Origin Energy: Energy Markets still failing to fire

About the author:

Max Vickerson
Author name:
By Max Vickerson
Job title:
Analyst
Date posted:
02 August 2021, 8:00 AM
Sectors Covered:
Industrials, New Energy

  • Origin Energy (ASX:ORG) is writing off c.$1.6bn from its generation fleet and has guided for significantly lower Energy Markets EBITDA in FY22. However, the strength of APLNG’s cashflows is also requiring it to book additional future tax charges.
  • We upgrade our forecasts, as the downgrade to Energy Markets is more than offset by higher assumed prices received by APLNG in the short-term.
  • We reduce our price target to (login to view) but maintain an ADD given the sharp market reaction to the news.

Event

Energy Markets will incur a $1.578bn (post-tax) non-cash charge because of ongoing weakness in electricity markets.

The company is also recognising a $669m deferred tax liability from future unfranked distributions from APLNG. Stronger commodity prices is causing the LNG JV to repay its tax effective shareholder loans faster than initially thought.

ORG has reaffirmed FY21 Underlying Energy Markets EBITDA guidance ($940m -$1,020m) but it has guided to a steep drop in FY22 EBITDA of $450m -$600m

Analysis

Our analysis of generation output and market prices in 2H21 suggest that electricity pool sales were very strong in June. Given that FY21 Energy Markets EBITDA guidance was reaffirmed we suspect that the extra pool sales were needed to cover a short market position.

Our estimate for Eing’s 4Q output jumped 43% qoq (+27% compared to pcp) while Newcastle coal prices have been rising.

We see little opportunity for ORG to significantly lift its Energy Markets FY22 EBITDA outlook given that retail prices and wholesale purchase costs have largely been set. We assume some recovery in FY23 assuming higher spot prices and volatility flow through to higher customer pricing.

Forecast and valuation update

We have reduced our FY21 and FY22 Energy Markets EBITDA forecast to $938m (-$42m, -4%) and $536m ($211m, -28%) respectively, as we’re expecting higher fuel costs and wholesale purchases. The EBITDA reduction is partially offset by reduced sustaining capital expectations, but the net effect is reduced forecast net cash flow of $285m (-$77m, -21%).

We also lift our oil price assumptions, which results in an upgrade to Integrated Gas earnings that more than offsets the Energy Markets downgrade.

Our valuation and target price have been reduced to (login to view).

Investment View

APLNG has the potential to deliver strong earnings in FY22 and beyond. However, the Energy Markets business is a drag on overall performance.

We see valuation upside as we think Energy Markets’ performance should begin to recover from FY23.

We maintain our ADD rating but think it may require the price catalysts below for the share price to meet our price target.

Price catalysts

1Q22 quarterly will provide evidence of the uplift in commodity revenue expected in APLNG.

Exploration success in the Beetaloo basin could provide a moderate uplift.

We think a strategic review of the structure of the business could unlock value as we believe the combination of electricity and LNG exposures is not adequately valued by the market.

Risks

  • Commodity prices (oil, gas, electricity, foreign exchange)
  • Production and exploration risk
  • Interest rates
  • Tax regimes

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