'Mad to vote against it': Why Woodside's BHP Petroleum merger could be a genuine moneyspinner

Woodside looks set to close its merger with BHP on June 1 with its shareholders to vote at its AGM on May 19
Analysts and investors have warmed to the deal as oil prices have surged

When news emerged Woodside (ASX:WPL) would be merging with BHP’s (ASX:BHP) petroleum division the response was a little tepid.

But with oil prices climbing to more than US$100 a barrel and Asian LNG cargoes trading at over US$30/Mbtu in the wake of Russia’s invasion of Ukraine – and tight supplies through a cold northern winter – Woodside is making money hand over fist.

In its last two quarters Woodside has generated US$2.85 billion and US$2.35 billion in sales revenue respectively.

Add BHP’s high performing and unencumbered Gulf of Mexico assets, including Shenzi and Mad Dog, and the free cash flow is set to fly.

The key date for the deal is May 19 when Woodside’s shareholders will vote at its AGM to approve the merger to make Woodside a $41 billion global top 10 energy producer.

Oil and gas analyst and Stockhead contributor Peter Strachan said “it would be madness” for shareholders not to approve the deal.

52-48 split

One of the voices initially critical of the Woodside-BHP deal was Simon Mawhinney, the managing director of Allan Gray, one of Woodside’s biggest shareholders with a stake of almost 5%.

Much of that initial criticism hinged on “unknowns” around the deal as details unfurled initially in newspaper articles before the terms were revealed to the market.

Allan Gray now plans to support the merger, with Mawhinney saying the deal structure which ensured a 52-48 split of the merged entity would go to Woodside and BHP shareholders respectively made it ‘share price agnostic’.

Other analysts have raised queries around what Woodside will do with ageing BHP assets with potentially significant closure liabilities like its Bass Strait oil fields.

BHP last year put a US$3.9 billion closure liability price tag on its oil and gas assets, much lower than analyst expectations.

Woodside shares hold value in a high oil price environment world

Woodside has the word of its independent expert KPMG onside, which says the deal that will almost double its production levels to 193MMboe (million barrels of oil equivalent) per annum is in the best interests of shareholders.

KPMG and Woodside’s calculations are based on oil prices sliding from current super-high levels over time to a long-term price of US$65 a barrel by 2026 when its US$12 billion Scarborough project off WA’s Pilbara coast is set to come online.

Strachan said that assessment was likely conservative. Since the deal was announced in August last year WPL shares have climbed from $20.39 to $31.82 yesterday, giving the Perth-based firm a market cap of ~$31 billion.

“If you’re looking at US$85 a barrel going forward and production of between under 190 and 200 million barrels of oil equivalent per annum,” Strachan said. “I’ve looked at that and said that just on a dividend-discount model alone, it’s worth somewhere between $34 and $36, that’s the merged entity.

“But if you put in there US$105 a barrel then the shares are worth something like between $48 and $51.

“And remember, Woodside’s peak price was something like $74-75 back in the day.”

Another attractive aspect of the deal is the unencumbered nature of BHP’s petroleum assets.

They carry no debt, significantly strengthening Woodside’s balance sheet by taking its gearing to just 8%, with WPL anticipating combined group revenue of US$12b, $6b in operating cash flow and over $5b in earnings a year out to 2027.

With high free cash flows expected at current and future oil and gas prices from BHP’s GOM assets and the new Sangomar development in Senegal due to begin production in 2023, it opens the door for higher yields and M&A.

At current prices Strachan said Sangomar would spit out $2b in free cash a year before taxes and overheads.

“Even if you halve that, that’s going to give them a lot of spending money,” he said.

“They’ve got enough basically on the books of development assets with Scarborough and Trion (BHP) and the other upgrading assets in the Gulf of Mexico, that they’ll probably be stepping out and looking at some M&A work as well.

“Because there’s plenty of opportunity in the North West Shelf as well for them to pick up stray bits and pieces of gas that they could put through their existing five LNG trains down the track.”

An increase in yield and shareholder returns is likely as well.

Barrenjoey analysts Dale Koenders and Jock Traveerungroj said in a note after the release of Woodside’s quarterly results in April the deal could be “transformational to capital allocation”, with incremental shareholder returns expected from August.

That balance sheet strength will make life easier for Woodside boss Meg O’Neill when it comes to developing new projects.

After Sangomar and Scarborough attention will turn to the long stranded Browse LNG resource off WA’s coast, which will require a carbon capture and storage solution due to its high CO2 content, and the Trion oil discovery, part of BHP’s GOM assets.

Carbon questions

One big question around the merger is what happens to the BHP shareholders who have pushed the firm to reduce its exposure to fossil fuels and will now be left with shares in an oil and gas stock.

Macquarie’s equities desk is anticipating a positive shareholder vote which will trigger selling from “investors who can’t hold Woodside stock or see better uses of their funds”.

With its enlarged bank balance Woodside could use on market and off market buybacks to reduce the potential volatility coming from fast sellers, Macquarie says.

Then there are questions about Woodside’s ability to meet its carbon reduction targets (including a customary 2050 net zero goal) with an enlarged portfolio.

While Strachan says there is merit to the argument that LNG will be a transition fuel — saying there was good reason to think the market would be strong for the next couple decades — he is less enamoured by Woodside’s move into “new energy fuel” hydrogen.

“(Woodside boss Meg O’Neill’s) also playing the green card and I don’t think there’s a lot of value in the the sort of hydrogen paths that they’re taking, because it’s all based on fossil fuels,” Strachan said. “And it’s all so much greenwashing as far as I can see.”

For BHP shareholders they are losing solid cash generating assets and diversity, with the sale of the petroleum business further exposing the Big Australian to swings in iron ore prices.

But they will be the recipient of a combined US$10 billion worth of franking credits from the deal following the expected in specie dividend of 1 Woodside share for each 5.5340 BHP shares held by eligible BHP shareholders.