Why Woodside is not the better energy trade

With February reporting season just around the corner, it’s always good to review the winners in your portfolio just in case the price doesn’t justify the reality. Woodside Energy (ASX: WDS) is one of those for me leading into reporting season that warrants review after a big year merging BHP’s oil and gas assets into the business and rallying around 50% in 2022.

In this wire, I’ll share with you why I believe Woodside’s financials are showing some red flags. I’ll also share our preferred energy trade at Maqro Capital.

Red flag: It doesn’t get much better than last year

It was a perfect scenario for WDS last year with the Ukraine invasion pushing oil and gas prices higher while the world economy was running white hot. Woodside also inherited some of the “BHP investor glow” which worked tremendously well for the likes of Bluescope Steel (ASX: BSL) and South32 (ASX: S32) after their spin-offs. 

The last update from WDS in October was a stellar release with revenue up 70% year-on-year. Management was also boasting about the extra profit margin from the 25% of the gas they sell because it was sold at the floating price.

Notably, there wasn’t too much statistical focus on the oil from market analysts, more of an attitude of an assumption that because of the historic success of BHP spin-offs, WDS will be a better company. Since then, the natural gas price has fallen 51% and the oil price is down 5%, 32% from its Ukraine highs and WDS is up 20%.

Red flag: Chequered earnings history

Woodside also has a chequered history during earnings periods, with 50% of earnings releases being a negative surprise over the last 5 years, and the positive earnings surprise being largely due to events out of their control leading to higher prices in their commodities. While the BHP assets have increased the margins for WDS, now market-leading amongst its international peers, the underlying dictates the fate of the company and as the chart below illustrates, this is one of the largest divergences in share price to the underlying we have seen in a long time.

Red Flag: Woodside has dislocated from Oil and Natural Gas Prices

As you can see in the charts, Woodside has outperformed significantly on a 1-year and since their October update. 

One year and since October update

Red Flag: Relative Value

Woodside’s relative value at these prices also concerns me. The company’s stock is looking expensive amongst many of its international peers. As the diagram below shows, WDS has the highest forward PE and the largest percentage price gain for the year.

Its Price to Earnings Growth (PEG) ratio sits in the middle of the pack. The ratio is the share price measured against the company’s predicted earnings growth. But as I pointed out above, the company has a 50% chance of disappointing in February based on sell-side analysts’ poor track record of picking results over the last 5 years.

Red Flag: Cyclicality

The fourth red flag is fairly obvious (at least to seasoned investors) - it’s a cyclical stock. The outlook for the global economy isn’t rosy for the next 6-12 months with most analysts calling a recessionary fallout from the sharp lift in rates from central banks last year.

While we do expect China, the world’s largest importer to recover, they still have access to Russian gas and oil at favourable prices, so the effect is unlikely to have as much influence as investors think.

An alternative idea

For Woodside shareholders who remain bullish on energy and Woodside long-term, the best alternative in our view is to take some profits in WDS and take advantage of the low oil price via the OOO ETF from Betashares (ASX: OOO), which tracks the WTI crude oil futures price.

Until the divergence between the share price and underlying normalises, taking the company risk is not worth putting your money on the line until Woodside starts to trade on cheaper multiples.

Never miss an insight

If you're not an existing Livewire subscriber you can sign up to get free access to investment ideas and strategies from Australia's leading investors.

And you can follow my profile to stay up to date with other wires as they're published – don't forget to give them a “like”.