Surprises To The Downside

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Origin Energy posted surprisingly weak FY24 numbers and FY25 guidance, but most brokers feel value is clear after a rebasing.

-Origin Energy’s FY24 results disappoint
-FY25 guidance disappoints more
-The company is still trying to reduce costs
-Kraken provides growth opportunity
-Most brokers retain positive views

By Greg Peel

Origin Energy’s ((ORG)) profit grew 58% year on year in FY24 but fell significantly short of market expectations. The final dividend, and FY25 guidance, also fell short.

The key down-driver was Origin failing to meet its targeted reduction in cost-to-serve of -$200-$250m by the end of FY24 due to cost of living pressures driving higher retail call volumes, in turn seeing higher labour costs, bad debts expenses and growing regulatory and compliance costs creep into the business, UBS notes.

Looking forward, Origin has a clear plan to realise targeted cost to serve reduction by -$100-$150m by FY26, via reducing headcount, compliance costs and improving debt collection.

The rebound in Energy Markets disappointed by being in the lower half of $1.6-$1.8bn guidance, arguably caused by Eraring generation issues in the June quarter, Macquarie suggests. Asia Pacific LNG (APLNG) earnings were in line with expectation, with a higher cash cost in the second half that’s been flagged to continue into FY25.

Earnings from Origin’s strategic UK partner Octopus were lower, with UK retailing renewable certificate costs higher along with product development costs. Core to the value are customer numbers, Macquarie notes, which continue to grow, and rollout of the new customer service platform, Kraken, for which commitments remain well ahead of licence revenue.

Cost-serve pressures are industry-wide headwinds, but Morgan Stanley suggests AGL Energy ((AGL)) and Energy Australia look better placed to manage the challenges this cycle, and believes investors had anticipated Origin having Kraken-based savings, which are taking longer than anticipated, as well as more leverage to pool volatility.

FY25 Guidance

FY25 guidance disappointed, with expected operating earnings of $1.11.4bn from Origin’s key energy markets business being lower than the FY24 result, Ord Minnett notes, as the division grapples with higher coal costs, narrower margins from gas, and regulatory pressure on electricity prices.

The broker also notes FY25 operating earnings guidance for the Octopus business is a wide range of $100m-200m, largely due to a time lag in converting new users of the Kraken platform to paying subscribers and as British regulatory costs have proved a drag.

The reduced rate of earnings growth over FY25 and FY26 from the Octopus business is the key driver of cuts to Ord Minnett’s group earnings and dividend forecasts over FY25-27.

Citi anticipated FY25 guidance being below consensus which could present a buying opportunity before medium term earnings growth. The trough now looks deeper than expected, but on the conference call management quite explicitly confirmed Citi’s thesis that Origin can outperform its own gross profit forecasts as wholesale volatility flows through into retail margins via the regulated tariff.

Origin’s energy costs rise more slowly than the industry’s. The -$100m downgrade to targeted reductions in cost-to-serve by FY26 is also more likely around a -$70m impact to earnings, the broker suggests, because bad debts and some of the compliance costs that dragged the target down can be recovered in future tariff determinations.

The regulator has little public data to work with on treating bad debts in the industry’s cost stack when determining the regulated tariff, Citi explains. Origin’s disclosures form a key component. Because the FY24 data will feed into the next determination in May 2025, Origin will recover the higher bad debt costs via FY26 revenue.

Compliance costs may have some partial recovery, though since some of this cost is Origin-specific, Citi doesn’t think all of it will be recoverable.

Green Machine

UBS forecasts margins towards the top end of Origin’s “base” medium-term electricity and gas portfolio margin targets, supported by earnings contributions from new batteries and renewables. By the end of FY27, this broker forecasts more than $300m on additional earnings via commissioning batteries across NSW, Victoria and Queensland, as output at Eraring power station begins to wind down out to December 2028.

UBS expects gas portfolio margins to expand as the supply contract to Gladstone LNG expires, allowing it to sell that gas into higher priced demand. A potential development of the Golden Beach storage asset could allow Origin also unlock a valuable option on some 35PJ of new gas supply and storage capacity, potentially adding margin upside.

All is not Lost

Citi saw nothing in the FY24 report that suggests its thesis on Origin Energy is incorrect, which is to say volatility in the National Energy Market is increasing and Origin is the best placed player in the market to capture this.

Because Origin’s costs in electricity procurement rise more slowly than the industry’s, and the industry’s costs determine the retail tariff, the difference in cost growth is margin in Origin’s retail book. The broker thinks wholesale volatility leading to retail margins is the missing link in consensus assuming flat earnings in the medium term.

The result nonetheless shows this is perhaps off a lower base, with FY25 guidance being -$100m lower than expected. Citi retains a Buy rating, lowering its target to $11.00 from $11.50.

UBS’s revised outlook anticipates a 16% compound annual earnings growth rate for energy markets over FY25-27, supported by Origin’s unique leverage to the growing value of firm capacity due to operating the largest fleet of peaking gas-powered plants in the country.

Origin also has a competitive advantage on gas supply and a strong free cash flow profile supported by APLNG, this broker notes, altogether providing a clear path to strong capital returns including dividend yields of 5-6% over the period.

UBS retains Buy, cutting its target to $11.70 from $12.10.

Goldman Sachs retains Buy on strong cash flow and returns, with free cash flow yield improving to 8% in FY26, supporting a 6% dividend yield. Goldman also highlights a standout gas portfolio with supply costs over -30% below current contract prices which could support market share gain or margin expansion over the next five years, and a growth opportunity through Octopus and Kraken as contracted accounts trend to target doubling over the next three years.

This broker’s target falls -4% to $10.75.

The disappointment of the FY24 performance and FY25 guidance notwithstanding, Origin Energy has quality assets in its portfolio and is a very good business, Ord Minnett insists, and even on downgraded dividend forecasts offers a strong dividend yield of 6-7% over FY25-FY27 following the steep fall in the share price post the results.

Given this robust level of income, the attractive prospects for earnings growth in the medium term from Origin’s role in the energy transition and the further development of its Octopus business, along with the upside to an $11.60 target price, increased from $11.20, Ord Minnett raises its recommendation to Buy from Hold.

But some is

Macquarie points out the second half FY25 is likely to see a change to the oil-linked pricing slope at APLNG through the contract reopening, with recent pricing suggesting a reduction of -13%, below APLNG’s current level. The cash flow impact of any change is principally expected in FY26.

Disappointing FY25 guidance affects confidence in the Energy Market growth outlook, Macquarie suggests, and there will also be uncertainty around APLNG slope repricing. The positive is a 6% dividend yield, which the broker sees as holding, and the balance sheet is under-geared, providing flexibility for transition growth.

Macquarie downgrades to Neutral from Outperform, dropping its target to $10.12 from $10.74.

On Morgan Stanley’s estimates, Origin Energy offers a one-year total shareholder return of -3%, including a 5% fully franked yield, in the lower half of both the broker’s Australia Infrastructure & Utilities coverage and Australia Energy coverage. On Morgan Stanley’s numbers, Origin’s free cash flow yield of 6% is attractive (AGL Energy’s is 8%), but harder to predict versus peers.

The broker sees better leverage to data centre and renewables development via AGL, owing to project timing (not owing to any major difference in project quality). Origin could surprise to the upside by capturing electricity volatility by accelerating the Kraken benefits, and by turning around bad debts.

Morgan Stanley downgrades to Underweight from Equal-weight, on a target reduced to $8.86 from $10.00.

That implies a significant dispersion in price targets among brokers monitored daily by FNArena, which does not include Goldman Sachs. Consensus is $10.66, but on a range from Morgan Stanley’s $8.86 to UBS’s $11.70.

These brokers are split three Buy or equivalent ratings, one Hold and one Sell, with Goldman Sachs on Buy.

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