Origin Energy's bumper $1 billion profit overshadowed by looming takeover

Origin Energy (ASX: ORG) returned its first statutory profit since FY20, marking a sharp U-turn from a $1.4 billion loss a year ago amid an improvement in electricity earnings and record LNG revenues. 

The FY23 result comfortably beat analyst expectations and the company expects this momentum to continue into FY24 on further improvements in electricity market earnings.

The strength of the recovery demonstrates why a consortium led by Brookfield Asset Management was so eager to acquire the business, which was made binding back in March 2023 and is currently progressing through a number of regulatory hurdles.

It begs the question. With Origin Energy set to be taken out at around $8.90 per share – Is the stock even worth a second look?

Vertium Asset Management Chief Investment Officer, Jason Teh says it might be a worthwhile place to park your spare cash.

Origin FY23 Key Results

• Underlying EBITDA +47% to $3.1 billion vs $2.92 billion estimate
• Statutory profit of $1.05 billion compared to a $1.4 billion loss a year ago
• Underlying profit +83.5% to $747 million vs $663 million estimate
• Adjusted free cash flow -9% to $965 million, reflecting an increased dividend and higher working capital
• Final dividend +21.2% to 20c/share

FY24 Outlook

• Energy Markets Underlying EBITDA in FY24 of $1.3–1.7 billion (FY23: $1.03 billion)
• Electricity gross profit is expected to improve reflecting higher tariffs and an increased contribution from Eraring and the peaking fleet
• Octopus Energy is in a rapid growth phase and continues to invest in international growth
• Australia Pacific LNG production is expected to be 680 – 710 PJ (FY23: 495 PJ)

Key Company Data

Origin Energy Chart

In one sentence, what was the key takeaway from this result?

Very strong results from Origin reflecting strength in energy markets and Octopus Energy.

What was the market’s reaction to this result? In your view, was it an overreaction, an under-reaction or appropriate?

Rating: UNDER-REACTION

If it was based purely on the results, it’s an under-reaction. I’m not sure why Origin is even providing forward guidance given the takeover.

If the market were to react to the forward guidance in isolation, the stock should be up a lot more. But the reason why it’s not rallying is because the takeover price is capping any upside.

Were there any major surprises in this result that you think investors should be aware of?

The key takeaway is the strength in energy markets and high wholesale electricity prices driving strong results in this space. That’s due to the energy transition that’s occurring with a reduced supply of energy from coal and higher wholesale energy prices feeding through into the earning results of Origin as well as other plays like AGL.

Would you buy, hold or sell Origin Energy on the back of these results?

Origin is very interesting from the point of view that it’s under takeover. The results take second place and you wouldn’t be buying Origin based on the results. The takeover caps any potential upside. Any view of buying, selling or holding Origin should be based on the takeover offer as opposed to the results.

What’s stopping investors from parking their funds in anticipation of the takeover?

There's a US dollar component to Origin Energy's takeover. At an exchange rate of 0.70 cents, the bid is valued at $8.90. At current levels of 0.64 cents, it's worth $9.20. This suggests the stock is trading at a discount between 5-8% (excluding the upcoming 20 cents per share final dividend).

When you buy takeover-type stocks, you are playing for that small margin with the assumption that the takeover is going ahead. It most likely will but if it doesn’t, you’d be exposed to a fair bit of downside. 

That’s why there’s a small spread associated with the takeover price versus the current share price. But you’re right, I’m looking at that small spread too because I have some excess cash to deploy.

What’s your outlook on the wider utilities sector? Are there any risks to Origin and its sector that investors should be aware of?

The utilities sector is undergoing a major transition at the moment associated with renewable energy and reduced coal consumption. That transition is resulting in higher wholesale electricity prices but over the medium term, when that new supply comes on, that should come off.

Energy providers are generating a fair amount of profit at the moment but they are also a part of the energy transition and expected to spend a lot of current profits on future CAPEX plans to build up renewable exposure.

From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing on the ASX right now?

Rating: 4

There are two thematics happening right now in the market, the first being China’s slowdown. We’ve had a few false starts in terms of the commodities sector rallying on stimulus rumours. Everybody’s now waiting for some sort of stimulus package from China but if that doesn’t come through, then that sector is likely to trade sideways.

It’s unlikely to collapse because there’s limited supply of new iron ore, which is why it’s still trading at US$100 a tonne, unlike the US$50 a tonne back in 2015 when there was lots of new supply.

Under a no-stimulus scenario, iron ore is likely to drift around US$90, which means the price of BHP (ASX: BHP), Rio Tinto (ASX: RIO) and Fortescue (ASX: FMG) will also likely move sideways.

The other major theme is higher bond yields, especially in the US. There are early signs that the US economy could be bottoming, which could push yields higher.

If inflation is not under control, that will give the Fed another reason to raise interest rates, which is not what economists are forecasting and outside of current market expectations. If that occurs, then long duration stocks like technology will come under pressure, which you can see right now with tech stocks coming off recent highs.

Under this higher rate thematic, you want to look out for companies that aren’t priced appropriately in the market and I think QBE Insurance (ASX: QBE) is one of them.

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