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Morningstar | Re-examining No-Moat Woodside’s Growth Drivers. No Change to AUD 46.50 FVE.

What are we pricing into our unchanged AUD 46.50 fair value for no-moat Woodside? It equates to a 2028 EV/EBITDA of 7.9, if the USD 6.1 billion lump sum we credit for contingent resources in Kitimat Canada, Senegal and elsewhere is excluded. We credit 10-year revenue and EBITDA CAGRs of 4.3% and 4.8% to USD 8.0 billion and USD 6.1 billion, respectively. This presumes a 44% increase in production to 130 million barrels of oil equivalent, or mmboe, by 2025, at a midcycle Brent crude price of USD 60 per barrel in 2021 dollars.

The chief underpinner of the production growth is assumed construction of a second Pluto LNG train, added to by restart of Enfield oil production. We credit commissioning of the second Pluto LNG train from 2024 adding over 38 mmboe in annual production, or a 42% increment on current 90 mmboe group output. But Greater Enfield is expected to come online sooner, this year, initially contributing around 10.0 mmbbl of annual equity oil production.

While these two projects account for the bulk of forecast production increase, it is the Burrup Hub overall that allows the unlocking of value. Over the next half decade, Woodside and partners will prepare existing onshore facilities for processing several new gas resources that will maximise utilisation of existing infrastructure. Woodside intends building a 430km trunkline from its 75% owned 7.3Tcf Scarborough gas resource into its 90% owned Pluto hub in support of a second 4.5Mtpa LNG train. Development cost is estimated at USD 11.0 billion on a 100% basis. It also anticipates building a 900km pipeline from its 31%-owned 13.9Tcf Browse gas resource to connect with its one-sixth-owned North West Shelf, or NWS, Project. Total development cost here is estimated at USD 15.0 billion on a 100% basis. It will also sensibly build a 4.5Mtpa Pluto-NWS Interconnector to maximise the efficient use of all these assets. Browse will increase NWS Project life by decades and contribute to improved hub redundancy.

The flexibility afforded by the linking of all these assets should not be underestimated. Each 1.0Tcf of gas resource notionally supports 1.0 Mtpa of LNG projection for just over 20 years. Browse adds the equivalent of 20 years of life to NWS Project, and Woodside’s effective average share in NWS Project production increases from one sixth to nearer a quarter, albeit a portion charged a toll given Woodside’s one sixth infrastructure share. Similarly, Scarborough’s gas represents 35 years supply for a 4.5Mtpa LNG train, in addition to opening up other future tie-back opportunities. The interconnect allows more targeted timing for developments via redundancy and opens the potential for even greater expansion, including via tolled third-party gas, to further drive efficiency. Still this wouldn’t likely be to the degree required to award Woodside a moat, given costly expansion undertaken during the resources boom which inflated the asset base. We project returns on invested capital approaching but not exceeding our assessed 9.3% WACC, due to already sunk costs.

Woodside is preparing for final investment decisions on Scarborough, Pluto Train 2, and Browse in 2020. And it is targeting a final investment decision on the Interconnector in 2019. This would have the Interconnector ready for startup in 2021, timed to coincide with drilling of Pyxis and Pluto North development wells. Scarborough is targeted to be ready for startup in 2023 and Pluto Train 2 in 2024. Browse would be ready for startup in 2026.

Despite a hefty capital expenditure program, strong cash flows and a healthy balance sheet should support ongoing dividend payments. We project peak net debt of almost USD 7.0 billion in 2024, but net debt/EBITDA of just 1.5, and falling to sub-1.0 by 2026. This includes a sustained 80% payout ratio and a five-year average dividend of over AUD 1.80 per share or plus 5% fully franked yield at the current AUD 34 share price.

At AUD 34, the market is more than discounting Woodside’s expansion potential in our opinion. Chief concerns stem around market demand for more gas, agreement from a complex joint venture partner structure, and execution risk on large projects. We think all concerns overdone, and already fully credit expansion in our fair value. Woodside’s expansion plans seem well timed to both meet expected supply shortfall, but also to take advantage of lower capital costs following the now completed inflationary Australian LNG construction boom. Market conditions point to a 40% increase in Chinese LNG demand by 2021, with growth driven by clean air policies and urbanisation, while European growth is driven by rising carbon prices and declining domestic supply. Woodside notes 230 Mtpa of additional LNG supply will be required by 2030, in broad step with our own views. And the company recently signed a heads-of-agreement with China’s ENN Group for the sale of 1.0 Mtpa of LNG from Pluto Train 2 for 10 years beginning 2025, equivalent to more than a fifth of Train 2’s likely capacity. Appetite is confirmed and Woodside’s shipping cost advantage over the U.S. Gulf into North Asia is estimated at USD 1.15/mmBtu.

With respect to joint venture partner agreement, we think vested interest will drive decision-making to its logical and sensible conclusion. Gas processing/tolling agreement negotiations are reportedly proceeding well for both Pluto and NWS Project. Woodside targets agreement completion for Pluto Train 2 in second half this year, while a non-binding, preliminary tolling agreement between the NWS Project and the Browse Joint Venture is already signed, and expected at less than USD 2/mmBtu. With respect to execution risk, Woodside has decades more experience in operating and developing LNG projects in the Australian context than any other company. We have little concern on this front. And it will be undertaking developments in a far more contractor friendly environment than last decade, meaning unlikely missteps would be less costly.