Woodside and the Willy Wonka Market

While the Australian market ignored the slow implosion of its big neighbour to the north yesterday, it held a party for Woodside, who boosted its dividend payout ratio from 55% of earnings to 80%, and promised to hold it there for the next few years. The stock price jumped nearly 10%.

There are a few ways to look at this. The fact that the share price rose sharply tells you what the market thinks of the ability of resource companies to create value via reinvested earnings. That is, not much.

The market places a much higher value on distributed earnings than reinvested earnings. A bird in the hand is indeed worth two in the bush. This is all good in the short term. But for big resource companies, you should ask what such a high payout ratio will do to its prospects.

That’s because these companies NEED to reinvest to create future growth. The strong cashflows coming from Woodside’s Pluto LNG project (that underwrite the dividend increase) are the result of many years of effort and billions of dollars of investment. The Woodside board has obviously made a call that (having put the massive Browse LNG project on the backburner) it can sustain an increase in dividends without having to reinvest in major new projects for a few years.

They probably can. But in time they will again need to find billions to invest in the next major, long term project to replace its slowly depleting assets. A cynic would observe that Woodside is simply trying to get its share price out of the pits by handing back funds to shareholders, so as to be able to raise equity at a better price when they need to down the track.

The other point to keep in mind is that when a company increases its payout ratio, its balance sheet grows much more slowly. So Woodside’s announcement yesterday was akin to saying it’s now an ‘ex-growth’ stock. That the share price rallied says a lot about the market’s views on growth, especially in relation to resource companies.

And if you look at Woodside’s long term share price performance, the market looked like it front loaded the company’s growth prospects during the 2002-08 commodity boom, when the share price moved from $10 to $70. It’s been a tough journey for shareholders ever since.

 

But unlike Woodside (for now, anyway), most resource companies don’t have the luxury of scaling back their investment. They constantly need to reinvest to maintain production and reserves. Shareholders never see a dividend because companies simply chase their (reserve maintenance) tail.

In this post-commodities boom environment, investors are now realising this painful reality. In the real world, risks sometimes go unrewarded, or even punished. In the real world, the best laid plans come undone. In the real world, nothing is certain. Success is fragile and fleeting.

But’s that in the real world. On the other hand you have the stock market, where torrents of money from the world’s busiest manufacturers create a Willy Wonka-like fantasy land of sunshine and lollipops.

Regards,

Regards,
Greg Canavan
for Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

 


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