With commodity prices stabilising and rising in 2016, many investors may contemplate the purchase of resources companies such as Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG).
Further, the price of Brent oil has risen from a low of US$28 per barrel in February to the current price of US$43 per barrel. This means oil and gas company Woodside Petroleum Limited (ASX: WPL) may be a worthy long term purchase at face value.
Financial standing
A key reason for this is Woodside's financial standing. Its borrowing levels are relatively low; Woodside had a net debt of US$4.3 billion in financial year 2015. This equates to a net gearing level of 29% which indicates that its balance sheet can accommodate more debt in order to pursue growth opportunities.
Woodside's net operating cash flow halved in FY 2015 to US$2.4 billion, but free cash flow was US$600 million after the payment of capital and exploration expenditure of US$1.8 billion. Woodside's finances and cash flow have also improved because of a reduction in dividends paid. They fell by 57% in FY 2015 and in my opinion this is a sensible strategy given the investment opportunities on offer.
Strategy
Woodside is taking advantage of low commodity prices to engage in an ambitious acquisition programme. For example, it has agreed to purchase all of ConocoPhillips' interests in Senegal for US$350 million. This provides it with future upside in exploration as well as the potential for near-term oil production.
Further, Woodside is reducing costs which forms part of a strategy to improve efficiencies. For example, in FY 2015 it reduced its break-even cash cost of sales by 22% to US$11.09 per barrel of oil equivalent (boe). It also achieved annual productivity program benefits of over US$700 million in FY 2015 as well as the US$500 million recorded in FY 2014.
Key to this fall in costs has been a reduction in staff numbers of 10%. Woodside's investment in leveraging technology and the commercialisation of stranded resources has also enhanced its competitive advantage.
Outlook
However, Woodside has a high risk profile in my view. It is a pure play oil and gas company which produces solely in Australia. Therefore, it lacks diversification in its operations and its geography versus sector peers. As such, Woodside is highly dependent upon the oil price, which has fallen by 19% from US$53 per barrel to US$43 per barrel since early June.
More oil price volatility could lie ahead and while Woodside's balance sheet, cash flow and strategy are sound, a lack of diversity and its status as a price taker mean its risk/reward profile is unfavourable.
