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Company: Woodside Petroleum

Stock code: WPL

Share Price: $33.38 (as at close Friday 21st October 2011)

Market Cap: $26.9 billion

Broker Calls

Shadforth Financial Group – BUY

Deutsche – BUY, $48.80 price target

Macquarie – BUY, $42.00 price target

Citi – BUY, $44.02 price target

William Shaw Securities – BUY

JP Morgan – Underweight, $44.73 price target

 

Chart: Share price over the year versus ASX200 (XJO)

Stock code: WPL

Charts: Woodside Petroleum Limited

More news: Woodside Petroleum Limited

Australia’s largest oil and gas exploration and production company, Woodside Petroleum (WPL), has dropped a staggering 40% since its 52 week intraday share price high of $50.85. WPL is currently trading around $35.  Chartists are pointing to technical indicators suggesting the shares of oil producing companies are currently oversold and ripe for a northward rise.  Should they be right, WPL is set to benefit. 

Woodside produces LNG (liquefied natural gas); LPG (liquefied petroleum gas); natural gas; natural gas condensate; and oil.  Woodside holds interests in oil and gas assets in Africa, the Gulf of Mexico, Korea, and Brazil.  While Woodside’s oil operations account for only 23% of the company’s total production, oil brings in 40% of revenue.

While Woodside is a solid blue chip worthy of inclusion in most share portfolios, there are growing concerns of a commodities slowdown.  So how does the retail investor plagued with fear over the possibility of the bottom dropping out of the commodities markets reconcile those opinions?

Are Oil Shares Oversold?

The fact is oil in the modern world is like no other commodity.  Oil is truly the lifeblood of the global economy with few, if any, alternatives for most consumers and businesses.  If the price of copper becomes prohibitively expensive, users have some alternative materials to which they can turn; or they can delay projects.  When the price of oil approached $150 a barrel a few short years ago, the airlines could not stop flying nor could the trucks stop shipping nor could the consumer stop driving.

In economic jargon, oil as a commodity has little price elasticity.  At some point, price rises in goods should decrease demand.  When it comes to oil, however, the decrease is minimal.  

Advocates of raising taxes on oil to reduce demand were shocked by the results of an IMF World Economic Outlook study released in April of 2011.  The study compared developed economies (OECD) against emerging economies (non-OECD) on several measures.  Here is the table that began popping up all over the blogosphere shortly after it appeared:

We are interested in price elasticity.  To translate the values in the highlighted boxes, a 1% increase in the price of oil would reduce (-) demand by .007% in emerging markets and only .025% in developed countries.  Even a 20% increase in the price of oil would take 20 years to yield a decrease in demand approaching 2%.  There are some who dispute these figures for a variety of reasons, but the basic truth is that price elasticity for oil is minimal.

Couple the demand with the inescapable fact that supply is finite and diminishing, and you should have a recipe for a relatively uninterrupted rise in the price of oil.  In a world without share market investors, that might happen; but with the addition of speculative investment into oil markets, two new and powerful factors enter the pricing equation – fear and greed.

Many speculative investors are highly intelligent people who see the enormous potential in a unique commodity where the burgeoning demand from emerging economies virtually guarantees continued rise in price.  What’s more, they are well aware that the supply side of the equation is more robust than many realize.  The reason is technological advancements in exploration and drilling technology.

Those of you who lived through the oil crisis in the 1970s remember the predictions of how long it would take the world to begin running out of oil.  Almost all were wrong because they failed to anticipate new technologies.  Back then few envisioned deep water drilling capability, nor the technological capability to extract oil from tar sands and shale rock.  Who knows what future technological advancements will bring.

Sensing the opportunity for substantial profit, speculative money pours in, buying contracts to purchase oil that they will never execute.  With the money comes the inevitable rise and fall in oil prices stemming from fear and greed.  When the money is flooding in, prices rise to levels totally unrelated to fundamentals, resulting in an overbought market.  

At the first murmur of trouble, the fear sets in and the money is flushed from the system, leading to oversold markets.  If you are a non-believer in technical analysis, you need to know there are technical indicators that historically have done a good job of spotting oversold and overbought market conditions.

Technical Indicators for Oversold and Overbought Markets

The RSI (Relative Strength Index) is one of several momentum oscillators that signal overbought and oversold conditions.  Basically the RSI measures the speed, magnitude, and change in price movements, with the resulting values “oscillating” between 0 and 100.  In its original formulation, an RSI above 70 indicated overbought conditions while and RSI below 30 signaled a potentially oversold condition.

Experienced technicians today do not rely on this single indicator and many have developed variations.  A common practice is to extend the range to 80 and 20 to avoid false signals.

We can do a simplistic “back test” using the RSI applied to a 5 year price chart of the NYSE AMEX Oil and Gas Index (XOI).  Investors are most interested in how the price of a barrel of oil traded in three different forms (West Texas Intermediate (WTI), Brent Crude, and Dubai Fateh) affects the share price of oil producing companies.  The XOI is a weighted index comprised of the world’s largest oil companies.  Chevron (NYSE:CVX) accounts for 13.66% of the XOI. Here is the XOI chart with the RSI values at the bottom:

The chart speaks for itself. 

A rise in the RSI approaching 80 and above has been followed by a decline in share price in almost all cases.  Similarly, when the RSI plunged to the 30-20 level, share price begins to rise.  A layperson’s description of this technical tool would be at 80 fear trumps greed, and at 20, greed begins to trump fear.  As you can see, the XOI recently entered oversold territory and began to rise.

We can apply the same “back test” to Woodside Petroleum.  Here is the five year chart:

Charts from TheBull.com.au make it easier to use the RSI with the red line drawn at RSI 30 and RSI 70.  As you can see, WPL share price followed the pattern of their bigger competitors in the XOI, entering oversold territory recently.  With the rising share price, is there still time to get in or should the average retail investor wait for another oversold signal?

While strict momentum traders might wait, anyone with a medium to long term horizon would want to look at some of WPL’s fundamentals, beginning with historical financial performance.

WPL Financials

 

12/2006

12/2007

12/2008

12/2009

12/2010

Revenue ($m)

2,620

3,224

5,045

3,467

4,193

Operating Cash Flow ($m)

1,457

2,082

3,224

1,483

2,104

Net Profit after Tax ($m)

1,075

864

1,546

1,4741

1,575

Dividends per Share ($)

.98

.91

1.0

.95

1.05

Long Term Debt ($m)

1,507

618

2,957

5,529

4,512

Gearing (Debt to Equity)

43.3%

20.3%

42.75

53.3%

42.1%

 

In some ways the most relevant line for the average retail investor is dividends per share.  Although capital expenditures for LNG growth projects and the impact of the GFC led to variations in revenue, profit, and cash flow, in the midst of this WPL has maintained a healthy dividend.  

Both long term debt and gearing levels saw significant reductions from 2009 to 2010.  Revenue increased about 20% over the same period.  NPAT increased 6.9% and operating cash flow showed a very healthy increase of 49%.  

This is solid if not spectacular performance and some share market participants seem to acknowledge that.  Despite the drop in share price, WPL still shows a P/E Ratio (17.48) higher than the P/E Ratio of the ASX Energy sector (16.23).  Back on 05 May 2011 WPL’s P/E stood at 24.85.  The P/EG ratio was 1.06 and now it has dropped below the 1.0 level indicating a fairly valued share price.  Today the P/EG is .85.

The real story with Woodside lies in its growth opportunities, especially in the LNG market.  While the development of the Pluto LNG project has been slightly delayed, the revenue potential of Pluto is substantial.  WPL has LNG projects underway at Browse and Sunrise as well.  As China and other Asian countries look for cleaner burning fuels, the LNG market is forecasted to explode in the near future.

No investment is totally risk free and WPL has its share of potential troubles.  They are not the only player in the LNG market and could well suffer from competition from bigger players like Chevron.

Of more immediate concern to some investors is the recent change in management.  While the new CEO has a solid background in the industry coming from Exxon, his future plans with some aspects of the LNG effort are unknown.  As you know, market participants do not like uncertainty.

And last, there is the ever present risk of the volatility of oil prices in the face of global economic uncertainty.  However, what some investors see as a risk to avoid, others see the risk of drops in share price as buying opportunities. Brokers certainly back the stock – as you can see from the list at the top of the article we tracked down plenty of buys from brokers including Deutsche, Macquarie and Citi, with price targets ranging from $44.02 to $48.80.

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Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.