Origin Energy: Steady strategy for yield

About the author:

Max Vickerson
Author name:
By Max Vickerson
Job title:
Analyst
Date posted:
10 March 2022, 11:00 AM
Sectors Covered:
Industrials, New Energy

  • Origin Energy (ASX:ORG) announced an on-market share buyback of up to $250m of the company’s stock likely to commence in April. FY23 could be another strong year for APLNG cash flows and we’ve revised our dividend forecast up significantly by 10cps.
  • The company also articulated its low capital expenditure strategy to transition its Energy Markets business as Eraring heads towards closure in 2025.
  • We maintain our ADD rating with an updated price target of (login to view) and potential 12-m TSR of 15%.

Strong gas cash flows and a strategy to limit electricity spending

ORG has repaired its balance sheet through the sale of a 10% stake in APLNG and with healthy cash flows from the steady increases in oil prices over the last year it is choosing to return $250m capital to investors via a share buyback commencing in April. We have assumed that this will be completed in six months.

The company also laid out a capital-light strategy for investing in its Energy Markets business. We don’t see major investments being likely in the near term and ORG will aim to partner with other investors to reduce the capital required to grow its volume of renewable energy.

ORG highlighted the size of its existing gas peaking capacity (~3GW) and its target to grow capacity in a Virtual Power Plant (VPP) to 2GW by 2026.

Commodity squeeze giving us more confidence in FY23 cash flows

We think LNG markets are likely to remain tight during FY23. Even before the conflict in Ukraine began LNG prices were elevated and, even if a resolution could be achieved quickly, we expect that a number of European buyers will look to grow alternative gas supplies to Russia keeping demand elevated.

Our forecast for strong cash flow into APLNG from spot sales gives us confidence to increase our forecast for cash distributions to shareholders. This lifts our free cash flow (via financing cash flow) and dividend forecasts in the FY23 and in the medium term.

We do have some concerns though about the tightness in the coal market as ORG seeks to renegotiate with domestic suppliers. Coal prices are much higher than the NSW wholesale electricity netback.

Management indicated that some customer volumes could contract if hedging (either physically or financially) can’t be sourced at an appropriate price. We are therefore allowing for higher hedging costs, lower generation volumes and a temporary reduction in business volumes in FY23. 

Our valuation increases marginally to (login to view) on higher assumed spot LNG revenue offset by potential weakness in Energy Markets in FY23.

Investment view

ORG is looking to farm down interest in its Beetaloo basin tenure and has reiterated steady production targets for APLNG. It is also taking a selective approach to Energy Markets investment. We therefore see limited growth opportunities for the company but equally limited need to spend capital.

Our outlook for commodity prices suggests ORG could sustain strong dividends in the medium term.

We maintain our ADD rating and see 10% upside to our valuation on today’s closing price and potential dividend yield of 5% giving forecast 12-m TSR of 15%.

Price catalysts

  • Price achieved on sell down of Beetaloo Basin assets.
  • Drilling success on exploration and appraisal wells in Integrated Gas business.
  • Spot LNG sales.

Risks

  • Commodity prices (oil, gas, electricity, coal, carbon). 
  • Renegotiation of Eraring fuel contracts.
  • Energy markets regulation and performance of generation assets.
  • Upstream production, development and exploration.
  • Interest rates.
  • Tax regimes.

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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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