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Ratings On Australian Integrated Utility Origin Affirmed At 'BBB/A-2' On Octopus Energy Stake; Outlook Remains Stable

  • Australia-based Origin Energy Ltd. will acquire a 20% equity interest in U.K.-based energy retailer Octopus Energy (unrated) for £265 million, which will be funded from a mix of internal cash flows and debt.
  • We believe that Origin Energy's financial metrics have sufficient buffer currently to absorb leverage related to the transaction.
  • We are affirming our 'BBB' long-term and 'A-2' short-term issuer credit ratings on Origin Energy. We are also affirming the issue ratings at 'BBB'.
  • The stable outlook on Origin Energy reflects the company's strong market position as one of the three largest integrated utilities in Australia and our expectation that Origin Energy will sustain a debt-to-EBITDA ratio of less than 3.0x over the next two to three years.
SYDNEY (S&P Global Ratings) May 1, 2020—S&P Global Ratings today took the rating actions listed above.
We affirmed the ratings on Origin Energy to reflect our view that the company has some buffer to absorb headwinds to its business operations and leverage related to the Octopus Energy transaction. In our view, Origin Energy's financial metrics will weaken in fiscal 2021 due to pressure on earnings in its energy market segment, as well as likely reduced distributions from Australia Pacific Liquefied Natural Gas (APLNG) project, based on our current oil prices assumptions. Further, the partial debt-funded payment for the equity interest in Octopus Energy will increase leverage. As such, we believe that debt to EBITDA could increase to slightly above 3.0x for fiscal 2021 before reverting to less than 3.0x in fiscal 2022 and beyond, as Origin Energy continues to reduce leverage amid a modest increase in EBITDA.
We expect Origin Energy to continue to deleverage, supporting its credit quality. Origin Energy is likely to continue generating strong positive discretionary cash flows (i.e., cash flows after accounting for capital expenditures and dividend payments), enabling further debt reduction. This is owing to its modest capital spending requirements and our expectation that Origin Energy will manage its dividend payout within its stated policy range of 30%-50% of free cash flows.
Origin Energy is looking to partner with Octopus Energy with a view to transform the company's retail energy business. With this partnership, Origin Energy is seeking to replicate Octopus Energy's customer-centric operating model and technology platform in Australia. Over the next few years, Origin Energy will transfer its 3.8 million retail electricity and gas customer accounts to the new technology platform, which it expects will deliver annualized pretax cash savings (operating and capital expenditure combined) of A$100 million-A$150 million. These savings will occur in phases, starting from the year ending June 30, 2022, amounting to about A$70 million–A$80 million. Origin Energy expects the savings to increase to A$100 million–A$150 million from fiscal 2024. This is in addition to a A$100 million cost reduction that Origin Energy expects to achieve by fiscal 2021, compared with the fiscal 2018 baseline.
Lower energy volumes, potential delays in collections, bad debts, as well as lower wholesale energy prices will weigh on Origin Energy's earnings and cash flows from its energy market segment over the next couple of years. This should be slightly offset by Origin Energy's current cost reduction target of A$100 million (A$43 million achieved as of the first half of fiscal 2020). We believe that the earnings trend in the energy market segment from 2022 will depend on wholesale prices, retail tariffs, as well as realization of cost savings via implementation of Octopus Energy's agile operating model.
Distributions from APLNG will be under pressure due to a low oil price environment. We have cut our oil price deck to US$30 per barrel (/bbl) in 2020, US$50/bbl in 2021, and US$55/bbl in 2022. As a result, we believe that distributions to Origin Energy from APLNG will significantly reduce for fiscal 2021, compared with A$1.1 billion–A$1.3 billion that the company expects for fiscal 2020.
That said, APLNG is targeting a A$300 million–A$400 million reduction in upstream capital expenditure for fiscal 2021. At the same time, APLNG will maintain production levels similar to fiscal 2020's, which should ensure that distributions for fiscal 2021 remain at least at one-third of fiscal 2020's based on our oil price assumptions.
The stable outlook on Origin Energy reflects the company's strong market position as one of the three largest integrated utilities in the country and the current buffer in its financial metrics to withstand current headwinds.
We believe Origin Energy will continue to generate strong positive free operating cash flows over the next couple of years with measured operating and capital spending at the company's energy market segment, as well as at APLNG. In addition, based on Origin's dividend policy of targeting 30%-50% of free cash flows as dividends, we expect Origin to sustain a debt-to-EBITDA ratio of less than 3.0x over the next two to three years, in line with the company's target capital structure.
We would lower the ratings if we believe the company's ratio of debt to EBITDA were to substantially exceed and remain at 3.0x. This could occur if:
  • Earnings in the core energy market segment materially underperform due to increasing uncertainties beyond those factored into our base case; or
  • Transition to the new retail model does not go as per the company's expectations, resulting in materially higher costs to implement; or
  • Oil prices were to reduce further or remain lower for a long period, which could result in decreased distributions from APLNG; hence, affecting Origin's overall ability to cut leverage.

We view ratings upside as highly unlikely, given the trend in the projected credit metrics and Origin Energy's policy of maintaining debt to EBITDA in the range of 2.0x-3.0x.

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