Australia | May 23 2016
-NWS output decline brought forward
-Small acquisitions targeted
-Supportive dividend yield
By Eva Brocklehurst
Woodside Petroleum ((WPL)) is manoeuvring to meet the challenges of a weak oil price and lack of growth. North West Shelf (NWS) output is now expected to decline from 2020, around five years ahead of prior guidance. Value is expected to be added via tolling third party gas.
The stated timing of the decline has unsettled Credit Suisse, who questions why this was suddenly brought forward. Production is running around 8.0% above previous expectations, but at the the time of the memorandum of understanding with Hess in December the broker notes there was no suggestion about production declines starting earlier. Macquarie attributes the reason partly to expanded capacity, which has improved to 16.9mtpa from the upgraded 16.7mtpa highlighted in the 2015 annual report.
There was no change to 2016 production guidance of 86-93mmboe at the investor briefing. Production is geared towards LNG from three Australian projects – NWS, Pluto and Wheatstone, while growth from development of existing discoveries is long dated. Acquisitions are only being sought in a sub US$1bn range, with the company reiterating a view that large scale M&A is not on the agenda.
Productivity improvements continue to be made with US$700m of a 2016 US$800m target delivered already. Macquarie observes the exploration strategy in Myanmar is achieving some success. With a smaller annual budget now proposed from 2017, activity in 2016 is limited to the Exmouth/Beagle Basins while a more active 2017-18 will include 4-7 appraisal wells in Myanmar, 3-5 in Australia and 3-5 across the Atlantic acreage and one in sub-Saharan Africa.
The company's global footprint is expanding and acquisitions of discovered resources could act as positive catalysts over the next 12 months, Morgan Stanley maintains. Woodside has outlined an opportunity to engage with third party resource owners, such as those with no current development options. Scarborough and Greater Gorgon are assets the broker suggests could fall within the criteria.
Given its underperformance over the past 12 months and attractive risk/reward characteristics in an uncertain oil outlook, Woodside remains Morgan Stanley's preferred large cap exposure, with an Equal-weight rating. The broker continues to believe that the company would obtain more value through a buy rather than a drill strategy, putting its focus on discovered resources and targeting oil.
Oil prices are correcting, UBS maintains, given the reductions to global investment and a sharp fall in US rig activity that has occurred. Markets should re-balance by the end of the year. The broker believes the company can survive three years of low oil prices given its low-cost LNG production, low sustaining capex and modest growth investment.
The company continues to suggest a soft pricing outlook for LNG, with medium-term agreements struck at a 20% lower indexation compared with 2013. Pricing is expected to recover by 2018, with a shortfall expected by 2022. UBS forecasts LNG markets to be oversupplied until 2023 and assumes future uncontracted LNG will sell for a 15% discount to prevailing LNG contracts, although suspects Woodside could achieve better outcomes because of a track record of delivery and relationships with key customers.
Macquarie accepts the company's LNG reliability and cost reductions have delivered tangible benefits to date yet much of the cost efficiencies have now been achieved and Browse LNG is back at concept phase. While the company continues to target 80-90% of LNG sales on term contracts, the broker observes the number expiring in 2017 will mean sales fall to the lower end of this range.
One aspect that differentiates Woodside from others in Australia, which Morgan Stanley highlights, is that it is evolving as a portfolio supplier of LNG. This means it can provide more flexibility for customers, with shorter contracts and options on destination.
While Woodside may be best placed of its peers to ride out the weak oil price outlook it still needs growth in the medium term and the focus on acquisitions in the past 18 months has not generated value accretion, UBS asserts. After putting Browse FLNG on ice, exploration appears the most likely path, but the broker considers this a slow burn. Nevertheless, in the meantime, the company rewards shareholders via its pay-out ratio, which pays a dividend yield of over 5.0% when oil prices recover to above US$50/bbl.
As Ord Minnett envisages it, development up until 2020 will focus on replenishing reserves while significant growth will more likely emanate from 2021 onwards: from Myanmar, Browse phase 1, Kitimat and utilising NWS as a tolling facility. Management has suggested that on a value basis the latter could be worth as much as US$500-800m.
There is no change to capex guidance for 2016 and the company has guided to average capex of US$1.5bn in 2017-18. Part of this outflow will fund unsanctioned projects such as Greater Enfield, Kitimat and Browse and, therefore, Ord Minnett has not yet encapsulated this guidance into modelling. This suggests potential downside risk to free cash flow forecasts.
Regardless of the juggling required in the near-term market in oil and gas, Citi likes the quality of the balance sheet and suggests any impact from Woodside's search for a growth engine may take two years before materialising. Hence, the broker is the one Buy rating in the pack on the FNArena's database. Otherwise, there are seven Hold ratings. The consensus target is $27.43, suggesting 3.0% upside to the last share price. Targets range from $23.10 to $31.12.
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