What’s the problem with Origin?


As the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) steamed past 4500 points this week, up about 14% over this time last year, many investors will be taking a renewed interest in their personal portfolios and retirement accounts. Some will be grinning. Others will simply be relieved to see a change in the tide of the market. Investors in Origin Energy Limited (ASX: ORG), however, will be wondering what is ailing Australia’s largest integrated energy retailer. Shares in the company have slumped around 23% this year — one of the notable exceptions to the recent good fortunes of the ASX 200.

So why has Origin lagged the market? It delivered a reasonable profit result for the year ending September 2012. Revenue was up 25% from the previous year to $12.94 billion and the all important free cash flow — the cash available to be distributed to shareholders or used for capital expenditure to grow the company — was up 7.5% to $1.42 billion for the year. The figures include the results of acquisitions made in 2011, such as the purchase of Country Energy’s electricity and gas retailing business, but even over an extended three-year period Origin has increased revenue 51.5%. The results were mostly around analyst expectations and were no great surprise to the market. Instead, it was the growing uncertainty around the company’s future earnings that seemed to cause investors to lose interest and take their money elsewhere.

Surge in retail demand over

One issue that has been shrouding Origin lately is the stalling consumption and demand for power in Australia and New Zealand. Origin has more than 4.4 million electricity, natural gas, and LPG customers in Australia — giving it a market share of about 33%, just ahead of competitor AGL Energy Limited (ASX: AGK) with 27%, and retailing accounts for almost three quarters of company earnings. Lower demand and increased pricing pressure from competitors both locally and in New Zealand, where subsidiary retailer Contact Energy Limited (NZX: CEN) is located, has placed uncertainty around future earnings growth as electricity margins are squeezed and it gets harder to retain customers.

Plotting Origin’s destination — the good news

The pressure on retailing electricity may last into the coming years, but Origin has solid long-term growth prospects in two areas. First is its expanding involvement in joint ventures exploring for energy resources across the globe. Most recently, Origin marked the first-ever discovery of natural gas off the coast of Kenya, a joint venture it is conducting with listed exploration company Pancontinental Oil & Gas NL (ASX: PCL).

The second significant prospect is Origin’s 38% stake in the $23 billion Australia Pacific LNG (APLNG) Project. The purpose of the project is to capture coal seam gas (CSG), convert it to liquefied natural gas (LNG), and sell it. Mining of CSG has been highly contentious, partly due the process of ‘fracking’ used to extract the gas, but it’s full steam ahead for Origin, which expects to reap its first production in 2015. It has become the company’s main focus of the next few years and carries numerous risks around costs and potential budget over-runs. However, the impact to shareholders could be significant — gas demand in eastern Australia is forecast to triple over the next five years according to Origin’s annual report, and there is increasing demand for energy from across Asia, which could become a key export market. So far the project is on schedule and on budget. Origin values its 38% stake in the APLNG Project at approximately $6.20 per share — more than half the company’s current value.

Foolish takeaway

They say the sun’s rays do not burn until brought to a focus, and with a strong emphasis on retail, exploration, and the APLNG Project, that’s exactly the strategy Origin seems to be pursuing. While short-term earnings (and thus share price) may remain under pressure with the squeeze on retail, Origin’s long-term growth prospects look strong, though certainly not without risk. Patient investors with a long-term view may wish to look at the 20% drop in share price not as a reason to pile out, but as an opportunity to jump in.

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Motley Fool contributor Regan Pearson doesn’t own any of the stocks mentioned. The Motley Fool’s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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