Company Overview: Origin Energy Limited (ASX: ORG) runs a customer-focused energy business, positioned for a low carbon future. The company sells electricity, natural gas, LPG, and green power products to Australian homes, businesses and industrial customers. ORG has a leading energy wholesale and trading capability and enjoys a large domestic retail customer base. The company intends to maximise the value of its existing business and pursue growth by expanding its customer scale through a low-cost position and platform business model and by pursuing opportunities in renewable fuels.

ORG Details

Large Customer Scale & Low-Cost Position Driving Growth: Origin Energy Limited (ASX: ORG) is a leading energy company, involved in the exploration and production of natural gas, wholesale and retail sale of electricity and gas, electricity generation and sale of liquefied natural gas (LNG). The company mainly operates two businesses - Energy Markets and Integrated Gas. Origin Energy Limited has a 37.5% interest in Australia Pacific LNG (APLNG), which is a significant supplier to both domestic and international LNG markets. The company’s strategy is to maximise the value of its existing businesses and pursue growth in customer value and low carbon solutions.

Over the last five years, ORG’s bottom line has improved significantly, rising from a net loss of $628 million in FY16 to a profit of $83 million in FY20.

Five-Year Financial Summary (Source: Company Reports)

Looking ahead, the company is focused on growing its customer scale through a low-cost position and platform business model. ORG intends to pursue opportunities in renewable fuels and crystalise value from upstream. In order to transform its customer experience, ORG is increasing digital engagement and bringing in simplified products. With a large fleet of gas peaking power stations and pumped hydro, decent position in natural gas development and trading, as well as options to upgrade or expand existing sites, ORG seems well-positioned to support increasing levels of variable renewable supply.

Decent Operational Performance in FY20: During the year ended 30 June 2020 (FY20), the company witnessed decent underlying business performance which drove growth in free cash flow and allowed reduction in debt. For FY20, Australia Pacific LNG (APLNG) reported record production of 265 PJ (ORG share) and made record cash distributions to ORG of $1,275 million. During the year, APLNG executed new contracts for over 100 PJ of gas sales to domestic customers starting in the calendar year 2020. Driven by record production by APLNG and a record cash distribution, the company’s free cash flow increased by $105 million to $1,644 million in FY20, compared to FY19. For FY20, the company reported an underlying profit of $1,023 million and an underlying EBITDA of $3,141 million, despite facing significant challenges caused by bushfires, drought, and the ongoing COVID-19 pandemic. Notably, the company reduced its net debt by $773 million during the year to $4,644 million. For FY20, the company has paid an unfranked final dividend of 10 cents per share, taking the total full-year dividend to 25 cents per share, in line with the prior year, and representing 27% of free cash flow.

FY20 Results (Source: Company Reports)

Q1FY21 Result Highlights: For the September 2020 quarter, the company reported electricity sales of 8.7 Terrawatt hour (Twh), up 11% on the previous quarter. Due to increased residential demand, a cooler winter and higher customer numbers (0.2 PJ), the retail volumes during the quarter were 5% higher than pcp. The Integrated Gas segment reported stable production of 64.2 Petajoule (PJ) in Q1FY21, compared to 64.5 PJ in the previous quarter.

Q1FY21 Performance Summary (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together form around 23.10%. AustralianSuper and The Vanguard Group, Inc. hold the maximum interest in the company at 8.39% and 6.02%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Metrics: ORG’s debt to equity multiple for FY20 stood at 0.54x, slightly lower than 0.58x in FY19. Current ratio for FY20 stood at 1.01x, compared to 1.07x of industry. The company’s gross margin and EBITDA margin for FY20 stood at 18.4% and 8.9%, respectively.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Lifting Investment in Octopus: In FY20, the company acquired a 20% interest in UK company Octopus Energy. The company’s strategic partnership with Octopus Energy is delivering a radical improvement in customer experience and driving a material reduction in costs. Since May 2020, Octopus has grown UK customer accounts by around 300,000 to 1.8 million and launched in the United States and German markets. Recently, a leading Japanese utility, Tokyo Gas, announced that it will take a 9.7% equity share in Octopus for a consideration of US$200 million and will create a new retailer, TG Octopus Energy, that will pursue growth in the Japan market. On 23 December 2020, the company announced that it will invest an additional £36 million (approximately A$65 million) in Octopus Energy Group Limited to maintain its 20% equity interest following a partnership between Octopus and Tokyo Gas. The investment will be made in three tranches based on agreed milestones, with 75% expected in FY21 and the remainder in FY22 and FY23.

ORG Farms into Prospective Canning Basin Permits: On 21 December 2020, the company announced a farm-in with Buru Energy for seven permits in Western Australia’s prospective Canning Basin, giving it exposure to conventional and unconventional gas plays. ORG will secure a 50% equity share in five permits with Buru Energy, and a 40% equity share in two permits with Buru and Rey Resources (Rey) in exchange for carrying $12.3 million of their share of work program costs. With its Canning Basin acreage position, ORG has the option to supply gas for LNG backfill and to customers in domestic and regional markets.

Change of Director’s Interest: Recently, one of the company’s Directors, Steve Sargent, who holds an indirect interest in the company acquired 10,000 ordinary shares of the company at a price of $4.86 per share via on-market trade. Mr. Steve Sargent ow holds 41,429 shares of the company.

Key Risks: ORG operates in a highly competitive retail environment which can result in pressure on margins and customer losses. The company is also exposed to the risks related to the changes in energy demand driven by price, consumer behaviour, mandatory energy efficiency schemes, government policy, weather and other factors.

Outlook: Looking ahead, the company is focused on progressing its plans to customise Octopus’ unique technology platform, Kraken, and adopt its globally distinctive retail operating model, with the aim of delivering a superior customer experience at market-leading cost. Due to stronger than expected energy demand, ORG recently increased its FY21 production to 675-705 PJ from prior guidance of 650-680 PJ. Further, the company has reduced distribution breakeven to US$25-29/boe from prior guidance of US$27-31/boe. For FY21, the company expects its underlying EBITDA from energy markets segment to be between A$1,150 million – A$1,300 million. FY21 free cash flow yield is estimated to be around 12-15% in FY21, reflecting resilient businesses with low-cost operations and limited near term investment required.

In terms of FY22-24 outlook, the company expects current production levels to be maintained on average. Further, the company is targeting the average total capex + opex to be lower than A$3.5/GJ, a 10% to 20% reduction from the previous outlook of ~A$3.9-4.4/GJ.

FY21 Guidance (Source: Company Reports)

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: EV/EBITDA Multiple Based Relative Valuation (Illustrative)

EV/EBITDA Multiple Based Valuation (Source: Refinitiv, Thomson Reuters)

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Month

Stock Recommendation: The stock of ORG has corrected by 15.10% in the last six months and is currently trading below the average 52-week price band, offering a decent opportunity for accumulation. On the technical analysis front, the stock has a support level of ~$3.97 and resistance of ~$6.47. We have valued the stock using an EV/EBITDA multiple based illustrative relative valuation method and have arrived at a target price of a low double-digit upside (in % terms). For the purpose, we have taken peers like AGL Energy Ltd (ASX: AGL), Woodside Petroleum Ltd (ASX: WPL), Ampol Ltd (ASX: ALD). Considering the company’s decent operational performance in FY20, stable production performance in Q1FY21, growth in expected energy demand, rise in FY21 production guidance, and current trading levels, we give a “Buy” recommendation on the stock at the current market price of $4.890, up by 2.087% on 6 January 2021.

ORG Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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