Is Woodside headed back to $45?

Chief Investment Officer and founder of Aitken Investment Management
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Woodside Petroleum (WPL) remains a member of my high conviction buy list and I completely agree with our analyst Johan Hedstrom that it is undervalued.

Today I want to do a quick reiteration of our positive short, medium and long-term investment theses on WPL ahead of their interim earnings and dividend release on Wednesday 22 August.

The Woodside share price hit an all-time high of $69.92 in early 2008 when WTI Oil reached $145 a barrel as the ‘peak oil’ theory was priced in. The Global Financial Crisis (GFC) and then the shale gas boom in America saw ‘peak oil’ proven to be nothing more than a sensationalist myth (thanks Al Gore), with WTI Oil prices collapsing to $33 billion in late 2008.

Turning point

Yet in a very similar way to Australian gold major Newcrest (NCM) underperforming the gold price, Woodside has badly underperformed the WTI Oil price because of a series of production disappointments and capital expenditure (CAPEX) blowouts. But just like Newcrest, Woodside has finally turned the corner in a production ramp up and is well past the peak of CAPEX spend. And just like Newcrest, Woodside should become a free cashflow, earnings growth and dividend machine from this point.

Since a change of CEO to the understated, low-profile Peter Coleman, the company appears to be moving to a culture of under-promising and over-delivering; always a very good combination for shareholders. The old CEO overpromised and under-delivered; always a bad combination for shareholders.

Below is Johan’s bullet point summary of Woodside’s most recent production report.

  • Great production result of 20.1 million barrels of oil equivalent (mmboe), up 43% on the March quarter, with Pluto the key outperformer (eight cargos, including three spot).
  • Production guidance for the year lifted from 73-81mmboe to 77-83mmboe. My estimate is for 78.4mmboe, which is now at the low end of range.
  • Balance sheet strengthened in the second half with the $2 billion sale of its 14.9% stake in the Browse project to MIMI.
  • One more exploration well at Ananke-1 for Pluto expansion to start drilling in the September quarter.
  • No comment on dividend, but I have an estimate of $0.60 dividend per share (DPS) in the first half of the year and $0.64 in the second half. That $1.24 a share represents a 51% pay-out ratio. Consensus full-year 2012 dividend per share is $1.15.
  • Yield for fiscal 2012 is 3.8% fully franked, and my estimate of $1.50 DPS for fiscal 2013 is 4.6%. Consensus DPS for FY13 is $1.25.
  • Discounted cash flow valuation won’t change much and is still around $47 a share.

Note well Johan’s comments above on dividends; one of the key reasons we are recommending Woodside is a dividend surprise.

While dividends are very important, the simple fact is Woodside remains a grossly under-priced growth stock. Woodside is a calendar year company, so the estimates below are December year-end, but to be paying just 10.9-times for 22% EPS growth in 2013 is simply too cheap.

Key: E = estimate, A = actual, ROE = return on equity, EBITDA = earnings before interest, tax, depreciation and amortisation, NPAT = net profit after tax, EPS = earnings per share, PER = price to equity ratio.

What I believe happens from here is that Woodside will get re-rated as the share prices of those building massive east coast coal seam gas (CSG) to liquefied natural gas (LNG) plants mark time on concerns about the technology and further capex blowouts. Woodside is past the capex blowout stage and North-West Shelf conventional gas to LNG is a proven, relatively low-tech process that should attract a significantly lower discount rate in valuation models than the unproven in large scale CSG to LNG process.

What about Shell?

In my conversations with investors, there seems to be broad agreement that Woodside under Peter Coleman is turning the corner. The only, and I stress only, pushback I get on the company is the perception of a Shell overhang.

This reminds me of Telstra (TLS) at the bottom when everyone was scared of the Future Fund’s selling. It turned out they were giving anyone who bought Telstra stock off them a true “gift from the Nation”.

Shell currently owns 190 million Woodside shares (or 23%). With the Aussie dollar at a record high vs. the euro and at 105 US cents, Shell may well be tempted to sell their remaining stake. Yet, just like the Future Fund selling Telstra, clearing this overhang will be extremely rewarding.

However, I have no idea what Shell’s intentions are and I don’t intend holding back buying Woodside shares waiting to find out. Trying to second-guess Shell is not how you are going to make money in Woodside from here. In fact, forgetting about Shell is most likely the right approach.

Woodside shares are down 50% from all-time highs, yet earnings (and dividends) are going to rise by 50% from 2011 to 2013. The company is starting to consistently beat analysts’ expectations, while the CEO/Chairman combination of Peter Coleman and Michael Chaney will prove a team to back.

Woodside remains a high conviction buy and a clear candidate for a ‘buy-the-fact, short-cover the fact’ response to the first-half result and potential interim dividend surprise. Our medium-term price target remains $45, with the risk/reward equation heavily favouring total return reward from these depressed share price levels.

Go Australia, Charlie.

Important information: 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. Anyone should consider the appropriateness of the information in regards to their circumstances.

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