OREANDA-NEWS. Fitch Ratings has today, downgraded Origin Energy Ltd's (Origin) Long-term Foreign Currency Issuer Default Rating (IDR) to 'BBB' from 'BBB+' and revised the Outlook on its IDR to Stable from Negative. The agency has also downgraded its foreign currency senior unsecured rating to 'BBB' from 'BBB+'. The agency has simultaneously affirmed and withdrawn Origin's Short-Term IDR at 'F2'.

The agency has also downgraded Origin Energy Finance Ltd's foreign currency senior unsecured rating to 'BBB' from 'BBB+' and downgraded Origin Energy Contact No. 2 Ltd's preference shares to 'BB+' from 'BBB-'.

The downgrade is a result of both reduced earnings diversity following the divestment of Contact Energy Ltd (Contact, 'BBB'/ Stable), as well as the weaker cash flows expected from its joint venture, Australia Pacific LNG's (APLNG) with increased pressure on oil prices.

Origin announced that it had successfully completed the book-build process for the sale of its entire shareholding in the New Zealand-based Contact on 5 August 2015. The transaction is fully underwritten, with settlement on 10 August 2015. Origin expects net sale proceeds of about NZD1.8bn, which will be used to repay debt and redeem NZD200m of redeemable preference shares, issued by Origin Energy Contact No. 2 Ltd. While the debt reduction from proceeds from Contact's share sale is positive, such improvements in credit metrics are modest relative to the earnings pressures faced by the company. Origin's utility businesses have also been facing difficult operating conditions in Australia, although some stabilisation in this respect is expected.

KEY RATING DRIVERS
Weaker LNG cash flows: Origin's exposure to oil and oil price-linked revenue will be substantially higher, following commencement of operations at APLNG's liquefaction project in the financial year ending 30 June 2016 (FY16). The downgrade incorporates Origin's increased exposure to non-utility type businesses, amidst high near-term leverage, following divestment of its shares in Contact as well as sustained pressures on oil prices and weaknesses in the liquefied natural gas (LNG) markets since our last rating action on Origin in May 2015 when its rating Outlook was revised to Negative from Stable. Fitch's forecasts for Origin incorporate remaining investments required in APLNG to bring the project to completion and lower cash contributions from APLNG, reflecting both the low oil price environment and slower production ramp-up phase over the next two years.

Reduced Earnings Diversity: Origin will have reduced earnings diversity following the divestment of its shareholding in Contact. Origin's investment in Contact benefitted from Contact's stable financial risk profile, including its low capex requirements as well as its dominant business profile, as reflected in its leading position as an integrated utility in New Zealand.

Limited Improvement in Credit Metrics: Forecast credit metrics incorporate expected total proceeds of about AUD2.8bn applied towards debt reduction by Origin, including de-consolidation of Contact and its associated debt, as well as the loss of earnings contribution from Contact. Any material improvement in key financial metrics will, however, be limited. This reflects the lower leverage of Contact Energy - relative to that of Origin Energy.

Deleveraging Dependent upon APLNG: Origin's financial risk profile will benefit from peak funding requirements in FY15, associated with its share of APLNG and use of proceeds from divestment in Contact in debt reduction in FY16. Origin's ability to deleverage will be more susceptible to low oil prices, albeit benefiting from commencement of cash contributions from APLNG from FY16 onwards. As a result, Fitch expects Origin's financial leverage (as measured by adjusted net debt to FFO) to remain much weaker than the levels appropriate for its 'BBB' ratings (of less than 3.0x) through till FY18. A material debt commitment related to a development path on the Poseidon exploration permits could also worsen Origin's financial leverage.

Continued Difficult Operating Conditions: Origin faces difficult operating conditions, including competitive pressures, which are reflected in margin pressures across its incumbent utility businesses. Fitch expects these pressures to continue in the near-term, although customer switching has declined for much of FY15. However, margin recovery is likely to be gradual and any meaningful improvement is not expected in the near-term. These developments coincide with a phase of heavy investment by Origin, especially on upstream assets.

Declining Electricity Consumption: Origin, together with other electricity market participants in Australia, face significant and unprecedented changes in electricity consumption, as demonstrated by lower generation volumes from increased use and penetration of energy-efficient appliances and solar photovoltaic installations. Subdued consumption conditions are likely to continue in the near term.

Lower Project Execution Risks: Remaining project execution risks associated with the APLNG liquefaction project appear to be low as Fitch notes the project remains largely on schedule for production in the second half of 2015.

Hybrid Business Profile Benefits: Equity in upstream gas assets provides an upside to Origin's overall credit profile in the medium-term but remains exposed to sustained weakening of oil prices. Rising gas production, supported by substantial reserves, will benefit from an uplift from oil-linked prices for contracted future gas supplies and the start of export liquefaction at the APLNG facility from FY16. Origin has also monetised its attractive upstream acreage, with contracted gas sales to other Queensland LNG projects commencing primarily from 2015.

Origin has issued three hybrids of EUR1bn in September 2014, AUD900m in December 2011 and EUR500m in June 2011. Under Fitch's hybrid criteria, the EUR September 2014 hybrid has been assigned a 50% equity credit till 16 September 2039, the AUD December 2011 hybrid a 50% equity credit till 22 December 2031, and EUR June 2011 hybrid has been assigned a 50% equity credit till 16 June 2016.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- About AUD2.8bn applied in debt reduction by Origin, including de-consolidation of Contact and its associated debt in FY16;
- Gradual improvement in EBITDA margin for the energy markets business to 12.5% by FY17;
- Contribution from APLNG's liquefaction exports based on Fitch's Brent price deck;
- FY15 capex of about AUD4bn, declining to about AUD1.5bn in FY16 and to about AUD750m in FY17; and
- Stable dividend payments of AUD475m over FY15 and FY16

RATING SENSITIVITIES
Positive: Fitch does not expect any positive rating action over the medium-term. However, future developments that may, individually or collectively, lead to a positive rating action include forecast FFO adjusted net leverage below 2.5x; and FFO gross interest cover increasing above 5.0x, both on a sustained basis.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include forecast FFO adjusted net leverage above 3.0x and FFO gross interest cover falling below 4.5x, both on a sustained basis.

Negative rating actions are also likely to result from material increases in project costs and timing delays of APLNG; lower contribution from APLNG; commitment to sizeable growth capex; and margin deterioration, in excess of Fitch's expectations, in respect of its incumbent utilities businesses over the next two years.