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Kick Off: Woodside Petroleum Limited v Santos Ltd

As the ASX World Cup heads into week two, a number of teams are emerging as frontrunners in their pools. In one of the most exciting matchups, the winners from their respective matches from last week, Woodside Petroleum Limited (ASX: WPL) and Santos Ltd (ASX: STO) square off in what looks to be an epic battle.

Pre-match commentary and stats

It’s been a pretty frantic week for Woodside, with the recent announcement that its major shareholder, Shell Energy Holdings Australia Ltd will be selling down its majority stake, with 9.5% to be sold to institutional investors at $41.35 per share. The remaining 9.5% stake will be extinguished via a share buyback at the cut rate price of $36.49 per share (a 14% discount to the VWAP over the prior five-day trading period). The company estimates that this transaction will be 6% EPS accretive. Although this does seem to be quite a good deal, it could see Woodside taking on an additional US$2.68 billion in debt to fund the deal which may be some cause for concern.

Some commentators have also questioned the validity of Woodside’s buyback of Shell’s stake given other shareholders may have benefited just as greatly from alternative actions, and with a higher EPS accretion than the (estimated) 6% that this transaction is to generate. Management’s response has been that the Shell transaction was struck at the maximum 14% discount to the VWAP and that this has effectively dealt with the major shareholder overhang issue.

Energy Company Comparisons WPL (pre-Shell transaction) WPL (post-Shell transaction) STO
Share Price (AUD$) $41.39 $41.39 $14.15
Market Capitalisation (AUD$m) $34,102 $30,862 $13,801
       
Evaluation Metrics      
Net Profit Margin 29.5% 28.3% 14.1%
Net Debt to Capital Ratio 9.2% 25.2% 33.4%
EV/2P 24.94 24.62 13.84
Reserves Life (based on TTM) 16.3 years 16.3 years 26.8 years
Trailing Price to Earnings 17.45x 16.46x 26.75x
Shareholder Yield 5.70% 15.55% 2.09%

As the match begins, Woodside goes on the offensive with a strong Net Profit Margin of 28.3% (slightly less powerful than prior matches given additional finance costs associated with the share buyback debt), causing Santos to lose ground, and it is left reeling given its significantly weaker Net Profit Margin of 14.1%.

Game On 

It seems that Woodside is pushing through the pain with its net debt to capital (gearing) ratio getting a drubbing from the recently announced share buyback (potentially fully funded by debt), moving from 9.2% to 25.2%. Despite the significant increase, Woodside’s captain sees this as a good play given this is still within its target gearing range and it looks like its credit rating will be unaffected. Santos, with its equivalent ratio of 33.4% cannot compete, and Woodside punches through a snappy goal.

Woodside: 1

Santos: 0

Although it seems to be a woeful start for Santos, a change in strategy seems to be giving them renewed energy, with an enterprise value to proven and probable reserves (EV/2P) ratio of 13.84 blitzing past Woodside’s 24.62. Santos scores an equaliser and the crowd goes wild!

Woodside: 1

Santos: 1

It seems that Santos is on a roll, and charges through with a reserves life of just under 27 years, with Woodside unable to respond adequately with a relatively paltry 16 years. Santos strikes again to take the lead, with questions now being raised about where Woodside’s growth is going to come from, given its recent pull-out from the Israeli Leviathan field project.

Woodside: 1

Santos: 2

As we near the end of the match, it appears that Santos has run a little too hard and is finding it difficult to maintain its blistering pace. Its (trailing) price to earnings ratio of 26.8x is looking a little expensive, especially when compared to Woodside’s comparatively attractive 16.5x. Both sides seem to be quite hard pressed here, but it seems that Woodside’s slow and steady pace is going to outrun Santos who might have sprinted a little too early in this race. Woodside takes the slow burn approach and scores in what is turning out to be a very close contest.

Woodside: 2

Santos: 2

In the last two minutes, it looks like Santos is completely exhausted, and despite its valiant efforts, Woodside pulls out its trump card – a dividend yield of 5.7% complemented by its recent buyback to bring its total implied shareholder yield to over 15%. Santos attempts to respond with its relatively small 2%, but does not have the firepower to defend against this onslaught, and Woodside puts it straight past the goalkeeper.

Woodside: 3

Santos: 2

As the match draws to a close, it is clear that, despite Woodside’s close win, some questions remain around its higher gearing and future growth prospects. These issues aside, on the baseline metrics presented above, Woodside appears to be an attractive proposition given its shareholder yield, disciplined capital management and strong focus on shareholder value.

Although Santos has lost today’s battle, it seems to have a lot of potential with its large reserves position (compared to enterprise value) and near term plans for the future. However, it does seem that a boost in earnings is priced in, which could be seen as a potential risk in the event that this does not eventuate.

 

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Motley Fool contributor Sid Narsey does not own shares in any of the companies mentioned.