On February 14, 2019, Australian LNG giant Woodside Petroleum (OTCPK:WOPEY, OTCPK:WOPEF) published 2018 annual report. After reading it, I should highlight a few improvements that arrested my attention. First, the firm practically doubled its FCF YoY and increased annual DPS by 47%. I highly rate companies that are able not only to grow the bottom line but also to fully cover capital expenditures by OCF and generate resilient free cash flow surplus enough to reward shareholders, and Woodside Petroleum succeeded in these cases. Second, its FCF considerably exceeds the net income, indicating a remarkable quality of earnings. What is more, the firm brought LNG unit production cost to the lowest level in 5 years, $5.1, while total production costs were slightly higher than in 2017, $465 million vs. $443 million. Wheatstone LNG production costs were higher than expected, but Woodside assured to keep on working with the operator, Chevron (CVX), to lower costs (see p. 20 of the annual report).
All of the above represent that Woodside is a decent investment. In my view, it could grow its market capitalization both in the short and long term. If the company will be able to deliver 2021 EPS of $1.98 (currently anticipated by analysts, see the chart with data from S&P Global below), it could be valued ~$31 billion in 2022 (a ~33% upside from the current market cap), assuming no changes in the P/E of 16.5x. Now let's go down to details.
Note: Despite being a company incorporated and domiciled in Australia, Woodside Petroleum reports its results in US dollars. In this regard, all the figures in the article are in US$ unless stated otherwise.
Share performance YTD
Although Woodside's shares are not as tightly correlated with Brent as equity of few other O&G integrated and E&P companies, it is obvious that late 2018 sell-off and early 2019 rebound could be explained by oil price movements and fluctuating investor sentiment.
The top line
Woodside Petroleum is focused on Australia, but at the same time, its portfolio is versatile, vast, and globally diversified with exploration activities in Myanmar, Senegal, Gabon, Peru, and Bulgaria, developments in Senegal (SNE Phase 1) and Canada (the Kitimat LNG). At the moment, the base business encompasses Pluto LNG, the North West Shelf (NWS) Project, Australia Oil, and Corporate. By now, Pluto LNG and the NWS Project are the essential drivers of operating revenue, EBITDAX, and free cash flow. In 2018, Pluto LNG brought 43.3 mmboe, $2,510 million in sales with a 56% gross margin, while the NWS brought 34 mmboe, $1,497 million in sales; its gross margin equaled 55%. Wheatstone LNG operated by Chevron also contributed, brought 9.1 mmboe in 2018, 10% of total production, while operations in Canada (meager oil production in the Liard Basin, anticipated to cease in mid-2019) also slightly impacted sales. Speaking about new revenue streams, I should mention that the Greater West Flank Phase 2 and Greater Enfield are expected to commence production this year providing additional support for the top line.
Woodside has a clear and concise strategy. The firm has divided the coming years into 3 stages: Horizon I (2017-2021, "Cash generation"), Horizon II (2022-2026, "Value unlocked"), and Horizon III (2027+, "Success repeated"). During the current stage, its essential capital allocation priority is to finance projects that will generate superior returns during the Horizon II in the time of the LNG supply shortfall. Pluto LNG Train 2 and Scarborough are among them. In 2019, Woodside will execute FEED activities to be ready for Pluto LNG Phase 2 FID in 2020 and assumed start-up in 2024. In 2018, Woodside increased its equity ownership in the second crucial asset, Scarborough, to 75%; that led to a considerable cash outflow reflected in the investment activities section on the CFS. The firm included it in the calculations of FCF, which, after all, was 83% higher compared to FCF in 2017. This year, WOPEY plans to work on FEED and prepare for FID in 2020.
Speaking about the P&L and cash flow measures more specifically:
- Operating revenue jumped to $5.24 billion backed by more solid production of 91.4 mmboe that increased compared to 2017 level of 84.4 mmboe and higher realized prices ($54 per barrel of oil equivalent compared to $44/boe in 2017). The major contributors to the top line are Pluto LNG and the NWS project.
- EBITDAX rose 31% YoY, while EBITDAX margin decreased by 0.8% to 77.1%.
- EPS grew 20.3% compared to 2017 and 8.8% compared to the trailing twelve months figure on September 30, 2018, equaled $1.48. Analysts anticipate the growth trend to continue in 2019 when EPS is expected to reach $1.71.
- Higher net profit after tax was spurred by higher volumes sold and favorable price. According to NPAT reconciliation (see p.19), higher prices added $863 million to sales revenue, while higher volumes added $286 million.
- Woodside promised to reduce 2019 exploration spending (both expensed & capitalized) to $200 million from the 2018 level of $310 million. In my view, the reduction could have a positive impact both on net income and FCF, while lower investment in wildcats & appraisal will have no adverse effect on Woodside's future organic growth.
- Most importantly, all the income statement improvements largely contributed to the CFS. Free cash flow (the firm's definition; net OCF less cash flow used in investing activities) practically doubled, reached $1,524 million, while organic FCF (net OCF less capital & exploration expenditures) was $1,962 million. $909 million were paid as dividends. Consequently, shareholder rewards were covered by FCF (Woodside's definition) of 1.67x.
Anticipated EPS growth trend. Analysts' consensus estimates. Data from S&P Global. 2019 EPS equals $1.68, 2020 EPS amounts to $1.88, 2021 EPS equals $1.98.
Despite stellar 2018 revenue jump and NPAT growth, Woodside is still far from its 2014 top line record of $7,435 million.
Data from S&P Global
Back then, an outstanding revenue was achieved because of higher sales in Australia LNG segment and also a more significant contribution from Australia Oil. But Woodside Petroleum growth story is certainly not over. The firm targets production of 100 mmboe in 2020. Moreover, it planned to double equity LNG production by 2027. In my view, higher output and growing demand make it possible to return to 2014 revenue level and surpass it.
Outstanding 2018 cash flow
2018 operating cash flow equaled $3,296 million, growing 37% YoY. Generated cash flow was enough to cover investment expenditures, exploration, and acquisition of a 50% stake in Scarborough from Exxon Mobil (XOM) fully. As a result, FCF equaled $1,524 million (a 29% FCF margin) or $1,962 (a 37.4% FCF margin) if we deduct only Payments for capital and exploration expenditure from net OCF. While the net margin was only 26%, Woodside has unquestionably high quality of earnings backed by robust cash generation.
2018 capex was primarily directed to the Greater Enfield Project, Greater Western Flank Phase 2, and Wheatstone LNG to ensure 2020 production target of 100 mmboe. In 2019, Woodside is going to increase investments in Pluto LNG, Pluto-NWS Interconnector, the NWS Project, Australia Oil, and Corporate segment, while financing of the Greater Enfield will be lower. After all, 2019 capex is anticipated to go up compared to 2018 expenditures (without investment in Scarborough). On p. 21 of the annual report, Woodside guided 2019 investment expenditure to be in a $1.6-1.7 billion range. I suppose even with an increase in investments, the company could generate decent FCF supported by production growth and low operating expenses.
Working with a dataset provided by Woodside on the p. 152, I have noticed a notable issue. It appeared that in 2015, capex comprised phenomenal 112% of full-year revenue. Figuring out the rationale I have delved into the 2015 annual report and found out that in that year the company acquired interests in Wheatstone LNG, in the Balnaves oil project, and the Kitimat LNG, so, the figure was so distorted by these one-off outflows.
The balance sheet
The next thing I consider worth analyzing is robustness of the balance sheet. A company that poised to finance a few expensive projects in the short term should have a solidified financial position.
- First, the total debt (current & non-current interest-bearing financial liabilities on the balance sheet) comprised only 22.2% of net worth.
- Second, 2018 net CFFO covered 81% of the total debt.
- Third, interest payments on debt were covered by EBIT 19.3x.
- Fourth, 2018 EBITDA amounted to $3,814 million, while total debt stood at $4,071 million. The company had $1,674 million in cash & cash equivalents; thus, the book value of net debt equaled $2,397 million. All in all, the total debt-to-EBITDA ratio amounted to 1.06x and net debt-to-EBITDA ratio was 0.62x. In my opinion, this is a quite decent and safe level for the firm that operates in a capital intensive industry.
All in all, Woodside has a sound balance sheet and solid liquidity, enough to finance the Horizon II growth. Also, it is worth mentioning that in 2019, Woodside will implement new standard AASB (Australian Accounting Standards Board) 16 Leases. As a result, it increased the target gearing range to 15-35% from the previous 10-30%. 2018 gearing was 12%.
Own creation. Data from Morningstar. Calculations are based on the share prices on the Australian Stock Exchange on March 11, 2019
It appears that Oil Search's P/E and EV/EBITDA largely deviate from the peers' ratios, probably because of higher anticipated 2019 EPS growth, but Woodside looks reasonably valued.
Anticipated LNG supply shortfall in the 2020s
Woodside will reap huge benefits from LNG demand in Asia, which is estimated to gallop ahead. I have already touched upon that matter in my coverages of Oil Search and Royal Dutch Shell (RDS.A, RDS.B), for instance. LNG demand growth is anticipated by industry experts and market participants. The following point on the future of LNG in the Reform market scenario was mentioned in Equinor's (EQNR) in-depth research "Energy Perspectives 2018: A call for action" (PDF file is available for download on the company's website, see p. 40 in the document):
The Asian market will continue to grow after 2020, led by strong Chinese demand towards 2030 as the country aims for a natural gas's share of primary energy of 12% by 2030, up from 5.7% in 2015.
In the 2018 annual report, citing the British energy consultancy Wood Mackenzie, Woodside mentioned that estimated 2035 forecast Asian LNG demand would be 76% higher than in 2018 (see p. 25). Apart from that, experts expect a supply shortfall in the early 2020s and new projects are essential to meet the exploding demand. All of the above provide perfect market conditions for LNG producers' revenue growth.
Woodside Petroleum reported solid results that considerably improved YoY. The firm has a high rating regarding value, dividend coverage, FCF, the robustness of balance sheet, past performance, and growth prospects. Also, it offers an opportunity to benefit from LNG market swings. All in all, I expect the firm to continue its growth story both in the short and long term.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FINEX MSCI AUSTRALIA UCITS ETF over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.