Analysis of Woodside Petroleum Limited - Case Study Example

Name Institution Course Date Analysis of Woodside Petroleum Limited Introduction The energy industry in Australia plays a critical role in terms of growth of the economy. Woodside Petroleum Limited is one of the largest oil and Gas Company in Australia, and has grown over the years to become a dominant force in the energy sector. Woodside is a publicly traded company that was listed on the Australian Stock Exchange in 1971 (Woodside 10). For that reason, this paper will analyze the financial statements for Woodside for the financial period ending 31 December 2013 in order to establish the company’s financial health. More so, this paper will analyze the internal and external environment so as to establish the factors affecting the company as a going concern, as well as the current market position of Woodside. Furthermore, this paper will determine the intrinsic value of Woodside using both the dividend discount model and cash flow to equity discount model. Woodside’s Products, Activities and Business Segments The nature of Woodside’s operations is such that they handle a portfolio of facilities on behalf of some of the world’s major oil and gas companies. Woodside is particularly concerned with upstream operations, meaning that they deal with the exploration and extraction of oil and gas from oil fields. One major activity that Woodside has come to be known for is in the production of liquefied natural gas (LNG), where the company has become the preferred suppliers given their more than 20 years’ experience in the market. Woodside has operated the North West Shelf since 1984 given that the project was one of the first LNG facilities globally (Woodside 15). To date, Woodside operates six of the seven LNG facilities in Australia implying the level of expertise that the company has built in LNG over the years. The company is a major supplier of LNG to the Asian market, which is the largest LNG market for Australia. In 2012, the company began the extraction of LNG at the Pluto LNG plant, which added more than 100,000 barrels of LNG per day to the total production (Woodside 16). Woodside is currently exploring for LNG in the Australia’s Kimberley region and the Northern coast of Australia. Another segment of the energy sector that Woodside serves is in the exploration and extraction of oil, in their own fields, as well as the oil fields they operate on behalf of their partners. The Timor Sea, Exmouth Basin and North West Shelf are some of the oil fields that Woodside operates and contribute approximately 25% of the company’s total productions (Woodside 16). The company has been able to develop technology that has enabled them to increase their deep-water exploration and extraction of oil. This has been effective with the use of four floating production, storage and offloading (FPSO), which increase the output of oil. Woodside also operates oil fields globally, such as the Gulf of Mexico, New Zealand, Canada, and Korea. Most importantly, Woodside has been active with regards to offshore exploration given that they have more exploration permits than any other country in Australia with a total acreage of more than 115, 000 km2 (Woodside 21). The company has strategically been able to ensure that they maintain the cost of drilling wells low both in Australia and globally. Woodside’s Corporate Strategies The strategies at Woodside have been guided by the company’s mission and value statements, which provide the objectives that the strategies have to achieve. Woodside’s mission has for years been to maximize the returns to their shareholders, and his has seen the company pursues three strategies with regard to their operations. One of the strategies has seen the company strives to maximize on their core businesses, which related to upstream oil and gas activities. To achieve these, Woodside has been able to grow their product portfolio through exploration by leveraging on their proven capabilities in geology and geophysics. Woodside’s vision is to become a global leader in upstream oil and gas, which they intend to pursue through successful partnerships, joint ventures, as well as leveraging on their technological capabilities to establish developed and undeveloped oil and gas opportunities with the aim of linking their products with the market. More so, Woodside is guided by a set of values that are meant to be reflected not only in their operations, but by also their employees as this would enable the sustainability of their business. The corporate values for Woodside include integrity, respect, working sustainably, working together, discipline, and excellence. This has seen the company develops technologies such as Browse floating LNG Development, which is bound to expand their LNG portfolio. In addition, the set of corporate values also works to strengthen their relationships with co-ventures, customers, governments, and communities. External Environment Analysis As discussed earlier, Woodside is categorized under the energy sector, and particularly in the petroleum industry. The company faces external pressures that are not under their control, but affect their performance currently and in the future. The commodity prices for oil and gas have been known to be volatile and prone to economic conditions that affect the global economy. It is important to mention that the Australian economy did not experience a recession like the U.S. and E.U., where markets were affected heavily due to depressed earnings (Woodside 41). The petroleum industry was the most resilient industry and could have explained the reason why the Australian economy never went into recession (Trading Economics 41). In addition, the prices of LNG and oil have usually been based on spot prices, meaning they are subject to greater price volatility. This acts to reduce the revenues that Woodside earns in a financial period and is likely to affect the company going forward. Another problem affecting the industry relates to the uncertainty in forecasting demand for oil and LNG. It is difficult to use historical demand data to forecast future demand because the supply of oil and gas may also vary from time-to-time, a factor which forces players such as Woodside to sell their products on the spot market at relatively low prices. Foreign currency fluctuation also affects the financial performance of Woodside in that they sell their oil and gas in the international market using the U.S. dollar, but account for their operations using the Australian dollar (Trading Economics 52). For that reason, a fluctuation in the currency exchange rates negatively impacts the financial results at Woodside. The exposure to foreign currency fluctuation increases with the increase in international operations as this would involve the conversion of the host country currency to Australian dollars. Woodside has been able to respond to these challenges by among other things having a diversified portfolio of long-term sale and purchase agreements. In addition, the company has been able to ensure that their oil and gas is sold in the domestic market using the Australian dollar, which has partially offset the exchange rate fluctuations (Fernandez, Aguirreamalloa and Linares 89). All these strategies have made Woodside a market leader in the upstream oil and gas segment of the petroleum industry. Financial Analysis Historical Trends In order to identify the growth rate at Woodside it is important that we analyze the current and previous financial results of the company by calculating a number of financial ratios, such as the leverage ratio, return on equity, dividend payout ratio, and revenue growth. Year Revenues Revenue Growth (%) ROE Leverage Dividend payout ratio Retention Ratio Growth Rate 2009 4,352 - 17.1% 1.9 0.44 0.56 9.58% 2010 4,193 -3.65% 13.5% 1.7 0.49 0.51 6.89% 2011 4,802 14.5% 11.4% 1.7 0.57 0.43 4.9% 2012 6,348 32.2% 19.2% 1.5 0.32 0.6 11.52% 2013 5,926 -6.65% 11.4% 1.6 0.96 0.04 0.46% Total 36.4% 33.35% From the analysis, the revenues for Woodside have been fluctuating with time given that they declined in 2010 by 3.65% and increased by 14.5% and 32.2% in 2011 and 2012 respectively, but later declined in 2013 by 6.65%. This trend is important as it shows how Woodside has been expanding their operations within the five-year period. On the other hand, the ROE measures the amount of net income that was a result of the investment of shareholders’ equity (Pinto et al 38). The ROE can provide more information about the growth of Woodside in that a higher ROE may mean that the company is experiencing high growth. Woodside experienced higher ROE based on the fact that their ROE was above 10%, but was higher in 2012 where the company recorded a 19.2% ROE, which also represented the highest growth the company reported. For this paper, we have used the three-factor du Pont model to analyze the factors affecting Woodside’s ROE namely efficiency, profitability and financial leverage using the asset-to-equity ratio and dividend payout ratio. Therefore, the growth rate for the respective years has been computed by multiplying the retention rate to the ROE for each year (Pinto et al 57). Woodside has been growing at a relatively higher rate until 2013 where the company grew by a mere 0.46%. The company can be said to be at the transition stage of its business lifecycle given that the revenues are on a decline and the growth of the company has declined from 11.52% to 0.46% in 2012 and 2013 respectively (Pinto et al 54). In addition, the dividend payout ratio has increased, implying the business is at the transition stage. Forecasting Woodside’s Intrinsic Value Usually, the valuation of securities is done using the Dividend Discount Model (DDM) and the Cash Flow to Equity Discount Model (FCFE) (Pinto et al 60). However, there are some factors to consider when determining the method to use when computing the value of the security. Some of the factors include the growth rate of the company, the nation’s GDP growth and the stage of growth the business is currently (Australian Government 2). However, for this paper, we will use the two stage model under the DDM and the FCFE models. This is because, Woodside had an abnormal growth of 11.52% in 2012, which declined to 0.46% in 2013, which is considered a sustainable level given that the nominal GDP growth rate for Australia in 2013 stood at 0.80 percent. This meant that the growth rate of 0.46% in 2013 was considered a sustainable growth for Woodside. Cost of Capital Woodside’s investments are financed by both equity and debt capital, thus we will compute the cost of debt, as well as the cost of equity. We will compute the cost of equity for Woodside using the CAPM equation since we have the following: Long-term government bond rate = 3.84% Woodside’s Financial leverage (2013) =1.6x Market risk premium (ASX) = 6% Cost of equity = 0.0384 + 1.6 (0.06) = 13.44% On the other hand, the cost of debt for measures the current cost that Woodside incurs from borrowing from commercial banks to finance its capital projects (Pinto et al 38). However, it is important that we state the ratings of Woodside petroleum. According to Moody’s Investors service, Woodside was rated in 2013 as a stable with a Baa1 grade given the increased cash flow from Pluto and proceeds from the sale of some of their operations (Paton 57). On the other hand, Standard and Poor grades the company as BBB+, meaning it was able to meet its financial commitments, but adverse economic conditions and changing circumstances are likely to lead to a weakened capacity of the obligor to meet their financial commitment (Standard and Poor’s 25). As a result, the cost of debt for Woodside will be computed using both the actual rating method and the synthetic rating method using the table below. Interest Coverage ratio Rating Spread >8.5 AAA 0.75% 6.5 – 8.5 AA 1.00% 5.5 – 6.5 A+ 1.50% 4.25 – 5.5 A 1.80% 3.0 – 4.25 A- 2.00% 2.5 – 3.0 BBB 2.25% 2.0 – 2.5 BB 3.50% 1.75 – 2.0 B+ 4.75% 1.25 – 1.75 B 6.50% 0.8 – 1.25 B- 8.00% Australian corporation taxes for resident companies in 2013 was 30%, where the operating revenue for Woodside was Aus$5926 while interest expense was $186. In addition, the 10 year government bond as a risk free rate of 3.84% on maturity. Therefore, using the Actual rating method Rd = (3.84% + 2.25%) (1 -0.30) = 6.09% x 0.7 = 4.263% Using the synthesis method: Interest coverage ratio = 5926/769 = 7.7 Thus, Rd = (3.84% + 1%) (1 – 0.30) = 4.263% Woodside’s Expected Growth of Net Income Expected Growth = Equity Reinvestment Rate x ROE Equity Reinvestment rate = (Net Capital Expenditures + Change in Working capital) (1- debt ratio)/ net income Woodside’s net capital expenditure = $(1,059) EBIT = $2,538 Tax rate = 30% Computation of changes in working capital for Woodside in 2013 2013 ($) Changes to trade and other receivables 101 Changes in Inventories 48 Changes in provisions (118) Changes in trade payables (163) Changes in other current assets and liabilities 11 Changes in working capital (121) Therefore, Reinvestment rate = (- 1059 + -121)/2538 (1 – 0.30) = (1180)/1776.6 x 100 = 66.42% Expected growth on EBIT = 0.6642 x 0.114 = 7.57% Two-Stage DDM Model Summary of inputs Market inputs Long term risk free rate 3.82% Risk premium 6% Current EPS $2.1250 Current DPS $1.0300 Variables High growth rate phase (2012) Sustainable Growth phase (2013 onwards) ROE 19.2% 11.4% Dividend payout period 0.2 0.96 Retention ratio 0.6 0.04 Expected growth 7.57% Cost of equity 13.44% Dividend Indicated gross yield 7.13% However, the present value of the high growth cash flow is: Vo = Do (1 + gs)/(1+r) = 1.03 (1+0.1152)/ (1+0.0982) = 1.148656/1.0982 = $1.046 Present value for first cash flow (PV1) = 1.03(1+0.0713)/1+0.0982) = 1.103/1.004 = 1.004 Present value for second cash flow (PV2) = 1.03(1+0.0713)^2/1+0.0982)^2 = 0.98 Present value for third cash flow (PV3) = 1.03(1+0.0713)^3/1+0.0982)^3 = 0.956 Present value for fourth cash flow (PV4) = 1.03(1+0.0713)^4/1+0.0982)^4 = 0.933 Present value for fifth cash flow (PV5) = 1.03(1+0.0713)^5/1+0.0982)^5 = 0.9 Present value for terminal cash flow (PV6) = 43.438/1+0.0982)^5 = 27.19 Terminal value of the of the share = 1.03 (1+0.1152)5(1+0.0713)/0.0982-0.0713 =$43.438 Present value of the terminal cash flow =Do (1+gs)n(1+gl)/(1+r)n(r-gl) = 43.438/ (1+0.0982)5 = $27.19 Vo =PV1+PV2+PV3+PV4+PV5+PV6 = $31.963 Two Stage Model under FCFE In order to calculate the intrinsic value of Woodside’s share using the FCFE model, it is important that we compute both the free cash flow to the firm (FCFF) and the free cash flow to equity (FCFE). 2009 2010 2011 2012 2013 Net income 1775 1577 1509 3044 1814 Add: Depreciation 1019 782 664 1217 1266 Interest expense 120.40 136.5 140 422.8 354.2 Less: Investment in fixed assets (6022) (3649) (3584) (1914) (710) Less: increase in working capital (172) 117 (20) (75) (121) FCFF -3279.6 -1036.5 -1291 2694.8 2603.2 Less: interest (120.40) (136.5) (140) (422.8) (354.2) Add: Dividends paid - 547 - 867 1748 Add: net borrowings 5354 608 362 (1252) (2470) FCFE 1954 -18 -1069 1887 1527 WACC Total equity 15958 80.9% Total debt 3764 19.1% Total 19722 100% WACC = (80.9% x 13.44%) + (0.191 x 0.04263 x (1-0.3) =10.87% + 0.57% = 11.44% Terminal value (2013) = FCFE 2014/r-g = 1527/ 0.0982 -0.0713 = $56,765.80 Vo = 1954/ 1.0982 + -18/1.0982^2 + -1069/1.0982^3 + 1887/1.0982^4 + 1527/1.0982^5 + 56765.80/1.0982^5 Vo = 1779.2 -14.92-807.11+1297.31+955.94+35536.90 = $38747.32 Value per share = 38747.32/823 = $47.08 Reasons for differences in the intrinsic value of Woodside’s Shares The major difference that may explain the difference between the value of the shares under both the DDM and PCFE models may be a tax effect on the value (Pinto et al 70). In particular, the discount model does not take into consideration the effect of tax on the dividend payout. The PCFE model, on the other hand, considers the corporation tax that the company pays by accounting for the tax effect in relation to the value of the company’s share (Damodaran 142). Under the DDM model the value of Woodside’s share was $31.963, while under the PFCE model, the value of the company’s shares was $47.08. Another factor may be the implicit assumptions under both models. The DDM model makes use of dividends as cash flows while the FCFE are cash flows that are available to shareholders or investors as both dividends and share repurchased are part of the cash flows; thus, transactions between shareholders and the company do not affect the free cash flow (Pinto et al 72). The share price for Woodside stock recorded a high of $39.18 and a low of $38.90 as at 31 December 2013. This varies with the intrinsic value of the company’s stock under the DDM model of $31.963 and $47.08 under the PFCE model. Using the results from the PFCE model, it can be said that Woodside’s share price has been undervalued. There has been activity with regards to the strategic positioning at Woodside after it announced their 2013 US$1,749 billion profits. Woodside paid out their final dividends for the financial year 2012 in February 2014. In addition, the company entered into a memorandum of understanding with Leviathan Joint venture participants to convert the principle agreement previously signed to a potential acquisition of an interest in the Leviathan field. In March, Woodside paid the final dividend of 103 US cents per share for the year 2013. Finally, the Australian and South Korean governments signed the Korea-Australia Free Trade Agreement (KAFTA) as this was important to Woodside given their partnerships in offshore exploration, in South Korea (Bloomberg 8). Conclusion The decision to use the two-stage model under both the DDM and PFCE was due to the growth rate of the cash flows and dividends not representing a constant rate for each stage. In particular, the abnormal growth for 2012 and the sustainable growth in 2013 made the Two-stage model the most suitable. However, the financial health at Woodside Petroleum Limited can be described as good, given that the company is not highly geared. In addition, the company performed fairly well in 2012 but revenues and net income declined in 2013, implying that they may be at the maturity stage of their business Lifecycle. The company has been able to maintain the capital structure at 80:20 for equity and debt respectively. However, the stock market has greatly undervalued Woodside’s share, although the share price has been rising with time. The energy industry has not been affected greatly by the global recession as Australia did not experience a recession. However, there are external pressures that still pose a risk to the financial performance at Woodside, namely uncertain demand, volatile oil and LNG prices, and the fluctuation in currency exchange rate. The diversification of their operations has been able to cushion the company from these problems. Works Cited Australian Government. 2013-14 Budget: Economic Outlook. 2013. Web. 15.05.2014. http://www.budget.gov.au/2013-14/content/bp1/html/bp1_bst2-01.htm Bloomberg. Woodside Petroleum Ltd. 2014. Web. 15.05.2014. http://www.bloomberg.com/quote/WPL:AU Damodaran, Aswath. Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Hoboken, N.J: Wiley, 2012. Print. Fernandez, P, Aguirreamalloa, J and Linares P. Market Risk Premium and Risk Free Rate used for 51 countries in 2013: A survey with 6,237 answers. IESE Business School. 2013. Web. 15.05.2014. http://www.netcoag.com/archivos/pablo_fernandez_mrp2013.pdf Paton, J. Woodside Risk Tumbles to 2009 Low on LNG Cash: Australia Credit. 2012. Web. 15.05.2014. http://www.businessweek.com/news/2012-07-10/woodside-risk-tumbles-to-2009-low-on-lng-cash-australia-credit Pinto, JE, Henry, E, Robinson, TR & Stowe, DD. Equity Asset Valuation. 2nd edition. New Jersey: John Wiley & Sons, 2010. Print. Standard & Poor’s. Global Credit Portal: Ratings Direct. 2012. Web. 15.05.2014. http://www.standardandpoors.com/spf/general/RatingsDirect_Commentary_979212_06_22_2012_12_42_54.pdf Trading Economics. Australia Stock Market. 2014. Web. 15.05.2014. http://www.tradingeconomics.com/australia/stock-market Woodside. Positioned for Future Growth: Annual Report 2013. 2013. Web. 15.05.2014. http://www.woodside.com.au/Investors-Media/Annual-Reports/Documents/2013_Annual_Report_Interactive.pdf Woodside. Woodside Petroleum Ltd Annual Report. 2009. Web. 15.05.2014. http://www.woodside.com.au/Investors-Media/Annual-Reports/Documents/Woodside%20Annual%20Report%202009.pdf Woodside. Woodside Petroleum Ltd Annual Report. 2011. Web. 15.05.2014. http://www.woodside.com.au/Investors-Media/Annual-Reports/Documents/Woodside%20Annual%20Report%202011.pdf Read More