Woodside Petroleum: Result 2014

Woodside Petroleum has reported impressive full-year results, with the Pluto LNG project adding to output and cash flow. Production for the year rose 2% to a record 87m barrels of oil equivalent, although asset sales last year meant that revenue declined 6% to US$5.9bn. On an underlying basis, profits fell 19% to US$1.7bn reflecting lower prices. Underlying earnings per share fell 16% to US$2.13 and a fully franked final dividend of US$1.03 was declared (ex date 29 Feb), making a total of US$2.49 for the full year.

Net debt, once a genuine concern for the business, plummeted 20% to just US$1.5bn. With investment expenditure halving to US$800m, free cash flow of more than US$2bn was generated, a pleasing turnaround after years of investment.

A full year’s production from Pluto illuminated the project's strengths and failings. With output of almost 35mmboe, Pluto contributed 40% of Woodside’s production but a far lower portion of profit. While the North West Shelf venture sold LNG at the equivalent of US$77 barrel of oil, Pluto attracted a price of just US$54 a barrel, suggesting either the spot LNG market is deteriorating or that Woodside sold output at bargain prices. We suspect the latter. Higher costs and lower prices meant that Pluto generated gross margins of 47% compared to 68% for the North West Shelf.

We’ve long maintained that Pluto would not be worth the enormous cost. These figures confirm that view.

For today’s investor, the sunk cost of Pluto is less concerning but it does explain why Woodside’s share price has gone nowhere for so long. Another concerning aspect of the result is the dramatic fall in investment expenditure, which won’t go far in replacing production.

Woodside’s growth planks – the Browse project and Sunrise in the Timor Sea – are unlikely to start production this decade if at all. Without production growth, earnings will peak shortly and begin a steady decline.

The company needs to invest in exploration or acquire new assets. The current payout ratio of 80% of underlying net profit leaves little cash to chase new ventures. Dividends today, although celebrated, are unsustainable as the company will have to redirect cash to new projects.

Leviathan purchase

The purchase of a stake in the enormous Leviathan gas field off the coast of Israel is encouraging, but this is a high-risk venture. Woodside and its partners will build a pipeline to the onshore Middle East to sell into high-priced gas markets like Palestine and Turkey. With a government reservation policy forcing cheaper gas for domestic use in Israel, returns from Leviathan are uncertain but acquisition costs are higher than what was suggested only months earlier. Woodside will spend about $1bn on the project next year. 

Other exploration ventures off the Western Australian coast and in Myanmar are a long way from filling an upcoming production hole.

Woodside projects the impression of success and in many ways that's justified. Debt has declined, profits are up and cash is building. The company must now reinvest that cash sensibly or face a slow, inevitable decline. On a PER of 16 and a yield of almost 6%, Woodside appears a bargain. But by not investing enough in new projects, today’s strength risks becoming a financial mirage. We’ve cut the buy and sell prices in our recommendation guide to reflect the potential for lower future earnings. With the share price down marginally since 29 Apr 13 (Hold – $38.45), HOLD.