One of the disappointing stories of recent years has been the falling price of liquefied natural gas (LNG). This is bad news for Origin Energy Ltd (ASX: ORG) due to its exposure to LNG via the 37.5% stake it has in Australia Pacific LNG (APLNG).
LNG prices
The major challenge facing the LNG market is an imbalance between demand and supply. In my opinion, this will worsen for a number of years. That's because global demand for LNG is not rising fast enough to keep up with planned projects. For example, the amount of LNG shipped in the first eight months of 2016 was 187 million tonnes. This compares with 168.5 million tonnes in the corresponding period of 2014. This is a gain of almost 11% in two years.
However, the supply of LNG over the next four years is forecast to rise from 247 million tonnes per year to 370 million tonnes per year. That's an annualised growth rate of 10.6%, which is more than double the annualised growth in demand for LNG over the last two years.
The reason for the rapid increase in supply is a number of new projects coming onstream, particularly in the US and Australia as lower costs have spurred the development of LNG assets. This situation would hurt the financial performance of Origin Energy as well as other LNG-focused stocks such as Woodside Petroleum Limited (ASX: WPL) and Oil Search Limited (ASX: OSH).
Financial standing
Origin Energy's new CEO has said that cutting the company's debt levels will be a key priority. Its balance sheet is highly leveraged and this increases its risk profile in my opinion. For example, total debt/EBITDA was six times in financial year 2016, while Origin's debt to equity ratio was 66%. Although the debt to equity ratio fell from 84% in financial year 2015, it remains too high in my view given the outlook for the LNG price.
Origin's net operating cash flow of $1.4 billion was sufficient to cover interest repayments of $611 million 2.3 times in financial year 2016. A falling LNG price coupled with a lack of growth in Origin's domestic energy retailing business would further stretch its ability to service debt.
The suspension of dividends in the second half of the 2016 financial year will help Origin's cash flow. However, net operating cash flow declined by 23% last year. This could limit the ability of the company's new CEO to invest in growth opportunities via higher capital expenditure, as well as inhibit the amount of investment which can be made in APLNG to improve operating performance.
Outlook
The status of Origin as a price taker means that the downbeat outlook for LNG prices could hurt its financial performance. It has an overly leveraged balance sheet in my view which increases its risk profile. Therefore, I believe that it is a stock to avoid. I'd rather focus on other stocks in order to turn $10,600 into an $8 million+ fortune.
