Fitch Affirms Origin Energy at 'BBB'; Outlook Stable

(The following statement was released by the rating agency) Fitch Ratings-Sydney-23 September 2020: Fitch Ratings has affirmed Origin Energy Ltd's Long-Term Foreign-Currency Issuer Default Rating (IDR) and its foreign-currency senior unsecured rating at 'BBB'. The Outlook on the IDR is Stable. The agency has also affirmed the ratings on the senior unsecured bonds issued by Origin Energy Finance Ltd at 'BBB'. Origin's rating is supported by its hybrid profile as Australia's leading electricity and gas retailer, its large and diversified generation assets and long-term fuel-supply agreements. Origin benefits from equity in upstream assets and LNG facilities through its Australia Pacific LNG (APLNG) joint venture. Its business risk profile remains appropriate for its 'BBB' rating and incorporates exposure to variable oil-linked revenue, with its well-positioned integrated utility business providing some buffer against its increasingly oil-price exposed business Key Rating Drivers Financial Profile Improved: Origin reduced financial leverage (measured by funds from operations (FFO) adjusted net leverage, which includes receipts from APLNG) to 2.2x by the end of the financial year on 30 June 2020 (FYE20) (FYE19: 2.5x). Strong cash receipts from APLNG aided the improvement in leverage. Lower oil prices are expected to reduce these receipts over the coming years, resulting in Fitch forecasting leverage to peak at 2.7x in FY21 - a level still commensurate with its 'BBB' ratings. However, reducing interest expenses and a modest dividend policy should allow Origin to deleverage thereafter. Lower Energy Market Earnings: Origin's core energy markets division faces challenges with National Energy Market (NEM) pool prices in backwardation due to coronavirus-related lower demand, reduced gas prices and increasing renewables penetration. Fitch expects these lower wholesale prices will be passed on to customers, while higher network charges will also have an impact. As a result, Fitch forecasts Origin will generate around AUD1.0 billion-1.1 billion of EBITDA a year over FY21-24 because these pressures are partially offset by Origin's ongoing cost savings and further savings due to Origin's acquisition of a 20% stake in UK-based Octopus Energy. Origin management has guided the acquisition will generate an additional AUD100 million-150 million of cost savings by FY24. High Exposure to Oil Prices: Origin has high exposure to oil and oil price-linked revenue, relative to other utility peers, due to dividend receipts from APLNG, which operates a gas liquefaction project. Ongoing receipts will largely reflect LNG prices and management of the cost of production with both of the LNG trains running at full production. APLNG benefits from long-term oil-linked contracts with key customers, however Fitch expects lower oil prices over the medium term due to the coronavirus pandemic. Lower oil prices resulted in Origin taking a AUD641 million onerous provision on its 20-year LNG purchase contract with Cameron LNG, which commenced in FY20. Origin has guided a AUD25 million post-tax impact average over the contract period. Origin also announced a AUD746 million impairment to the carrying value of its APLNG holding because of lower long-term oil prices. Fitch sees the effects of these as manageable within the current rating even though it does highlight Origin's high oil-price exposure compared with that of other utility peers. Further Regulatory Risk Limited: Fitch believes the regulatory risk for Origin, and the rest of the energy sector, has declined following the introduction of the default market offer (DMO) and Victorian market offer (VMO), which lowered Origin's FY20 earnings by around AUD110 million. The Australian government's hard-line energy regulations since June 2020 have given it powers to issue fines and force divestment should energy market participants act in an anti-competitive manner. Fitch views the likelihood of the use of these powers as limited and the increased regulatory risk as manageable for Origin. Ongoing Shift to Renewables: Origin remains well placed to benefit from the shift towards increased penetration of renewable energy in the NEM. Increasing renewable generation exposure through contracted power purchase agreements, such as the 530MW Stockyard Hill wind farm, should reduce Origin's average energy procurement costs and support margins. Origin's fast-start gas fleet is well placed to provide flexibility to meet demand during periods of lower renewable generation, while Origin's Eraring coal-fired power station is also being run with increasing flexibility to support increased renewable penetration. Supportive Financial Policies: Fitch expects Origin's leverage profile will be supported by the company's modest dividend policy to pay 30%-50% of free cash flow a year, with the remaining cash to be used towards debt reduction or organic or inorganic growth. Fitch expects ongoing capex of between AUD470 million-500 million a year alongside AUD363 million of staged and contingent consideration for the Octopus Energy acquisition over FY21-FY23. Fitch has not forecast any further major growth projects, and leverage may be higher to the extent that cash is used towards shareholder returns or growth projects at the expense of further deleveraging. Derivation Summary Origin's rating is well-positioned relative to 'BBB' category European utilities. European peers have a presence across the entire utility value chain, including sizeable but varying presence across regulated networks and quasi-regulated renewable energy; however, Origin's strong financial profile supports a similar category rating. Origin's is rated at the same level as Fortum Oyj (BBB/Negative), which also has a limited share of regulated earnings and an increased exposure to thermal generation assets following its acquisition of a further 23% stake in Uniper SE. Fortum's rating benefits from its high-quality generation fleet and historically high load factors, while Origin has stronger leverage profile but higher exposure to oil prices through APLNG. As a result, they are rated at the same level. Statkraft AS (BBB+/Stable) benefits from its long-term contracts and low-cost hydro asset base as well as a one-notch uplift for sovereign support, placing its rating one notch above Origin. Key Assumptions - EBITDA of around AUD1.0 billion a year over FY21-24 as lower electricity pool prices are offset by cost savings, and synergies from Octopus Energy - Contributions from APLNG of between AUD650 million and AUD950 million a year, based on Fitch's Brent price deck - Capex, excluding APLNG, of AUD470 million in FY21, around AUD500 million a year thereafter - Dividend payments of between 30%-50% of free cash flow a year - Excess cash used towards debt reduction, no major growth projects or additional shareholder returns. RATING SENSITIVITIES Factors that could, individually or collectively, lead to positive rating action/upgrade: Rating upside is limited due to the company's business profile. However, developments that could lead to positive rating action include sustained cash receipts from APLNG and a conservative financial profile such that the company maintains: - FFO net leverage below 2.0x Factors that could, individually or collectively, lead to negative rating action/downgrade: - Forecast FFO net leverage above 3.0x Best/Worst Case Rating Scenario International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579. Liquidity and Debt Structure Strong Liquidity: Origin has a strong liquidity position, through undrawn committed credit facilities of AUD2.9 billion as of FYE20 after adjusting for a debt maturity extension in July 2020 (FYE19: AUD3.8billion) and cash of $1.2 billion (FYE19: AUD1.5 billion), sufficient to cover all debt maturities due in 2021. REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria. ESG Considerations The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. Origin Energy Ltd; Long Term Issuer Default Rating; Affirmed; BBB ----senior unsecured; Long Term Rating; Affirmed; BBB Origin Energy Finance Ltd ----senior unsecured; Long Term Rating; Affirmed; BBB Contacts: Primary Rating Analyst James Hollamby, Associate Director +61 2 8256 0347 Fitch Australia Pty Ltd Suite 15.01, Level 15 135 King Street Sydney 2000 Secondary Rating Analyst Leo Park, Associate Director +61 2 8256 0323 Committee Chairperson Muralidharan Ramakrishnan, Senior Director +65 6796 7236 Media Relations: Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@thefitchgroup.com Peter Hoflich, Singapore, Tel: +65 6796 7229, Email: peter.hoflich@thefitchgroup.com Additional information is available on www.fitchratings.com The following issuer(s) did not participate in the rating process, or provide additional information, beyond the issuer's available public disclosure: Origin Energy Ltd Origin Energy Finance Ltd Applicable Criteria Corporate Rating Criteria (pub. 01 May 2020) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10120170) Corporates Notching and Recovery Ratings Criteria (pub. 14 Oct 2019) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10090792) Country-Specific Treatment of Recovery Ratings Rating Criteria (pub. 27 Feb 2020) (https://www.fitchratings.com/site/re/10111386) Applicable Model Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s). 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