For the first time since listing, Origin released its recent interim results without Grant King in sight. Frank Calabria, who formally ran the domestic retail business, is the new boss and things are already changing.
We rated King highly, even after the losses from LNG. Before anyone else, it was Grant King who saw the benefits of vertical integration and understood how renewables and gas would alter the energy market. His replacement appears keen to make his mark, making changes in swift time.
With the APLNG project now completed and contributing cash flow, the focus has shifted to lowering Origin’s enormous $9bn debt pile.
Spilt of production assets confirmed
Will improve cash flow
Debt still too high
To that end, Origin will split its oil and gas production business from the rest of the company via either a trade sale or an IPO.
The new company will include fields in the Cooper Basin, the Otway Basin, the BassGas project, fields offshore New Zealand and, perhaps the best asset of the bunch, the newly discovered Waitsia onshore gas field in WA.
The sale will raise $1bn–2bn and help lower debt.
Lowering debt is certainly a good thing but, by losing its production business, Origin will lose a vital advantage: operating energy assets gave it a natural hedge against price changes at its energy retail business. Without the production business, Origin will be more exposed to price swings.
The sale will, however, lower capital intensity and reduce cash outflows. The production business routinely sucked in capital and spat out little cash. Expelling production assets will help to conserve cash.
|US$50 oil||US$90 oil|
|Corp Cost ($m)||(800)||(800)|
We have long imagined a split, but we didn’t think it would look like this. Instead of spinning off APLNG, Origin has elected to keep it. We might yet see a sell down or exit from the LNG business if oil prices get higher but, for now, Origin will remain a dual-natured beast.
The core energy markets business remains the top earner. Its $12bn of assets should comfortably generate at least $1bn in operating profit annually and spit out healthy free cash flow.
The LNG business is trickier. Over $20bn has been spent by Origin and its partners building APLNG. Origin’s 37.5% stake has a notional cost of about $10bn but it is earning a pittance while oil prices remain low. Hedging will limit losses and write-offs will lower depreciation charges. As debt falls, so will interest costs and a decent flow of cash could ultimately come from the project.
At US$90 a barrel, APLNG was supposed to generate generous free cash flows of about $1bn a year. It might not get that high but it may not be too far off. All up, Origin's stake in APLNG could be worth $4bn–10bn, depending on oil prices.
Adding the two pieces together (see Table 1) Origin itself is probably worth between $4 and $11 a share. The wide valuation reflects the huge variability imposed by oil prices, leveraged with debt.
Origin may now look a little different, but not much has changed about the investment case. Current prices are probably marginally cheap but not enough to elicit any action.
Origin still carries too much debt but the strong retail business offers armour its peers lack (we’re looking at you, Santos). The LNG business also carries extensive hedging to limit downside if oil prices should crash again. We will update the situation following the asset sale but, for now, HOLD.