Woodside is the one

PORTFOLIO POINT: The surge in global oil prices comes at just the right time for our premium energy company Woodside.

A soaring oil price means one thing for Australian investors'¦a surge of interest in our top oil and gas stocks. But if you want the works – that is, a stock with substantial oil production as well as exploration – then the field thins out pretty fast. Certainly, there are attractions in Santos or Oil Search, or a string of junior players, but for Eureka Report readers I’m backing Woodside – the greatest of Australia’s oil companies. Let me tell you why.

Woodside’s revival has already started – the share price has flown in recent days – but so far, the share price has largely reflected the higher oil price rather than rewarding management for a job well done. The price elevation should come in the next phase of Woodside’s resurrection, which gets underway in a few weeks when the first shipment of liquefied natural gas (LNG) leaves the trouble-plagued Pluto project in WA’s north-west (not that analysts are getting too excited about that significant event).

Past mistakes, and a reputation for over-promising and under-delivering, are responsible for Woodside remaining on the watch list of many stockbrokers, with a survey of recommendations showing a leaning towards sell, rather than buy.

Compared with the market’s view of three months ago, when I last looked closely at Woodside (see Oversold Woodside hot value) the current opinions of analysts are distinctly colder.

What appears to be happening is that Woodside won friends last year for the way it was repairing its damaged reputation after the delayed start to Pluto, and repeated exploration failures, but is now being punished for talking about what could be an overly ambitious step back into international deals – an area in which the company stumbled badly 10 years ago.

My view is that analysts are underestimating the ability of new chief executive Peter Coleman to take very careful steps back into the global oil and gas market, and are not recognising the unique skills embedded in Woodside in building and operating LNG plants, or the potential for the company to generate capital by selling part of its Browse and Sunrise LNG projects to Asian investors keen to secure future energy supplies.

Massively complex and expensive, LNG plants are multi-billion dollar monsters costing more than $10 billion (and up to $40 billion in the case of Chevron’s Gorgon project). Woodside is unique among mid-sized oil and gas companies anywhere in the world in having more than 20 years’ experience in directly running an LNG project – the North West Shelf – in which it is a minority partner, and building Pluto, in which it is the 90% owner and operator.

The accumulated LNG skills are an asset Woodside can start marketing to other mid-tier oil and gas companies around the world, which are looking for ways into an industry dominated by the super-sized oil and gas companies such as Chevron, ExxonMobil, BP and Shell.

However, before we look at possible future deals – one of which could involve a very neat arrangement with the mid-sized US oil and gas company, Hess Corporation – here’s a snapshot of what’s happened since the November 2 story.

Back then, Woodside was trading at $36.17, having dropped $10 in the first five months of Coleman’s tenure, largely because the $15 billion Pluto project had run over-budget and was heading for a 12-month start-up delay. It continued to fall, touching a low of $30 just before Christmas, before starting a rapid recovery to $37.40 last week.

Some investors who followed my November view of the stock have reason to feel disappointed; I was early with my call. Those who bought a few weeks later have reason to feel pleased, though that’s the case with most energy stocks, which have reacted positively to the ongoing crisis in the Persian Gulf (that situation could see Iran cut off 20% of the world’s seaborne oil supply).

At $US121.70, the Brent crude oil price appears to be heading towards its all-time high in mid-2008 of $US147/bbl. In fact, oil today is already at an all-time high when measured in euros, the depreciated European currency, and British pounds. (To read more about the wider implications of the higher oil price, click here for Shane Oliver.)

Oil price aside, the specific issue affecting Woodside is a two-fold question of timing. It was sold off because of the problems with Pluto, recovered as the Pluto start-up got closer (and the oil price rose), but is now being watched closely because of concern that management will not handle wisely the future cash flow from Pluto.

The importance of Pluto to Woodside cannot be over-stated. The 90% ownership is unusually high for such a big project, but was regarded by previous management of the company – led by Don Voelte – as its “break free” project, putting a gap between it and its major shareholder, Royal Dutch Shell.

Shell expressed its concern about the future direction of its recalcitrant associate by selling a third of its Woodside holding in 2010, and making it clear that the residual 24% was available at the right price, effectively creating a stock overhang problem in the eyes of the market – and a problem that will remain until Shell sells, or Woodside buys back, the Shell stake and cancels the shares.

It is concern about the Shell overhang and next investment phase which drowned out the positive reaction to the company’s results for the full year to December 31, including a 14.5% increase in revenue (all from the higher oil price), and a modest 4.3% net profit of $1.5 billion.

Analysts at investment bank Goldman Sachs gave the best assessment of Woodside by saying that the result did not “materially change our view” of the stock on which they retained a buy rating and a 12-month share price target of $42.96, or 14% higher than the price today.

Mind you, that’s on the high side, with the market consensus figure running at $40.20, an estimate trimmed by some quite low forecasts such as BofA-Merrill Lynch, which has the stock as an 'underperform’ with a price target of $33.20.

But even a positive view of the outlook for Woodside was masked by concern about what management will do with the cash from Pluto, particularly if it involves risky international acquisitions at a time of high oil prices.

Analysts at investment bank RBS Australia picked up the expansion risk theme when noting that comments from Coleman about diversifying the company “added complexity” to the mix. RBS maintained a hold tip on Woodside.

Citi was sterner. After the full-year profit announcement and management briefing, it downgraded Woodside from buy to neutral, though largely because it had risen strongly since touching the pre-Christmas price bottom of $30.

On the buy side is Deutsche Bank, which likes the imminent Pluto start-up and renewed focus on growth which could “redefine” the company. UBS also welcomes the Pluto start and a fresh gas discovery in the Ragnar exploration well. Macquarie has the stock as outperform, because it has reached the end of a downgrade cycle.

Goldman Sachs in its positive assessment of Woodside likes the potential of the company to capitalise on its LNG experience as a way to “leverage its LNG reputation and operating expertise to access unique opportunities”, adding that Woodside would face competition for good assets.

What none of the investment banks appears to have looked at is the potential for a Woodside/Hess joint venture involving Australian and US assets.

Woodside needs extra gas to expand Pluto to maximise its efficiency, and Hess has made a series of significant gas discoveries off the north-west coast, but is yet to reveal how it will convert that gas into a saleable product.

Selling gas to Woodside makes sense for Hess, but might be an even better deal if Woodside teams up with Hess in the US, where the American company has made major oil and gas discoveries in North Dakota, but is selling that gas cheaply into an over-supplied US domestic market.

If Hess could find a way to convert its gas into LNG and sell into the export market, it would dramatically increase its profits. A relationship with Woodside and its LNG skills would also offer a solution to its Australian and US gas issues.

The next few months are important for Woodside, and while some analysts are wary of the company going back into the international market, it is highly unlikely that Coleman, or his cautious board of directors (led by the deeply-conservative chairman, Michael Chaney) will do anything risky.

For Chaney, a US deal might even bring back memories, as after graduating in geology from the University of WA he worked as a petroleum geologist in Australia and the US – a background he shares with Coleman.

There is risk in Woodside seeking new growth opportunities from its Pluto cash, but on balance it remains an essential part of any balanced investment portfolio.