Woodside: Cash Flow Versus Growth, Or Lack Thereof

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December 11, 2013 1:13 PM EST

- Woodside production guidance lacking
- Low capex a positive
- Leviathan still an unknown
- Cash flow remains solid

By Greg Peel

Woodside Petroleum ((WPL)) held its annual investor update yesterday. The company narrowed its 2013 production guidance to 86-88 million barrels of oil equivalent from 85-89mmboe and announced 2014 guidance of 86-93mmboe. The latter is a little less than analysts were hoping for.

The issue is that Woodside is facing declining reserves in the North West Shelf, the expiry of a long term contract, and is looking ahead to 2017 when its NWS entitlements fall to 17% from 50% of domestic gas. NWS will now refocus on exploration, while the additional Xena well for the Pluto project will be developed earlier than expected. From 2015, Chevron's Gorgon project, and later its Wheatstone project, will compete with Woodside on WA gas. This means deferring production for LNG export next decade makes sense, says Goldman Sachs, but it highlights that east coast gas is a more attractive proposition.

Further impacting on shorter term volumes are the sale of a 20% interest in the Power Play field in the Gulf of Mexico, and planned maintenance shutdowns at Pluto, North Rankin and NWS trains 1 and 3.

At this stage Woodside is still factoring the Leviathan development in Israel into its growth expectations, and provided base case capex and Leviathan capex guidance in line with expectations. UBS notes planned exploration spend is lower than expected, while JP Morgan was surprised to see maintenance capex for LNG set at just US$100m annually, much lower than the "many hundreds of millions" assumed.

These cost positives have offset the production negatives. Meanwhile, Woodside can only wait for the Israeli government to finalise its Leviathan deal, the timing of which has been pushed out to the first half next year. The one year anniversary has now passed, notes UBS, and the broker is "less confident the transaction will complete".

There's still Browse FLNG, which the company hopes will reach a final investment decision (FID) by the second half of 2015. Woodside has only now begun to market the project. Woodside will not deign to develop both Leviathan and Sunrise concurrently, but if Leviathan falls through, there remain tough negotiations to be had with the East Timor government on Sunrise. This really only leaves Browse as Woodside's growth option, and as BA-Merrill Lynch puts it, "with long-term volume growth otherwise solely hinged on Browse, walking away from a quality resource such as Leviathan will not be easy".

Thus Leviathan remains an unknown. Also remaining unknown at this stage is the result of the LNG export pricing review, which the company expects to be "essentially concluded" by April but could offer no further detail. The good news is Asian LNG export prices have risen, but the bad news is Woodside is suggesting pricing will be based on the Japanese landed price, and Japan has been agitating for lower pricing given the relative cheapness of US spot gas.

Merrills nevertheless expects a positive pricing outcome. Yet Merrills struggles to see value in Woodside at the current price. The stock is offering negligible growth out to 2020 and the analysts feel the market is failing to recognise this fact. Woodside is trading on a 12.4x multiple of consensus forecast 2015 earnings while energy rival Oil Search ((OSH)), for example, trades on only 11.6x. Woodside's production declines to 2020 while Oil Search's increases five-fold, the analysts point out. Merrills retains a Sell (Underperform) rating and is joined by Credit Suisse (Underperform), who suggests Woodside is a well-run business with a portfolio of high quality producing assets but is priced too richly for the broker's liking.

On the other side of the fence, Citi is keen on Woodside's "cash cow" status. Woodside's capex in 2013 will be the lowest in a decade, Deutsche Bank notes, and Citi points out capex going forward is low compared to projected cash flows, thus underpinning the likelihood of Woodside's 80% dividend payout ratio being sustained, even throughout the development of Browse.

Citi rates Woodside a Buy and is joined by JP Morgan (Overweight). The upshot is two Buys, two Sells, and three Holds among the seven FNArena database brokers covering the stock, which rather suggests a split of opinions. The Hold-raters largely cite a fair price from the market, although Macquarie sums up the risk element in noting that the LNG pricing review underway and Leviathan remain the largest uncertainties going into 2014.

The consensus target price on Woodside is $39.09, which suggests only 3.6% upside from the current trading price. By contrast, consensus targets from the same brokers suggest 8.8% upside for Origin Energy ((ORG)), 10.3% for Santos ((STO)) and 14.4% for Oil Search, suggesting PNG/Queensland CSG and east coast gas are where to be in the energy space.

That said, these projects are still "de-risking" as they approach first production. Woodside may not offer such sexy growth, if any growth, but does offer around a 7% yield on solid production cash flows. Investors need to weigh up these comparisons.

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