Posted on the Value Lab 04/07/22
Woodside Petroleum (OTCPK:WOPEF) is probably one of the smartest ways to invest your money in the oil and especially the gas markets. It has several facilities on gas fields and is one of the largest semi-pure gas plays to play the commodity situation that arose in response to the Russian invasion. Our view on oil is that it is more fragile due to geopolitical and OPEC factors, but gas is much more robust. Indeed, that is the hand Putin is playing, and tight prices in gas markets are going to be a boon for companies like Woodside as long as the political capital is stacked against Russia. Their exposures are only increasing, and with realized prices could increase in 2022, their already excited revenues could increase further from the low multiple. We think Woodside could have even more upside despite its already substantial rally, and qualify it as a buy.
A look at the 2021 financial year
The story for 2021 has been all about pricing, while volume increases are more in the future for Woodside as new projects and the merger of BHP’s oil division (BHP) come to fruition.
LNG represents around 70% of the company’s revenues. The rest is basically oil and condensate which is just more hydrocarbons similar to crude oil. Let’s look at the evolutions of the price of LNG.
2021 has seen the substantial rise in LNG prices as well as the rest of the commodity boom. In 2022, we start at more than half of the average level of fiscal 2021 and have already reached new highs in terms of trading conditions and speculation around gas prices due to the Russian invasion of the Ukraine and the threat of sanctions. Prices are currently peaking around 50% above the 2021 average.
Oil saw similar astronomical growth in 2021 with prices rising from $60 to $80 and then peaking at $120 as the invasion of Ukraine began. Prices are currently around 50% above the 2021 average.
Substantial sales growth had come from 2021 due to the rise realized prices, leading to a major increase in gross profits by a factor of 5x, and at an adjusted EBIT where the company barely managed to achieve profitability in 2020 to reach $3.5 billion in profits in 2021.
2021 has already been a great year, with an EBITDA of around $5 billion with an EV of $37 billion at the annual report. Even assuming that the company does not reach realized prices for 2022 before 2021, and using only 2021 figures, we have a multiple of 7.4x EV/EBITDA. Prices are currently ahead of 2021 levels by around 50% for both oil and LNG. While oil may not hold up for reasons related to major geopolitical players seeking new production on the market from previously sanctioned countries, gas prices are much more robust. The main reason is that so many households depend on gas. Certainly in developing countries where electricity is less reliable, and therefore gas becomes indispensable, but also in Europe where millions of households in Germany and Italy use gas, enough so that in the initial phases of the sanctions, these countries have been reluctant to alter relations with Russia. In other words, Russian oil, now less attractive to the markets and thus encouraging them to have a higher price, is replaceable. This means that the oil bounty might not last as long. However, Russian gas is much less replaceable, so the tension in this trading relationship, and therefore the premium given by traders buying gas for their terminals, is likely to continue. With prices having started at a higher point in both segments in 2022, and with a quarter already well past, those high levels are already starting to lock in for 2022, meaning that EBITDA well above $5 billion through operating leverage is likely.
While Russian gas supplies are strategically needed even for hostile nations on the immediate horizon, Woodside is also involved in expanding its assets to be able to add more gas to the market.
Scarborough is in our view a world class project with an expected internal rate of return of over 13.5% and a globally competitive supply cost of approximately $5.80 per MMBtu.
Meg O’Neill, CEO of Woodside Petroleum
Scarborough was one of the top new project approvals this year, and the IRR of 13.5% is estimated based on an LNG price of $5.8, where the price is 10% higher than ‘currently. It is good to see opportunities for reinvestment in LNG despite the political setback, and their IRRs are clearly accretive.
Pluto projects are also being expanded. Although this was met with resistance in Australia due to the powerful green influence in politics, the complaints were dismissed by the judges, so the expansion goes ahead and allows new opportunities for reinvestment in the situation. very robust LNG.
In oil production they are moving forward with the Sangomar field which will be operational from next year, and they are also merging with BHP’s Petroleum division in an all equity deal valuing it at around 10x which is maybe -be a little high compared to other producers. multiples in the market following Woodside’s recent price spike. This merger still needs to be voted on and approved and will affect shareholders in the coming months. The more Woodside is valued, the less economical this transaction unfortunately becomes, but a 10x as a benchmark based on current value does not hurt or help Woodside’s investment case at this point.
Commodity prices start much higher in 2022 than in 2021, and the commodity boom has been extended by market dislocation following the invasion of Ukraine. The risks for this thesis are peace in Ukraine, or any other situation where political capital will be less invested in an anti-Russian position, which will cause the premium on these commodities to dissipate. Other risks are lower oil prices due to the release of taps by OPEC or due to the introduction of oil from previously sanctioned nations into international markets. However, the 7.5x multiple assumes last year’s income. It could improve significantly if prices continue to stay at current levels throughout the year. With high levels of operating leverage, we believe a 50% increase in EBITDA for 2022 is possible. However, even in the absence of this or in the event of falling commodity prices, there is a margin of safety in the multiple.