Woodside downgraded to "Sell": Citi flags M&A fears and bearish oil price outlook

Citi has downgraded its rating for Woodside (ASX: WDS) from Neutral to Sell amidst a bearish macroeconomic outlook as well as uncertainties around its dividend payout and M&A activity.

Woodside shares opened 5.9% lower on Thursday, which includes it trading ex-dividend for 101 cents a piece (a yield of approximately 3.7%).

The analysts lowered their target price from $25 to $24.50 to reflect weaker oil prices, asset depreciation and poor returns on recent acquisitions.

Why the downgrade

Below, we'll highlight the moving pieces to the downgrade.

#1 Sangomar depreciation changes: Citi's NPAT forecasts have been consistently coming in too high. The August result revealed one helpful clue as to why their forecasts were wrong: Sangomar depreciation. The new data increased the depreciable asset base for Sangomar significantly:

• 2024: +US$0.6 billion

• 2025: +US$0.7 billion

• 2026: +US$1.4 billion

#2 Bearish oil prices: Citi projects US$60 per barrel oil in 2025, well below consensus. This forecast is based on:

• Slowing demand

• Robust non-OPEC supply growth

• Spare global oil production capacity

This bearish outlook directly impacts Woodside's earnings forecasts, with Citi noting "lower revenue is starting from a lower figure against the higher 'fixed' expenses on the P&L."

#3 Mixed M&A track record: Woodside has struggled to release the full value of recent acquisitions. The report cited:

• The acquisition of the Wheatstone, Balnaves and Kitimat parcel of assets in 2015 has, we estimate, been written down by >90% of the purchase price.

• Sangomar is at risk of being NPV negative if the PSC (product-sharing contract) with the government become more onerous.

• BHP-P assets have had their production outlook downgraded, Wildling appraisal was unsuccessful, and an impairment has been recorded against Shenzi.

• We have been underwhelmed by Driftwood and Beaumont, and the share price reactions suggest the same is true of the broader market.

The analysts also flagged the US$7 billion in exploration expenses since the completion of Pluto's final investment decision, cost overruns (Pluto and Sangomar) and poor capital allocation.

#4 When will we see strong free cash flow: Citi expects Woodside's free cash flow yield to track around 2.5% in 2024 and 2025 but dramatically improve towards the second half of this decade.

"The free cash flow yields look very high once Scarborough comes online, and higher again with Driftwood," the report said.

Their models forecast free cash flow yields of approximately 10% in 2029 and almost 20% in 2030. "We can understand the long-term investor positioning for this. However, we are just not convinced that the FCF yield is going to be as high as what we present," the analysts warned.

#5 M&A may undermine cash flows: CEO Meg O'Neil's comments suggest potential M&A in upstream and blue ammonia sectors. Citi anticipates further acquisitions to address:

• Limited upstream diversification beyond Scarborough

• Growing Atlantic Basin LNG portfolio

• Single blue ammonia project

#6 Gearing and dividends: Citi's analysis, under a conservative oil price scenario, without factoring in a Driftwood sale, projects peak gearing of 19% in 2026, with high levels persisting through the decade. This financial outlook could prompt bondholders to advocate for strategic changes, such as dividend reductions, issuing hybrid bonds, or even raising equity to support capital expenditures.

The long haul

Citi outlines two key conditions that "must be met for buying Woodside": A trough in dividends and the completion of deal-making activities. However, they caution, "neither of which, we believe, can be satisfied today."

While Woodside shares have already dropped approximately 32% over the past twelve months, there doesn't seem to be a positive catalyst in sight.