Let me tell you about one of the most interesting investment opportunities presently available on the ASX. It's one of the largest listed Australian companies, currently offering investors a trailing dividend yield of over 6.5% — fully franked.
This company is also one of the most successful in its industry, having tripled its sales over the past decade and maintaining an unbroken record of consistent profit. The balance sheet is very strong; it's most recent annual financial statements reveal a business with modest debt and over $2.4 billion in cash.
Enter Woodside Petroleum (ASX:WPL).
Not so fast
Before you rush to load up, though, it's worth reflecting on a few key points.
The first, and perhaps most important, is that Woodside, like all commodity producers, has the rather dubious privilege of having its profitability held hostage by global markets. In other words, it has little control over the price of its products, and those prices can swing wildly, and usually in unpredictable ways. Few, if any, energy experts predicted the timing and scale of oil's recent sell off.
To make matters worse, Woodside must commit billions of dollars of capital to projects that can take years to come online, and usually needs to rely on the good graces of banks and shareholders to fund these expensive endeavours. By the time they are ready to go, the economic landscape could have changed substantially.
Even if projects can be supported by existing cash flows, it means much of that money is being reinvested into the business, rather than going into the pockets of shareholders. And ongoing investment is a must for a business whose core assets continually decline in value (as the valuable stuff is pumped out and sold).
On top of it all, there remains the not-so-distant prospect that the energy sector is disrupted by new, or vastly improved, alternate energy technologies. Or, as we've already seen to some extent, increasing energy efficiencies reduce the growth of overall energy demand.
Take care with the yield
Despite the challenges, investors could still be tempted by that juicy dividend yield, which has come courtesy of a near 20% drop in the share price over the past 5 months. With franking credits, that yield grosses up to a very tempting 9.3%.
Here too, though, caution is needed. The company is under no obligation to maintain its dividend, and has in fact cut the dividend a number of times in the past. Moreover with such a massive drop in the price of oil of late, the company may have little choice but to pare back its payments to shareholders.
The yield being quoted relies on the assumption that last year's dividend will be maintained in full in the years ahead. That may be the case, but then again it may not.
Maybe, maybe not
Of course, the price of oil could rocket back up in the months ahead, and with hindsight we could see that Woodside really is a great bargain at today's price.
Then again, oil could remain depressed for a lot longer, or any recovery could be slow and stilted.
Without much trouble, you could line up a dozen unquestioned experts on the energy sector, and half would offer a coherent and well-reasoned argument as to why oil will recover and soon. The other half, with equal weight of argument could argue the exact opposite.
