Treasure Chest: Woodside, One Of The Best?

This story features WOODSIDE ENERGY GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: WDS

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Morgan Stanley believes the new Woodside Energy is one of the world's best plays on gas.

Whose Idea Is It?

Morgan Stanley

The subject:

Woodside Energy ((WDS))

The Argument:

In June of 2014, Brent crude oil was trading at US$114/bbl. By January 2016 it was down to US$28/bbl. One of the biggest oil price collapses in history resulted from a global oversupply, driven by a technology-led rise in fracking which unlocked an abundance of shale oil.

Many a marginal oil producer did not survive the collapse. Investment in oil production dried up. By 2018 the price was back at US$84/bbl but had fallen to US$70/bbl as the world entered 2020, and then locked down. In March Brent dropped below US$20/bbl.

The rebound was swift. As covid restrictions began to ease, demand met supply that was further limited by an ESG groundswell that led investors to shy away from the sector, and exacerbated by OPEC production cuts implemented to drive prices higher. Brent had recovered to US$92/bbl when Russia invaded Ukraine.

Throughout the ups and downs, Woodside Petroleum was Australia’s biggest pure energy company by a margin, with the focus in Australia squarely on LNG production. LNG prices are linked to oil prices. When Santos ((STO)) merged will Oil Search, Australia had two very large global oil companies. When Woodside merged with BHP Group’s ((BHP)) Petroleum division, the newly named Woodside Energy became bigger still.

Russia’s invasion has driven Europe to seek alternative sources of energy, particularly gas, which conveniently crosses the continent from Russia through pipelines. Russia had been supplying some 40% of Europe’s gas consumption. Even if the war were to end tomorrow, Europe’s push to diversify its energy supply to the point of cutting off Russia altogether will continue until it is complete.

To achieve this Europe must look to alternative/renewable energy sources, but that transition will take time. Right now, Europe needs seaborne LNG. As there is not enough LNG being produced in the world to fill the hole, cargoes will need to be diverted from the current dominant buyer – Asia. Gas prices will thus remain higher for longer.

To that end, Morgan Stanley believes Woodside is in the box seat. The broker suggests the market is underestimating the cash flows the new Woodside Energy will generate, and then distribute to shareholders.

Woodside has underperformed its global peers on a year to date, one year and two year basis. There have been two issues holding investors back – a weak balance sheet, and concerns over insufficient returns from the company’s significant Scarborough LNG project. But with the merger complete, the balance sheet is now reset (BHP shareholders received Woodside scrip), and given the current LNG price profile, as well as cost cutting at the project, Scarborough returns are no longer an issue.

Moreover, Scarborough still has some 50% of its volumes to sell. And Woodside has also for years been sitting on another huge but as yet untapped gas field, being Browse.

Given Woodside’s leverage to rising oil and gas prices is on par with the best in the global sector, Morgan Stanley believes Woodside is one of the best global plays on gas.

Morgan Stanley had been advising on the merger but this week resumed coverage of the stock, with an Overweight rating and $40 price target. The highest target among FNArena database brokers was previously $34.37 from Credit Suisse (Outperform).

Macquarie also updated its views this week following the merger completion. Macquarie is more sanguine, suggesting the stronger balance sheet should provide growth impetus in the traditional as well as the clean energy sector (in which Woodside also has aspirations), but believes the company must guard its balance sheet in order to preserve funding for deepwater growth projects in the Americas.

If oil price strength persists over the next 6-12 months then Woodside is expected to be in a better position to assess whether surplus capital exists. Macquarie retains a Neutral rating and $29 target.

By contrast, Morgan Stanley believes Woodside could generate US$40bn in free cash flow – more than its market cap – by 2030 based on forward energy prices, rising to US$75bn if current spot price levels persist. That includes US$5bn to be spent on new energy transition opportunities. The broker forecasts US$20bn will be paid out in dividends over the coming decade, leaving US$20bn for reinvestment in growth and energy diversity, and to pursue further capital management.

Morgan Stanley forecasts a dividend yield of 10-12% over the next few years, assuming energy prices remain elevated.

Morgans (Add) suggests, at least, that its expectations for Woodside dividends have improved with a stronger balance sheet.

UBS expects the company will continue to offer an attractive dividend over the next two years but maintains a Neutral rating.

With Ord Minnett also on restriction, and yet to resume coverage, the FNArena database shows three Buy or equivalent and three Hold ratings, for a consensus price target of $32.90 which, as it happens, is right where the share price is at the time of writing.

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