Origin Energy: Electricity performance worse than we thought

Author name:: By Max Vickerson
Job title:: Analyst
Date posted:: 21 October 2022, 7:30 AM
Sectors Covered:: Industrials, New Energy

Origin Energy (ASX:ORG) released guidance for FY23 Energy Markets EBITDA that was in line with consensus but well below our expectations. The company highlighted the weak expected performance of the electricity business.
Management expects FY24 EBITDA to increase but pointed to the uncertainty remaining over coal contracting costs and the BPT gas contract repricing.
We have lowered our forecasts to align with guidance and maintain our HOLD rating on a reduced price target of (login to view).

Event

In FY23 Energy Markets is guided to earn between $500m - $650m in underlying EBITDA (Morgans forecast was $747m).

ORG pointed to strong gas margins underpinning earnings improvement and noted difficult market conditions for electricity.

Analysis

We had thought that increased output at Eraring since July, despite higher coal costs, would have improved this year’s outlook more than the guided range. We have adjusted our expectations for electricity profitability which has a flow-on impact in FY24.

We continue to hold the view that ORG’s short electricity position will become more expensive as some wholesale contracts reprice. ORG’s market contracts cost it ~$61/MWh in FY22 compared to the current FY24 NSW baseload contract price of ~$218/MWh.

We don’t think all of the book will necessarily reprice but we do anticipate that as tariffs rise, ORG’s margins will increase, but at a much lower rate.

Similarly we think ORG will be exposed to higher gas purchase prices in Victoria as 50PJ of contracted gas is repriced. While gas prices were low at the start of the reference period in FY21, prices climbed much higher in FY22 and have since moved higher again.

Forecast and valuation update

We decrease our underlying EM FY23 forecast to align with guidance to $555m (- 26%). We have also reduced our forecast for Integrated Gas EBITDA after reviewing our hedge cost assumptions to $2,287m (-4%). This brings our FY23 underlying net profit down to $689m (-22%).

The flow-on effect of reduced earnings by re-baselining electricity profits brings our FY24 underlying net profit down to $786m (-20%).

The total effect on our valuation is a 5% reduction to (login to view).

Investment view

We maintain our HOLD rating given the difficulty we see remaining ahead of ORG in a very tight electricity market. Overall, conditions will improve but the business is not positioned well in an environment of very high average electricity prices.

We are looking for more detail from the company about its investment strategy which has been to avoid committing capital in previous years. This served the company well at the time but it risks losing competitiveness if it continues to defer new projects.

Price catalysts

1Q23 report expected on 31 October.
1H financial results and draft DMO due in February.

Risks

Availability of fuel, generation performance and renegotiation of Eraring fuel contracts.
Commodity prices (oil, gas, electricity, coal, carbon).
Energy markets regulation.
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.