Well Oiled

Woodside (WPL) has reported interim net profits for the six months to June 30, of $449 million (up 20 per cent) before allowing for the value of commodity derivatives ($64 million). Despite the result being well above market expectations ($410-420 million), Woodside's share price sank 3 per cent.

Among items that may have disappointed the market:

• Although the dividend was up 30 per cent, to 35 cents, it was still
  below many forecasts
• Operating cashflow grew only 3.2 per cent, to $673 million
• Per unit oil production costs were up 70 per cent
• Depreciation, mainly due to increased reserve estimates, was down 14
  per cent

Because Woodside's stock had risen 80 per cent in the past year, it needed a superb result, not just a good one, to continue its upward trajectory.

The main influences in the result:

• Production volume up 5 per cent
• Sales volumes up 7.5 per cent
• A 30 per cent rise in sales revenue, mainly due to a 41 per cent rise in the average BOE (barrels of oil equivalent) price, to $US49.27
• Woodside has increased its 2005 production target 3.5 per cent, to 58 million BOE.
• Strong balance sheet

Woodside's gearing (net debt to equity) remains very low, only 14 per cent, giving it plenty of scope to increase expenditure on exploration, development or acquisitions. Indeed, it is projecting a doubling in capital expenditure this year, to about $2 billion. (Its much publicised Pluto project is still classified a "production opportunity" and is not included in its capital expenditure figures.)

Perhaps the most attractive aspect of Woodside is its production profile. It expects to double production over the next three years.

Oil Price

Despite all its growth attributes, the key to earnings '” and therefore to its share sensitivity '” is the oil price. Woodside says that every $US10 change in the oil price could change its December-half NPAT by about $A80 million (20 per cent). The June-half average oil price of about $US49 a barrel was $16 below the price today, which suggests that, all else being equal, if the oil price remains unchanged, Woodside's December half earnings could be up $A125 million (28 per cent) on the first half's $449 million.

Woodside's sensitivity to the oil price overwhelms all other sensitivities. For example, it calculates that every Australian 1 cent rise in the value of the $A against the $US subtracts about $A10 million from earnings (the $A averaged US77.3 cents in the June half); and a 100 basis points rise in the US interest rate subtracts only about $US2 million from NPAT.

Valuation

Despite its many attributes, Woodside does not appear cheap. The 3 per cent fully franked yield is high by resource standards, but not a reason to invest. Most analysts peg Woodside's share price today at a 15-25 per cent premium to its estimated net present value. Woodside is trading on a high 2006 P/E (price/earnings ratio) of 20 times, commensurate with its status as a growth stock (doubling production over the next three years). Even allowing for a decline in the oil price to $US50, Woodside's earning could double in the next three to four years.

Despite these company-specific attributes, clearly the biggest factor underpinning the Woodside investment case is the oil price. If oil stays around $US65 (or moves higher), Woodside is an outstanding investment at its present share price. Even if oil falls to $50, it still represents a reasonable bet. But if, for example, the oil price halves, then even with a doubling of production, investors would not see any earnings growth and a susbstantial share price decline would occur.

The oil price remains the great imponderable. And this may have as much to do with politics in the Middle East as global growth. A better buying opportunity than exists today may occur for this first-class oil-and-gas stock. It certainly should be kept on every investor's radar screen.

Leading stockmarket analyst Mike Mangan previously worked with Deutsche Bank, he wishes he had Woodside in his portfolio.