Woodside is damned if they do, damned if they don’t
We take a different view than the market on Woodside shares.
Mentioned: Woodside Energy Group Ltd (WDS)
No-moat Woodside (ASX: WDS) is to acquire 100% of OCI Global’s Beaumont low-carbon ammonia project in Texas for USD 2.35 billion cash. The transaction is targeted for completion in the second half of 2024, subject to OCI shareholder approval. Construction of Beaumont’s first phase is 70% complete and OCI will manage work through to completion. Consideration is inclusive of capital expenditure for phase 1, with first ammonia targeted for 2025.
We make no change to our $45 per-share fair value estimate. We expect Beaumont will form a robust part of the platform Woodside is setting itself to navigate the energy transition. In fact, Beaumont will form a material piece of the company’s planned USD 5 billion of investments by 2030 to meet its scope 3 emissions targets.
Woodside expects Beaumont to be cash flow-accretive from 2026 and EPS-accretive from 2027. Notwithstanding, we will carry the project at cost for now and it’s unlikely to be material to our fair value when factored in. We don’t yet model Beaumont’s impact and our EPS and dividend-per-share forecasts stand.
Beaumont is expected to achieve an internal rate of return in excess of 10% with a payback of less than 10 years. And risks have been creditably lessened with the final 20% of the purchase price not due until Woodside’s provisional acceptance of the facility. Further, supplier agreements for gas and other feedstock are already locked in at favorable terms.
Despite this, the market persists with its negative view on Woodside. The shares are down 5% on the day of the announcement and down more than a third since July 2023 highs of $38. It seems a case of damned if they do and damned if they don’t. We continue to view the stock as materially undervalued, in 5-star territory. A key catalyst for the rerate includes commissioning of Scarborough/Pluto T2 in 2026, among others. The liquid natural gas project was more than two thirds complete at June 2024 quarter’s end.
Business strategy and outlook
As Australia's premier oil player, Woodside Petroleum's operations encompass liquid natural gas, natural gas, condensate and crude oil. However, LNG interests in the North West Shelf Joint Venture, or NWS/JV, and Pluto offshore Western Australia are the mainstay, and the low-cost advantage of these assets form the foundation for Woodside. Future LNG development, particularly relating to the Pluto project, encompasses a large percentage of this company's intrinsic value.
Woodside is unique among Australian energy companies in that it has successfully managed the development of LNG projects for more than 25 years—unparalleled domestic experience at a complicated and expensive task. Adding to Woodside's competitive advantages are the long-term 20-year off-take agreements with the who's who of Asia's blue chip energy utilities, such as Tokyo Electric, Kansai Electric, Chubu Electric, and Osaka Gas. These help ensure sufficient project financing during development and should bring stability to Woodside's cash flows once projects are complete. Woodside also enjoys first-mover advantages. The NWS/JV has invested more than $27 billion since the 1980s, building infrastructure at a fraction of the cost of today's developments. With substantial growth aspirations, Woodside still has considerable expenditure ahead of it, but the existing infrastructure footprint is regardless a huge head start, from both an expenditure and a regulatory-approval perspective.
Woodside's development pipeline is deep, enabling it to leverage the tried and trusted project-delivery platform as a template for other world-class gas accumulations off the north-west coast of Australia. Woodside is well suited to the development challenge. With extensive experience, it remains a stand-out energy investment at the right price. Gas is the fastest growing primary energy market behind coal, and the seaborne-traded LNG portion of that gas market grows faster still. China is building several import terminals, and so demand is likely to pick up, helping to move LNG pricing toward oil parity on an energy-equivalent basis.
Moat rating
We think Woodside lacks a moat.
The primary source of competitive advantage for resource stocks stems from maintaining lower costs than peers. We don’t think Woodside qualifies on this front.
LNG is an up-front capital-intensive business. Australia’s remoteness and underdeveloped industrial base make for particularly high capital costs in contrast to markets with deeper services industries like the US. Woodside has favorably low cash operating costs, but these are largely countered by high capital costs, meaning it is not a low-cost operator on an all-in basis.
Woodside's Western Australian gas assets are large, long-life, have low cash operating costs, and offer expansion potential. They also have low sovereign risk and are proximal to key Asian markets. Shipping is around a fifth of the Australia-delivered Asia cash cost. Depending on shipping rates at the time, Australia-Asia shipping costs are a third of those for US-Asia via Panama or a fifth for US-Asia via South Africa. Low operating costs ensure cash profits throughout the commodity cycle – Woodside has enjoyed earnings before interest, taxes, depreciation and amortisation (“EBITDA”) margins averaging 80% over the past five years. Unit operating costs are around USD 15 per boe. However, high capital costs detract and preclude a moat. EBIT margins average less than 50% over the past five years.
We don't expect Woodside to generate midcycle returns on invested capital materially above its cost of capital. Woodside's return on invested capital (“ROIC”) has occasionally exceeded the weighted average cost of capital (“WACC”) during periods of favorable commodity prices. However, heavy Pluto LNG capital expenditure between 2008 and 2012 resulted in largely single-digit returns.
Material capital expenditure is now again being undertaken on the Scarborough gas field, and a second Pluto LNG train further dampens returns nearer-term. Commissioning of Pluto train 2 will see improvement from 2027, but still not sufficiently to take group returns above the cost of capital.
Pluto was initially built with expansion in mind, and current expansion activity is more capital-efficient than for the foundation. Pluto's first train was built during the peak of Western Australia's mining investment boom, resulting in Woodside’s bloated invested capital base. Capital cost savings come from better utilization of pre-existing Pluto tankage, wharfage, and surrounding infrastructure via the second LNG train. But not sufficiently to drive WACC-beating returns at the group level or a moat.
We don’t expect Woodside’s economic moat potential to be undermined by material shareholder value destruction from environmental, social, and governance, or ESG, risks.
ESG risks are based largely on industry risks that are already incorporated into our base-case analysis. And natural gas is the predominant value driver for Australian E&Ps like Woodside. Natural gas is less carbon-intensive than coal or oil, and stands to benefit from efforts to minimize emissions, at least in the medium term. This is because renewables like wind and solar, while growing rapidly, can’t hope to entirely meet global energy requirements for decades, if ever.
Hydrocarbons’ share of primary energy consumption fell to 84% from 87% over the last decade, though in absolute terms consumption increased by 74 exajoules or 15% to 492 exajoules. Share was displaced by renewables, which increased to 5% of total from 2%, or by 21 exajoules to 29 exajoules. Note in absolute terms, growth from hydrocarbons was more than triple that for renewables. And gas played the lead role, consumption increasing by 36 exajoules or 34%. We expect the trend for gas in particular to continue at least in the medium term, as the most effective way to quickly reduce emissions meaningfully. Gas’ share of primary energy consumption increased to 24% from 22% over the last 10 years.
Further, E&Ps are doing more to defray emissions from their extraction operations. Woodside plans to reduce emissions by 30% by 2030 and to achieve net-zero emissions by 2050. Another element of ESG risk for E&Ps includes potential loss of field access due to poor community relations. Woodside’s gas gathering infrastructure for example is largely offshore, limiting potential for landowner unrest. Woodside did run into controversy in the early 2000s over a proposed hub at James Price Point, north of Broome, to process gas from the offshore Browse field. Many environmentalists and traditional landowners opposed the project. But the development was ultimately scrapped on economic grounds, with limited impact to Woodside given alternative development options available—Woodside already has sufficient infrastructure and capacity for expansion further south on the Burrup Peninsula, where Browse gas can be piped to if necessary.
Woodside bulls say
- Woodside is a beneficiary of continued increase in demand for energy. Behind coal, gas has been the fastest-growing primary energy segment globally. Woodside is favorably located on Asia's doorstep.
- Woodside's cash flow base is comparatively diversified, with LNG making it less susceptible to the vagaries of pure oil producers. Gas is a primary component of Asian base-load power generation.
- Gas has around half the carbon intensity of coal, and it stands to gain market share in the generation segment and elsewhere if carbon taxes are instituted, as some predict.
Woodside bears say
- The global economy is cooling off and demand for energy will follow suit, particularly if Chinese growth rates taper.
- Technological advances in the nonconventional US shale gas industry have the potential to swing the demand-supply balance increasingly in favor of the customer.
- LNG developments are hugely expensive, and the balance sheet is at risk until such projects are successfully commissioned.
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Terms used in this article
Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.
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Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.