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.
for The Daily Reckoning Australia
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