We believe ORG is undervalued on estimates.
We estimate intrinsic value could rise to over $12 per share by FY18e vs. the current share price of around $6 a share, largely driven by the value of the APLNG project as we draw nearer to start-up.
We think the electricity business has now largely troughed and margins should improve over the next few years, with the gas business seeing uplift from re-contracting and additional sales volumes in 2015 - 2016.
However, oil prices in Australian dollar terms remain an issue, particularly given recent weakness and OPEC's reluctance to cut supply.
Continued weakness of the Australian dollar against the US dollar is a potential key driver of earnings and valuation upside.
An earlier than expected increase in the oil price could lift earnings.
Electricity deregulation in NSW & QLD could lead to greater than forecast electricity earnings.
Every $10 MWh increase in NSW & QLD margin adds $14 million to earnings before interest and tax, all else being equal.
The downside scenario assumes weaker than expected oil prices.
Assuming our currency estimates are maintained but oil trades in line with the futures curve, 2016 earnings would decline 7%.
The valuation impact would likely be more meaningful (25% impact) assuming oil trades in line with current futures curve and at inflation thereafter.
Australian electricity retailers are facing decreasing demand for electricity in the market; they also face pressure from small-scale renewable technologies, especially solar, which are reducing consumer’s demand for grid electricity.
For the gas sector, we are expecting Australian gas prices to increase from $3.50 GJ to $9 GJ due to export parity pricing.
Price growth in electricity tariffs is expected to fall to 2-3% per year compared to the 15% compound growth of recent years.
Currently trading at $5.50 we see upside of 20% and gross yield of 5%.
For more information about Origin Energy Limited (ORG) please contact us on 07 4771 4577.