Investment banks the world over are calling for the bottom of the worst commodities rout in a decade, with Morgan Stanley being the latest to upgrade its position on crude oil (from bearish to neutral). Its reasons are that demand for crude oil is robust despite increased supply, and that macroeconomic fears around China and the U.S. are overdone.
If Morgan Stanley's views are correct, and oil is poised to rebound, then oil-related stocks like Origin Energy Ltd (ASX: ORG), Oil Search Limited (ASX: OSH), Santos Limited (ASX: STO) and Woodside Petroleum Limited (ASX: WPL) are considered cheap.
Woodside's attempt to acquire Oil Search and yesterday's failed takeover bid for Santos by Scepter Partners (dubbed "opportunistic" by Santos' board) is evidence of this.
If predictions are incorrect however, and the status quo remains, then at current oil prices Origin's recent capital management initiatives make it a buy under either scenario.
The capital management initiatives
Origin is not the company it was two months ago. Back then, its capital expenditure burden on the Australia Pacific LNG (APLNG) project raised concerns over the strength of its balance sheet in a low oil price environment. However, things have since changed and the outlook does not appear as bleak for Origin.
Management has been actively cutting costs, selling assets and reducing debt to survive in an oversupplied market. In August this year, Origin sold its stake in New Zealand-listed Contact Energy Limited (NZX: CEN) for $1.8 billion to Macquarie Capital. Then in late September, Origin surprised the market by issuing a mammoth $2.5 billion rights issue and cut its dividend for the 2016 and 2017 financial years.
The market reaction
The share market seemingly approved of these initiatives, driving shares up 22% from the theoretical ex-rights price of $5.32 in the days after its trading halt. Origin's Subordinated Notes (ASX: ORGHA) jumped almost 6% in one day, indicating concerns over debt levels subsided and that Origin would flourish in the current climate.
However, since last week, Origin's share price has pared half of its gains, placing it near all-time lows once again. I believe this makes it a solid buy at the present time.
What's changed?
Fundamentally, nothing has changed for the worse at Origin; in fact, the company is now stronger than ever with debt to decline to $9 billion by 2017 and available liquidity to sit at $5.8 billion this financial year. This should provide sufficient working capital for Origin to complete its APLNG project at current oil prices.
Why Origin?
Although the recent retreat in crude oil appears to be driving its share price decline, Origin operates a vertically integrated business being a producer, wholesaler and retailer of energy. This should partially shield Origin against future falls in the oil price, as its other businesses continue to perform to plan.
Origin's structure therefore makes it less susceptible to oil prices compared to Oil Search, Santos and Woodside Petroleum. Whilst the latter trio's leverage to oil will cause them to rebound sharply if and when oil prices recover, Origin's utility business provides it with annuity-style revenue to weather short-term volatility in crude pricing.
Additionally, Origin's exposure to top quality gas reserves in the Cooper and Surat Basins, alongside its stake in APLNG, should provide a good platform for growth when the oil price recovers.
This mix of stability and growth makes it, in my opinion, a solid buy today.
Foolish takeaway
Time will tell whether or not the investment banks are correct in calling for the end of the commodities rout.
However, if investors are looking for a top quality company with oil exposure for when (not if) the oil price recovers, they should look no further than Origin Energy Ltd.
