Major broker questions sustainability of Woodside’s dividend yield

Resources company investor days are typically about glossy PowerPoint presentations filled with images of hard hat wearing workers, plenty of bottom left top right graphs of forecast supply deficits, and tea and milk arrowroot biscuits for the dozens of analysts the big brokers send to attend. 

If the price of the commodity the relevant mining company is obsessed with happens to be booming, it might even be Tim-Tams.

Yesterday, Woodside Energy (ASX: WDS) held its annual Investor Briefing Day in Perth. CEO Meg O’Neill outlined the company’s strategy across its three major projects, Sangomar in Senegal, Scarborough in Australia, and Trion in Mexico.

O’Niell noted Woodside’s future looked bright as it looked to leverage its “high quality global portfolio with low cost and high margin operating assets” to service demand for the company’s products. 

That demand is expected to remain robust even as the world transitions to a lower carbon economy. “Woodside’s LNG-weighted portfolio is well suited to capitalise on that demand”, O’Neill said. Tim-Tams all-round then!

In keeping with investor day tradition, Woodside offered the customary supply deficit chart which appeared to demonstrate increasing demand for natural gas out to 2040 under a scenario of +2.5 degree Celsius change in global temperatures compared to pre-industrial levels. Growth for crude oil under this scenario only extended as far as 2030.

Woodside shows two possible scenarios which result in supply deficits for natural gas and crude oil out to 2050. Source: Woodside Energy

Demand for both commodities drops off from each respective point, but is still higher than current levels by 2050 for natural gas as Woodside suggests it is the more suited of the two to generate low-emissions baseload power capacity.

Whilst demand is expected to level off, or in certain cases fall, Woodside proposes supply is likely to decline even further. This could result in a supply deficit of up to 14 Mtpa by 2050 for natural gas, and around 6 MMbbl/d for crude oil.

Citi sees through Woodside’s PowerPoint

From there, it was all par for the course in terms of the usual investor day briefing fodder, until one seemingly innocuous free cash flow versus production chart appeared. Whilst it looked like a bunch of squiggly lines on a chart for most, the clever analysts at Citi read between those squiggly lines to draw some pretty important conclusions about a potential downgrade in Woodside’s free cash flow.

If they’re right, such a downgrade could have serious implications for Woodside’s dividends, and therefore its share price valuation. 

The free cash flow versus production chart Citi’s analysts took umbrage to

According to Citi, the five-year outlook depicted in the chart implies a “deterioration” in free cash flow compared to a similar diagram Woodside provided at last year’s Investor Briefing Day. It’s also potentially “meaningfully short” of a well respected consensus aggregator’s free cash flow estimate for the company. 

Citi speculates Woodside’s free cash flows may now be as much as $2 billion lower than previously thought. While acknowledging there may be some assumptions made by Woodside which haven’t made public to the analyst community, the free cash flow of circa US$12.5-14.5 billion implied by the new data, as well as the roughly $7 billion in dividends it suggests, are both “materially below the consensus forecasts”. 

Citi is concerned that if the lower dividend scenario comes to fruition, and if the company “goes into a downgrade cycle that affects the outlook for the dividend yield”, it could lead to a materially lower valuation for Woodside shares in the market.

Citi’s views certainly cast some doubt on Woodside’s attractiveness as a yield play in an energy sector they describe as “somewhat crowded”. They’ve called for further disclosure from the company to clarify its five-year outlook, and to dispel Citi’s interpretation of the data which was presented at the Investor Briefing Day.

In this most recent note, Citi dropped their target price for Woodside from $32 to $31.50 and retained their ‘Neutral’ rating.