Origin Energy: Default pricing is depressing energy markets

About the author:

Max Vickerson
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By Max Vickerson
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Date posted:
11 June 2019, 11:00 AM
Sectors Covered:
Industrials, New Energy

  • The impact of default electricity pricing will be deeper than we'd previously thought. We estimate the impact of ORG's recently announced price cuts on FY20 EBITDA will be ~$50m.
  • Our estimates for the costs of fuel at the Eraring power station have also increased which lowers our estimate for FY20 electricity gross margins for Energy Markets to ~$35/MWh.
  • Oil price volatility will drive fluctuations in the short term and we see the next significant positive catalyst being the release of the dividend policy at the full year result.
  • We reduce our price target (access by Morgans clients only) but maintain our Add rating with a potential 12-month TSR of 13%

Default pricing will bite harder than we'd thought

ORG announced a price cut for 520,000 consumer electricity customers. Those cuts will go further than the minimum required by the default market offer (DMO) set by the Australian Energy Regulator (AER). Not only do the cuts apply to standing offer customers but also to those on non-discounted market offers and some of those on time-of-use tariffs. This is not the majority of customers but nevertheless it will reduce FY20 earnings (~$50m FY20 EBITDA impact).

We've updated our estimate for Eraring's fuel costs

We've looked again at fuel costs in ORG's Energy Markets division and compared that to historical coal futures prices. Eraring is supplied by a legacy coal contract (~4Mtpa) and by short term purchases. It is hard to be precise when we don't know the exact timing or duration of ORG's short term purchases but we estimate that the long term contract is priced at approximately A$90/t. We now carry this assumption until 2022 when the contract expires, with Morgans' long term assumption for thermal coal (US$75/t) after that.

Brent oil volatility is also weighing on the share price

Recent volatility in the Brent oil price has been weighing on the energy sector. The front month futures contract for Brent traded was ~$70/bbl on 22 May 2019 but in the space of two weeks it had plunged nearly 13%. ORG is less leveraged to oil than others in the energy sector because of its diversification into energy retailing but nevertheless ORG has suffered as well. Given the tensions in international trade negotiations there may be continued volatility in the short term but we think the longer term fundamentals of the oil market point to higher prices (see Morgans' recent note: Commodities - Trade tensions a sentiment grenade)

We think there's still value but the potential returns are lower

The impacts of the electricity price reductions and our increased estimates for Eraring's fuel costs have reduced our expectations for future earnings. This is offset to some extent by reducing our estimate for system use gas losses in APLNG so that our sales estimates are in-line with ORG's guidance as well as updated assumptions for D&A which reduce the tax burden on cashflows to equity holders. We reduce our price target to $7.69 and maintain our ADD rating with a potential 12-month TSR of 13%.

More information

Morgans clients can login to view our detailed report and increased share price target for Origin Energy (ORG). Alternatively, please contact your Morgans adviser or nearest Morgans office for access.

Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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