Published on LiveWire 08/09/2020 (Original Article Here, subscription required) – Vishal Teckchandani
The year has not been kind to Woodside and its peers in the oil and gas patch. In February, the company weathered Tropical Cyclone Damien – the most severe storm ever to pass over its WA facilities. Then just as things were looking up, a greater second storm – in the form a global pandemic – crushed the energy market so badly that crude prices were negative at one stage.
CEO Peter Coleman himself described conditions as “the most difficult I’ve seen in nearly four decades in the industry.” Despite all this, Romano Sala Tenna and Hendrik Bothma of Katana Asset Management point to bright spots: the company is still profitable, saw record half-year production, reduced leverage, boosted liquidity and paid out a dividend on top.
With its share price off ~40% this year, the fundies reckon investors have a rare chance to snap up a discounted quality business with re-rating potential, given the prospect for global oil demand lifting and Woodside’s ambitious pipeline of growth projects. Here, Romano and Hendrik expand on their views and why they’ll boost their position in Woodside over coming months.
How long have you held the stock and how big is your position in the stock currently?
Woodside Petroleum (WPL) has been a regular in Katana’s portfolios since our inception nearly 15 years ago. However, given the volatile nature of the underlying commodity, its weighting has fluctuated dramatically during that time.
There has been no better example of this than the past six months. As COVID-19 was unfolding and we were beginning to get a handle on its impact on global demand, the decision was taken to move to a nil weighting. Fortuitously this occurred in early February when the market was slow to react and the price was hovering in the mid to low $30s.
On the flipside, when the price of WPL bottomed in March at around $15, we were slow to react and remained on the sidelines. However, as the oil price rebounded and then stabilised, we began to monitor the technicals more closely for signs of an inflexion point. Whilst we are still to see a technical turning point, the price was sufficiently low for us to toe-dip, and we have commenced with a 1% across both funds. We would expect this to grow to between 3-5% in the coming months.
Please outline the key points of why you’re attracted to the company.
Our attraction to WPL begins with our overlaying thesis that the energy sector has seen the worst of the COVID-19 impact and stocks in the sector offer a good opportunity for a recovery play.
The sector was hit especially hard as the pandemic spread and then OPEC+ negotiations failed which saw the Oil price collapse to 80% of its pre-pandemic level. WPL along with its peers including STO, OSH and BPT have been heavily sold as they faced perhaps once in a lifetime conditions and are still trading at heavy discounts to their pre-COVID levels.
As signs of a recovery gains momentum with global oil demand lifting, ever-increasing news of a vaccine, travel bubbles and most recently the Centre of Disease Control (CDC) in America advising all 50 states to be prepared to distribute vaccines as early as October, we see greater potential to the upside than risk to the downside.
What attracts us to WPL in the large-cap energy basket is the strength of their balance sheet which management improved during 1H2020. Gearing has fallen below 20% and liquidity has been increased to US$7.5bn. They are the least levered to the oil price and have a clear focus on rewarding shareholders by maintaining an 80% payout ratio, which is well above their policy minimum of 50%.
They also have an ambitious pipeline of growth opportunities which offer catalysts to the current price including acquiring Chevron’s 16.7% stake in the North West Shelf and Cairn’s 40% stake in the Sangomar project.
Could you give us a brief overview of the dynamics of the Oil market?
As with most commodities, the oil price is driven by the balance of supply and demand and as the pandemic spread, countries across the globe were forced to shut borders and implement travel restrictions. This had the simple effect of sending oil demand off a steep cliff. In a very short period, demand dropped ~21% from ~100mmbbl/d at the start of the year to 79mmbbl/d in April. The oil price dropped ~80% from US$60bbl to US$13bbl.
Demand will fall as far as the market dictates however price has a safety net called OPEC – or at least that’s the idea. OPEC+ controls around ~46% of the world’s oil production and if there’s a supply/demand imbalance they generally act to stabilise the price. As we know, initial meetings didn’t go according to plan and instead of providing a safety net, they acted as weights, flooding the market with more production and further driving down the price. Eventually, tensions eased and a series of production cuts were agreed, ranging from 7.7-9.7mmbbl/d in 2020 and 5.8mmbbl/d in 2021.
Demand has since recovered from the April lows and is currently ~91mmbbl/d. Consensus expectations are for demand recovery to pre-COVID-19 levels of ~100mmbb/d, however, there is a wide range of forecasts regarding the speed of the recovery stretching from 2021 to 2023. In contrast, the oil price has recovered 65% to its current range of US$40-45/bbl.
What were the key points of the recent result?
It was no surprise that earnings and cash flow would take a hit in the 1HY2020 results based on the tough operating conditions. WPL reported a half-year net loss after tax of US$4bn, however, this was softened by the pre-announced impairment loss of US$5.7bn which was the principal driver of the loss. Headline results included NPAT of US$303m (down 28% pcp), positive cash flow of US$264m and payout ratio maintained at 80% of NPAT.
They also added strength to their balance sheet by deferring US$200m of major capex and securing a US$600m debt funding facility.
Keys points to take from the results are despite COVID interruptions:
- They delivered a record first-half production of 50.1mmboe
- Are on track to meet full-year guidance
- They also managed to generate positive cash flow despite the low oil price
- The company reported a breakeven price of US$32/bbl which has some headroom to the current oil price of ~US$40-45 and is at the lower end of Australian peers which range from ~US$30-50/bbl.
How did the results compare with your expectations? And those of the broader market?
NPAT of US$303m and a record half-year production was slightly ahead of expectation given the circumstances. WPL has a history been good at reducing costs, however, 2020 cashflow conversion was slightly weaker with operating costs increasing by US$200m. The increase was largely due to the AUD appreciating against the USD and lower labour efficiency which was driven by COVID. The increase, however, was offset by the US$200m deferral of capex.
Overall results were largely in line with expectations, aided by the pre-release of the impairment cost which was expected given the low oil price.
Where there any surprises?
WPL’s commitment to maintaining a payout ratio of 80% was a surprise given current market conditions and their pipeline of costly growth projects (consensus was ~65%). This highlights management’s focus on rewarding shareholders, however, it does beg the question whether this is sustainable at current spot prices of $US40-45/bbl.
Its likely external funding will be required to maintain this payout ratio and complete its pipeline of ambitious growth projects. Alternatively, they could reduce the payout to the policy minimum of 50%.
Has your position on the stock changed post results?
There weren’t any shocks or material deviances in the half-year results to change our view. Rather we saw confirmation of record production, positive cash flow and strong liquidity.
