Woodside Petroleum (WPL) – Testing investor patience…

Current thinking on WPL and potential drivers of recent share price underperformance:

Recent announcements have minimal impact on underlying earnings estimates
Recently WPL announced it will exit its 50% non-operated interest in Kitimat LNG development in British Columbia Canada. The Company acquired the interest in 2015 for approximately US$850m, with much of the carrying value already written down over the years due to market downturns. WPL will maintain a position in the Liard Basin upstream gas resource. The announcement has no impact on underlying earnings estimates or the dividend outcome (given the $40-60m costs will be excluded for these calculations).

Higher Sangomar capex estimate was disappointing
The Company appears to be focused on its Scarborough LNG development in WA and Sangomar oil project in Senegal. At the recent quarterly results update, management increased the capex guidance for Sangomar to US$4.6bn (from US$4.2bn) or approx. up +10% . Whilst after the expected sell-down WPL’s share of increased capex will be approximately US$200m, it is nonetheless disappointing. Especially in the context of previous management comments of potentially reducing the overall project costs. The Company is also reviewing Scarborough / Pluto Train 2 costs – perhaps some concerns around revisions here.

CEO uncertainty
New CEO is yet to be announced and with plenty of hurdles to navigate this year – FID for Scarborough, sell down of stakes in projects etc – it wasn’t the best timing for the current CEO to announce his retirement. There remains the potential of a new CEO wanting to come in and resetting the strategy, M&A, dividend policy or the direction of key assets.

Capital expenditure profile significantly increases
WPL is heading into a period of significantly higher capex phase, which could be playing on investors thinking around dilutive capital raising given gearing (ND / ND+E) is around 24%. Further, increased capital profile also brings with it associated execution risk (e.g. capex blowout). However, these are investments for growth projects.

Potential downside risk to payout ratio
Management recently noted they are reviewing the dividend policy in order to balance capital return with investment in growth. The recent average of 80% payout ratio may fall down to the lower end of 50% (minimum guidance). We note consensus is around 68% payout ratio for CY21, so potentially some downside risk here.

Current valuation + share price giving little value to growth projects
On our estimates the WPL’s base business is approximately worth $22-24 per share. Whilst somewhat justified, the current share price is giving little to no value (even on a risked basis, in our view) to Scarborough, Pluto Train 2, Browse, Sangomar and Myanmar growth projects. These assets can add (on a risked basis) between $8-10 per share in value to the base business. The final investment decision (FID) on Scarborough and Pluto 2 is expected in the second half of CY21 (2H21), which could significantly derisk consensus valuation and could see a re-rating of $3 – 4 per share – so there is a meaningful catalyst coming up. Undemanding valuation – WPL is currently trading on a forward PE-multiple of 12.7x versus 10-yr average of 16.5x.

Bloomberg, Banyantree

The broader macro is still supportive of oil prices
With motivated governments focusing on vaccinating the population, the demand side of the equation should continue to improve. There is a significant amount of pent up demand for international air travel in our view and this remains another demand catalyst. Recently, issues around Iran supply coming back to the market have markets concerned, but we believe this risk is well understood by the market and should be in the price/expectations. U.S. inventory levels continue to head in the right direction plus India’s (major importer of oil) latest Covid-19 battle appears to have peaked. The ESG narrative is also holding back long-term oil price expectations.

Whilst we are broadly in agreement here, we do believe the significant lack of investment in new oil production and diminishing funding options for smaller players (e.g. U.S. Shale producers), could see an environment where oil markets see a significant mismatch between improving demand and lack of new supply. This will put the Saudis and Russians in the box seat – who control OPEC supply and want higher prices to repair their own budgets. The ESG push by investors and banks has in part helped OPEC producers fight off non-OPEC supply, which in the past have pumped more supply on the back of improving oil prices. However, this is not so much the case this time around. In fact they are focused on maximising the cash flow from existing assets given the long-term uncertainty.

Bloomberg, Banyantree

Overall, we maintain our Buy recommendation and continue to hold it in our key Australian equity portfolio.

Please let me know if you have any questions.