Woodside slows up, then pays up

Chalk up a win for the bottom-up investing crowd. Woodside's announcement on Tuesday that it would pay a special dividend and significantly boost its payout ratio was a victory for them, and a miss by the herd.

Woodside announced on April 12 that it was deferring a $40 billion-plus development of the Browse Basin centred on an onshore LNG production in north Western Australia. Then last Friday it said it had stopped investigating a second-stage expansion of its $15 billion Pluto LNG project, which came on stream last year.

Woodside is responding to tougher project economics. Development costs are up, the peak of the resources boom has passed, and the Australian dollar refuses to fall. But in doing so, it is super-charging its cash flow outlook. The question is what it will do with the cash splash that is coming, and after it gave an answer on Tuesday, its shares roared up by 9.7 per cent per cent or $2.8 billion.

The group has always had the habit of investing for success, and its cash flow profile reflects that fact. Free cash flow was negative to the tune of $6 billion between 2008 and 2011 as it built Pluto. Cash flow turned strongly positive last year as Pluto kicked in, but would have gone negative again by about $5 billion in 2015 and 2016 as Woodside paid for its 31 per cent share of the Browse development. With Browse shelved, free cash flow might be positive by a similar amount in those years.

Woodside's shares didn't respond quickly to speculation by analysts and hints from Woodside that surplus cash would be returned to shareholders, however. They were $35.28 a day before the Browse announcement on April 12, $36.40 at the close on April 12 despite comments by chief executive Peter Coleman that Woodside could "consider additional measures to accelerate the return to investors," fell as low as $33.86 last Thursday, and closed at $34.60 on Monday ahead of Tuesday's dividend announcements.

Woodside said on Tuesday that a fully-franked dividend of 63 US cents a share would be paid on May 29 to shareholders registered on May 6. Chairman Michael Chaney also said that Woodside's liquidity position was so strong and its franking credits reservoir so big that a dividend payout ratio of 80 per cent of underlying post tax profit would be aimed at.

To put that in perspective, Woodside earned $US2 billion or $US2.52 a share last year, and paid out $US1.07 billion in dividends of $US1.30 a share, a payout ratio of 53.5 per cent. If it had paid out 80 per cent of earnings the dividend would have been $1.94 a share, or $1.6 billion, and the difference of 64¢ a share is in line with the special dividend it has declared.

The initiatives turn one of Australia's great exploration and development successes into a yield-play alongside the usual suspects, including the banks and Telstra. Even after Tuesday's $3.36 share price leap to $37.96, last year's dividend, plus the special dividend, represent a 5.1 per cent yield before tax, and a 7 per cent yield if imputation credits are applied by a top marginal tax-paying shareholder.

Woodside will be a yield-play for a reasonable period of time. The group won't take an expansion spending holiday forever, and Chaney says looming new projects or changes in the operating outlook will prompt a review of the 80 per cent payout target. He also says, however, the board expects to deliver the 80 per cent ratio for several years. Given the amount of cash that is coming Woodside's way, other initiatives are in fact likely.

Why didn't Woodside shares rise strongly before speculation became fact? A possible answer is that between the April 12 announcement and Tuesday's dividend news, the top-down investing herd was in charge, and running in the other direction.

Woodside was heavily hinting that cash returns were coming, but the resources sector at large was retreating on concerns about global growth. Its shares fell by 5 per cent between April 12 and Monday. The energy company component of the S&P/ASX 200 share index that Woodside dominates fell by 5.3 per cent, and the materials index that includes the miners fell by 5.8 per cent: bottom-up sentiment may have been trampled in the bear stampede.

There will be other cash return opportunities for investors as big companies step away from projects. BHP, Rio Tinto and other big miners are not as well placed, however, because they are responding to weaker prices as well as the project cost and currency pressures that were the catalyst for Woodside's project deferrals.

LNG is linked to the price of oil, and it is holding up pretty well. Tapis crude, an Asian oil benchmark, is about 6 per cent above its five-year average price, for example: Woodside might prove to be the best example of the dividends that investors can extract as resources groups initiate a go-slow in the post-boom environment.

mmaiden@fairfaxmedia.com.au