Markets: Forgiving investors spark an Origin Energy rally

Investors were pleased with today's results but should brace for more bottom line shocks as the utility moves further into LNG exploration.

Origin Energy Limited today delivered underlying earnings of $760 million, at the bottom of its guidance for a fall of 10 to 15 per cent from last year.

In terms of actual profit, Origin reported $378 million, down 61 per cent on the previous year, hit by asset impairments and decrease in fair value of financial instruments.

Despite the drop, investors have pushed the stock up over 5 per cent in trade today.

Although the numbers came in better than the market was ultimately braced for, Origin faces some tough issues. As the company continues to move further away from being a traditional utility providing energy, to an exploration and producing firm, it changes the risk profile.

There are headwinds faced not only by Origin, but other businesses such as Santos that operate in the exploration and production of LNG.

Cost revisions are prominent across the LNG space. They have stifled Woodside’s share price for years – remember the $900 million increase in Pluto, bringing the total project cost to $14.9 billion? Over two years later and Woodside still isn’t trading where it was before that blowout.

It was only in February the Australia Pacific LNG project, which Origin holds a 37.5 per cent interest in, had an increase in costs of 7 per cent to $24.7 billion. For Origin, it meant their portion of costs increased from $3.6 billion to $4.4 billion.

Origin seems on track judging by today’s figures but there are risks ahead. The history of cost increases experienced by Origin’s peers suggests this won’t be the last, with a high risk of material increase to costs at some stage. Consider the increasing debt profile and Origin is far from your everyday utility.

The year looks like it will remain tough as Origin campaigns for the removal of price controls on electricity, arguing it discourages competition. You can’t have cheap energy at home and demand higher profits from a utility-offering company. It’s a case of one or the other.

While deregulation will liberate the energy market from price controls, significant discounting should be expected to continue in the retail electricity space for the remainder of this financial year.

Consequently, earnings don’t look like they will recover in the year ahead.

The cash cow for Origin is the Australia Pacific LNG joint venture it is part of with Conoco Phillips and Sinopec. It is tipped by mid-2015 the project will deliver its first LNG, improving earnings and cash flows.

But along the way, Origin will need to increase gearing to fund the project. With gearing at 30 per cent, significant increases from here heighten risk. Santos with a similar business has gearing around 25 per cent.

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