Shifting To Renewables Will Increase Costs And Compress Future Margins

Key Takeaways

• Transitioning to renewables and investing in infrastructure increases capital expenditure, impacting cash flows and net margins due to delayed ROI.
  
• Rising costs from gas supply investments and heightened competition in energy retail may squeeze margins, offsetting customer growth efforts.
  
• Origin Energy's strong earnings growth, international expansion, and focus on cost reduction suggest potential revenue growth and stability in shareholder returns.

Catalysts

An integrated energy company, engages in the exploration and production of natural gas, electricity generation, wholesale and retail sale of electricity and gas, and sale of liquefied natural gas in Australia and internationally.

• The ongoing energy transition and shift towards renewables could result in higher capital expenditures without an immediate return on investment. This could pressure earnings and particularly impact cash flows as Origin Energy invests significantly in battery storage and renewable infrastructure.
  
• The necessity for increased investment in gas supply and infrastructure, due to risks of shortfalls and capacity constraints, suggests potentially rising costs and tighter margins in the energy markets business. Higher costs could compress net margins.
  
• The rapid expansion and significant investments in Octopus Energy’s growth, particularly in the energy services segment like heat pumps and EVs, may lead to short-term earnings volatility. Initial losses and high upfront costs could impact profitability before long-term benefits materialize.
  
• The anticipated increase in APLNG's optimization activities and ramping up of development drilling, necessitated by lower-than-expected production optimization results, implies higher operational costs. These costs could impact net margins as they strive to manage production declines.
  
• High levels of competition and regulatory compliance costs in the energy retail market might impact Origin's cost-to-serve reduction efforts. This could compress net margins, offsetting the potential financial benefits from customer growth and retention strategies.

Origin Energy Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Origin Energy's revenue will decrease by 0.5% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 8.4% today to 6.8% in 3 years time.
• Analysts expect earnings to reach A$1.1 billion (and earnings per share of A$0.65) by about July 2028, down from A$1.4 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting A$1.3 billion in earnings, and the most bearish expecting A$799 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 19.7x on those 2028 earnings, up from 14.1x today. This future PE is greater than the current PE for the AU Electric Utilities industry at 10.4x.
• Analysts expect the number of shares outstanding to decline by 0.13% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.41%, as per the Simply Wall St company report.

Origin Energy Future Earnings Per Share Growth

Risks

• Origin Energy's APLNG business has experienced a 14% increase in earnings due to higher realized prices and increased sales volumes, which could lead to improved revenues and cash flow.
  
• The LNG trading business has delivered a significant EBITDA of $285 million and is heading towards the top end of the range of guidance, indicating strong earnings potential.
  
• Octopus Energy, Origin's global growth vehicle, continues to expand, with a strong presence in the U.K. and growing international markets, suggesting potential for revenue growth and diversification of income streams.
  
• Origin Energy has a robust balance sheet and strong cash flow generation, enabling it to increase dividends while investing in its energy transition strategy, implying potential stability in shareholder returns.
  
• Origin Energy's retail and technology platforms are focused on continuous cost improvements and customer experience, with an anticipated cost to serve reduction of $100 million to $150 million by FY 2026, which could enhance net margins.

Valuation

• The analysts have a consensus price target of A$10.885 for Origin Energy based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$13.0, and the most bearish reporting a price target of just A$8.7.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be A$16.7 billion, earnings will come to A$1.1 billion, and it would be trading on a PE ratio of 19.7x, assuming you use a discount rate of 6.4%.
• Given the current share price of A$11.68, the analyst price target of A$10.88 is 7.3% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.