The number one question at our Boom, Doom, Zoom webinar last Thursday was whether Woodside Petroleum (WPL) was in the buy zone. That’s because the company’s share price has been on the ropes and now languishes just over $18.
Woodside has always had the potential to be a genuinely great Australian company. Investing billions of dollars in incredibly complex, long lead time oil and gas projects that involve huge feats of engineering, usually in partnership with one or more of the global resource giants. Doing it for Australia.
But unfortunately, it has struggled to live up this potential. Over its 40 plus years of being a listed company, it has disappointed shareholders more often than it has delivered
I have to admit that I have a “love/hate” relationship with Woodside. It was the first company I bought shares in, way back in 1978 when the North West shelf project was still in the concept phase. I think I paid about $2.00 a share, selling out a few years later and more than doubling my money.
But I have also followed the lead from oil industry majors and paid more than $40 for Woodside shares.
Woodside – 2010 to 2020
Over the last couple of decades, I have witnessed:
- Shell bid for 100% of Woodside in 2001 (it then owned about 34%) and be famously rejected by then Treasurer Peter Costello on “national interest grounds”;
- Shell start its exit from Woodside in 2010 (after not being able to take Woodside over), selling 10% (its first tranche) at $42.23 per share;
- Shell sell 9.5% of Woodside (its second tranche) in 2014 at $41.35 per share;
- Shell sell 13.5% of Woodside (its final tranche) in 2017 at $31.10 per share; and
- Woodside raise $2.5bn of capital at $27.00 per share in March 2018 (a 1 for 9 entitlement issue).
While Woodside shareholders have enjoyed a supportive dividend return, from a capital perspective, the return over the last several decades has been appalling. So why would an investor contemplate buying Woodside shares now?
The case to buy
The case to buy includes the following:
- Woodside’s break-even cash flow, that is where cash flow from operating activities equals cash flow from investing activities, is a Brent oil price of US$32 boe. The current Brent price is around US$40 boe. Most analysts expect that over the long term, the oil price (and ipso facto the LNG price) should head higher as the world recovers from Covid-19.
- Most of Woodside’s LNG sales are made on long term, fixed price contracts. Although in the latest half 31% of sales were in the spot market, Woodside expects that for the full year (calendar 2020), spot sales to be approximately 25% to 30%. This provides revenue certainty and reduces vulnerability to a volatile oil market.
- Woodside delivered record production in the first half of 2020 of 50.1 MMboe, and has forecasted full calendar year production of 97 to 103 MMboe.
- In response to the pandemic and lower oil and gas prices, Woodside has prioritised financial strength, cutting investment expenditure by 50% and delaying final investment decisions on its Scarborough, Pluto Train 2 and Browse developments.
- Woodside is trading very close to its NTA (net tangible asset value) or book value. Following a US$4.0bn write-down on the carrying value of its assets at 30 June (in response to changed long term assumptions for oil and LNG prices), Woodside’s NTA fell from US$18.06 per share to US$12.72 per share, or approximately A$17.50 per share.
- According to the broker analysts (see below), Woodside is trading at a 28.3% discount to its target price of $23.27.
There is considerable upside potential should the financial investment cases stack-up to develop three marquee projects – Scarborough, Browse or the second Pluto train. Woodside has also lifted its interest to 68% of the Sangomar field, Senegal’s first offshore oil development.
For investors where income is relevant, Woodside paid a first half fully franked dividend of 29 US cents (A$0.363) per share. Woodside has signalled that it hopes to maintain a payout ratio of 80% of underlying NPAT. Brokers forecast a full year dividend of A$0.558 (this looks light), rising to A$0.757 in 2021 (a prospective yield of 3.1% for FY20 and 4.2% for FY21).
The case against
The main reason not to invest in Woodside, and probably the reason its shares have underperformed over the last couple of months, is the prospect of a dilutive capital issue.
Driving this thinking are two events. Firstly, Chevron has put up for sale its one-sixth share of the North West Shelf project and a formal sale process has commenced. Woodside is the operator of the field and also owns a one-sixth share (the other owners are BHP, BP, Shell and Japan Australia LNG). Woodside is seen as the most logical buyer because it is the operator of the field and increased ownership may help facilitate the development of the Scarborough field. Analysts say the one-sixth share could be worth up to US$3.5bn (A$4.8bn).
Secondly, if any of the other major projects are to get the go-ahead (Scarborough, Pluto Train 2 and Browse), then in the absence of divestments, Woodside may need to ask shareholders to assist.
Oil bears, or those who believe that lower/declining global growth will place ongoing downward pressure on the oil price (and the LNG price), will place Woodside in the “avoid” category.
What do the brokers say?
The major brokers are positive about Woodside with 5 buy recommendations and 2 neutral recommendations (no sell recommendations). The consensus target price sits at $23.27, a 28.3% premium to Friday’s closing price of $18.13. Individual recommendations are set out in the table below.
One caveat to reading too much into these target prices is that a critical input is the brokers’ long term forecasts for the oil price (and ipso facto the LNG price). A change in the forecasts can have a material impact on valuation (and target price). The brokers also collectively see 25%+ upside with the other energy majors (Santos, Oil Search and Origin).
Commentary from the major brokers includes the following:
UBS says that “The market has oversold Woodside on growth capex concerns over the next 4 years.” It believes processing Scarborough gas at the North West Shelf (NWS) is the most value accretive of the various approaches assessed. If Woodside Petroleum were to acquire an additional 33% equity in the NWS, the broker thinks this may allow the company to pivot towards the higher value Scarborough concept.
Morgans views Woodside Petroleum’s share price as trading at a discount to the value of its existing operations. The pursuit of growth opportunities and maintenance of an elevated dividend payout ratio raises the spectre of the need for additional external capital, the broker acknowledges. However, under various equity raise scenarios, Morgans shows the company’s value is more sensitive to an eventual recovery versus future dilution risk.
Macquarie says that it expects the third quarter to be even weaker due to rangebound LNG prices. Macquarie believes Woodside Petroleum’s M&A activities in 2020 ‘til the first half of 2021 will capture value on existing assets and in the case of North West Shelf, position it for delivery on the Scarborough project.
Ord Minnett says that while the likelihood of Woodside raising additional equity has increased, the broker suspects this could be dependent on divestments or the timing of the Browse development.
Credit Suisse says growth will come to fruition, but also suggests investors need to be patient.
My view
“Patience” is the operative word. Over the medium term (next 3 to 5 years), buying around $18 should prove to be a rewarding strategy.
However, I can’t see an immediate catalyst to re-rate Woodside. Purchase of Chevron’s holding (and possibly others) in the North West shelf project could be the trigger, particularly if it makes the Scarborough development more viable but it is likely to be accompanied by a capital raising.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.