Too risky to re-enter Origin just yet

At face value, the 63% drop in Origin Energy’s (ASX: ORG) share price since mid-May last year to $4.05 – courtesy of the huge selloff in global oil markets – looks like an opportune time to capitalise on distressed oil and gas prices. But with continued pressure on the energy sector fuelling growing speculation that oil could fall into the US$10/barrel range, investors are better served taking a ‘wait and watch’ approach.

The oil price (Brent crude $30.41 and West Texas Intermediate $29.93) overhang is creating further grief for Origin’s long-suffering shareholders who had every right to expect an upturn in the share price following some badly needed good news for the company. However, the stock continued losing ground during the market’s most recent selloff amid fears around China and global growth.

Everything else being equal, the market would typically have given Origin a big thumbs-up for embarking on its previously announced divestment plan to sell a basket of assets, including gas pipelines and wind farms to raise around $800 million in cash.

Not even revelations that Origin’s joint venture project Australia Pacific LNG (APLNG) has just achieved its inaugural shipment on LNG – a milestone for the LNG project which cost $25 million and took seven years to enter production – couldn’t stop the stock from coming under even greater selling pressure, following the start to global financial markets this year.

With oil prices currently where they are now, no one is under the illusion that Origin Energy can even cover the operational and financing costs for the (LNG) plant, let alone make a profit. According to Origin’s 2015 annual report, the company requires an oil price of around $55/barrel to receive a cash flow distribution from APLNG.

Assuming oil is at $100/barrel, Origin expects to make $900 million in cash flow annually, but with each drop of $10 that amount decreases by $200 million.

Nevertheless, Origin’s managing director Grant King has tried to impress on the market the long operational life of APLNG, and its capacity to deliver a significant amount of earnings once oil prices start going up.

To reduce the risk of any potential further price drop, in December Origin brokered a deal for 2017 LNG shipments, which will see it sell 75% of shipments at $55 a barrel and the rest at $40 a barrel, which – compared to where the oil price might fall to -may end up looking extremely favourable.

Assuming oil prices were at $28/barrel, the company’s additional contributions to (APLNG) would be around $200 million.

With the Organisation of the Petroleum Exporting Countries (OPEC) looking increasingly unlikely to agree on measures that would address the oversupply situation in oil markets, any immediate rebound in oil prices appears unlikely.

As a result, speculating on a turnaround in oil markets is something even the bravest investors should try to avoid.

The continued fall in oil prices puts Origin’s balance sheet under renewed pressure following  the $2.5 billion in new equity it raised late last year to help reduce its debt. The stock has a funding surplus of $12.1 billion, and its net-debt to equity increased from 69.70% in 2014 to 91.35%.

Meantime, while the stock’s forecast (2016) return on equity (ROE) is underwhelming at 2.55%, earnings per share (EPS) growth – which has been dismal over the last five years – is forecast to deliver some exceptional growth – albeit off a low base – from $0.04 in 2015 to $0.25 in 2016.