You might think I'm very foolish for purchasing shares in an oil and gas company and perhaps it will ultimately be proven that I am, however, there are a number of reasons why Origin Energy Ltd (ASX: ORG) – a stock which is seriously 'on the nose' with investors – looks appealing to me.
To begin with, when making an investment which requires you to buy what everyone else seems to be selling, it can be worth drawing on some timeless wisdom.
Here are a few quotes from famed investor Seth Klarman which can help to clarify what investing should be all about…
- "Rather than buy from smart, informed sellers, we want to buy from urgent, distressed or emotional sellers."
- "Institutional constraints and market inefficiencies are the primary reasons that bargains develop. Investors prefer businesses and securities that are simple over those that are complex. They fancy growth. They enjoy an exciting story. They avoid situations that involve the stigma of financial distress or the taint of litigation. They hate uncertain timing. They prefer liquidity to illiquidity. They prefer the illusion of perfect information that comes with large, successful companies to the limited information from companies embroiled in scandal, fraud, unexpected losses or management turmoil."
- "Every security or asset is a 'buy' at one price, a 'hold' at a higher price and a 'sell' at some still higher price."
The oil and gas market would certainly appear to meet many of the criteria Klarman is looking for in terms of a place where potential bargain investment opportunities may be lurking!
Around one month ago I sat down and took the time to come up with a conservative value of Origin's Energy Market division – this is the division that houses the retail operations and has produced average earnings before interest and tax of around $1 billion over the past five years.
I also analysed the group's debt position and the timing of repayments and cash flows.
I chose not to ascribe any value to the Exploration and Production (E&P) division even though I think this is most likely a large positive number.
Finally, I thought about different scenarios and outcomes for the much maligned APLNG business. I consider valuing this business a very difficult task and hugely time consuming, so my aim here was to determine the downside risks. This knowledge helped to establish at what price I could buy with a margin of safety.
As Klarman warns:
"A bargain price is necessary, but not sufficient for making an investment, because sometimes securities that seem superficially inexpensive really aren't."
When I started work on analysing Origin it turns out the share price was still above what I was willing to pay, however the stock kept dropping and when it came out of its trading halt after announcing a capital raising and strategic cost cutting measures things fell into place to put in a buy order.
While the oil price could still halve from here, taking a long term view – which is certainly required when one thinks about the prospects for APLNG – the risks of permanent capital loss look limited given the price Origin's Energy Markets division was available for.
Importantly, in my opinion there also looks to be plenty of upside potential should APLNG prove to ultimately perform better than the dire expectations the market is currently factoring in and considering the value which should be housed within the E&P division.
Not alone
While it is a lonely pursuit to buy what others are selling, it's interesting to note who one of my fellow Origin shareholders is…
Arguably the most high profile contrarian fund manager in Australia is investment house Allan Gray. The top three holding across both of Allan Gray's funds (as at June 30) were Woodside Petroleum Limited (ASX: WPL), Newcrest Mining Limited (ASX: NCM) and Origin Energy.
