Gas Delivers Upbeat Outlook For Origin Energy

This story features ORIGIN ENERGY LIMITED. For more info SHARE ANALYSIS: ORG

Robust production outcomes for Origin Energy in the June quarter were driven by a record performance at APLNG. Gas production at Otway Basin also exceeded expectations.

-APLNG hurdles significant milestone, concluding operating phase of 90-day production test
-APLNG debt should soon become non-recourse to Origin Energy
-Higher wholesale prices should mean increase in generation output while higher retail prices should mean margin expansion
 

By Eva Brocklehurst

Robust production outcomes for Origin Energy ((ORG)) in the June quarter were driven by a record performance at APLNG. Gas production at Otway Basin also exceeded expectations.

APLNG achieved record production, having successfully concluded the operations phase of the 90-day production test. LNG production at the plant throughout May and June was more than 10% above nameplate. This is a significant milestone, in Morgan Stanley's opinion, adding a much needed margin for comfort in a higher Australian dollar environment.

The highlight for Ord Minnett was better-than-expected production from the Otway gas project, with output up 90% on the prior quarter because of higher well deliveries and plant availability.

APLNG

Citi suspects APLNG is currently purchasing QCLNG gas during a partial shutdown at QCLNG, which is scheduled to last until August 10. Thereafter, the broker expects APLNG will preferentially re-direct volumes into the domestic market to capture higher winter gas prices.

Origin is confident the remaining phases of the test will be completed in the current quarter, which suggests APLNG debt will become non-recourse to Origin Energy. Once this occurs the joint venture could restructure the debt in order to increase distributions to equity holders, Ord Minnett suggests.

Morgan Stanley believes APLNG should consider reducing or slowing upstream production and/or marketing gas to other LNG producers, or domestically. The broker also suspects APLNG may consider refinancing or restructuring of the project's facilities, which are understood to be amortising relatively quickly.

Origin Energy's quarterly was underpinned by an 8% quarter-on-quarter increase in APLNG's upstream gas production. There were 33 LNG cargoes shipped from APLNG including those contracted to Sinopec and Kansai Electric.

Brokers observe the pace of CSG well drilling was modest, with 28 operated wells drilled during the quarter. This is down from an average quarterly run rate of around 80 wells in the December half, which means, in Deutsche Bank's view, APLNG is reaching ample gas production capacity, able to fulfill its LNG and domestic gas supply.

Macquarie also observes this will flow through to better capital expenditure, but the pace of development may need to rebound in the coming year to ensure growth and FY19 production.

Origin Energy contributed net cash to APLNG for FY17 of $170m, lower than previous guidance, and received $5m from APLNG during the June quarter. UBS flags a need to view FY17 results to confirm if the lower cash contribution is a permanent or temporary cash saving.

Lattice Energy

There was no update on the company's planned IPO/trade sale of its assets into Lattice Energy but Ord Minnett believes the strong performance of the APLNG assets bodes well for the expected sale. However, Citi cites uncertainty around the ability to sell Lattice Energy for a reasonable price and suggests investors need a more compelling entry point to the stock to compensate for this risk.

Catalysts

The next catalyst for brokers to consider is FY18 guidance on operating earnings (EBITDA), which should confirm continued growth in energy markets, primarily driven by the company's strong position in a rising gas price environment. Improving market sentiment for the stock throughout FY18 remains the thesis behind a Buy rating, UBS says.

Deutsche Bank increases APLNG production forecasts, believing the joint venture will seek to maximise the value of its upstream footprint. The broker now incorporates quarterly APLNG production of 61PJ over FY18-19, broadly in line with the June quarter and believes incremental volumes will be sold into the domestic gas market.

With spot LNG markets to come under continued pressure the broker believes the tight east coast domestic gas market provides a high-value monetisation route for incremental APLNG volumes.

Citi suggests higher wholesale prices should mean an increase in generation output from the company's assets and higher retail prices should mean margin expansion. In gas, the broker believes the company has the best upstream and procurement portfolio of the large retailers, with a flexible sales strategy to target the highest priced market, domestic or export.

Origin Energy should deliver growth in free cash flow to help de-gear the balance sheet while the worst of oil prices is likely now past for the current cycle, in the broker's opinion.

Citi revises up 2017 earnings by 4% and 2018 by 1% but believes the stock is fairly priced at current levels, assuming a US$55/bbl long-term oil price. The main risk is that, without an oil price recovery, any de-gearing may take longer and reduce valuation at the forward curve.

FNArena's database has three Buy ratings and four Hold. The consensus target is $7.52, suggesting 7.5% upside to the last share price. Targets range from $6.40 (Deutsche Bank) to $8.82 (Morgan Stanley).
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms