Why I think you should avoid Woodside Petroleum Limited shares
Woodside Petroleum Limited’s (ASX: WPL) purchase of half of BHP Billiton Limited’s (ASX: BHP) offshore Scarborough LNG assets in WA will cost US$400 million. This may cause some investors to question whether such a deal is good news for Woodside. It faces an operating environment where the oil price has struggled to push past US$50 per barrel after its 2016 recovery. Its outlook is highly uncertain thanks to a glut of supply from Saudi Arabia as it seeks to counter US shale production.
Prior to the deal, Woodside’s balance sheet was modestly leveraged. As of 30 June 2016, Woodside had a gearing ratio of 23%. Although this is higher than the 20% of one year prior, it is within the company’s 10%-30% target range and in my view it shows that Woodside can afford to add more debt to its balance sheet to fund acquisitions. In fact, Woodside had liquidity of US$2 billion at the end of the first half of financial year 2016. This comprised of US$300 million in cash and a further US$1.7 billion in undrawn facilities.
Further, Woodside’s cash flow indicates that it would cope with greater debt levels in my view. For example, Woodside’s net cash from operating activities of US$1.1 billion covered capital expenditure of US$950 million in the first half of the 2016 financial year even though Woodside’s investment in its asset base increased versus the first half of financial year 2015. Interest payments of US$77 million compared to free cash flow of US$176 million plus an interest coverage ratio of 19.7, which provides evidence of further headroom. Therefore, from a purely financial perspective, I think that Woodside’s finances are sound and further acquisitions are affordable.
However, where I feel Woodside lacks longevity is with regard to its business model. It is a price taker and this means that the price of oil has a direct impact on its profitability. If the oil price fell, its cash flow and ability to make interest payments would be strained.
In my view it would be affected less than many of its oil and gas sector peers such as Santos Ltd (ASX: STO). That’s because Woodside has reduced unit production costs by 38% to US$5.20 per barrel in the last year and has a stronger balance sheet. But even so, it still faces the risk of a lower oil price.
Further, Woodside lacks diversity even when compared to other resources stocks such as BHP. Woodside is a pure play oil and gas company and its acquisitions are mostly within this arena. For example, prior to the BHP deal Woodside purchased ConocoPhillips’ Senegal operations. Although it has derisked its 2017-18 revenue streams due to 85-90% of expected production now either committed or subject to finalisation agreements, its producing assets are focused on Australia and this increases its long term risk profile in my opinion.
Woodside’s financial standing shows that it is built to last in my view. However, I feel that its status as a price taker and its lack of geographical and operational diversity mean that in the long run there are question marks about its sustainability.
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Motley Fool contributor Robert Stephens has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
Woodside Petroleum Limited?s (ASX: WPL) purchase of half of BHP Billiton Limited?s (ASX: BHP) offshore Scarborough LNG assets in WA will cost US$400 million. This may cause some investors to question whether such a deal is good news for Woodside. It faces an operating environment where the oil price has struggled to push past US$50 per barrel after its 2016 recovery. Its outlook is highly uncertain thanks to a glut of supply from Saudi Arabia as it seeks to counter US shale production.
Prior to the deal, Woodside?s balance sheet was modestly leveraged. As of 30 June 2016, Woodside…