We believe the Australian energy sector could rerate if it moved to slow its production growth outlook.
Despite a rising oil price environment, where positive operational leverage should be highly advantageous for company earnings and share prices, the performance of Australian energy stocks has been disappointing. Over the past two years, Brent oil is up +70%. Santos (STO) is -5% and Woodside (WPL) -14% on total return basis (Feb 20 vs Feb 22). Over this period, Australian energy company share prices have lagged offshore peers by over 50%.
We see an opportunity for the Australian energy sector to cut its production growth and return a higher level of free-cash-flow (FCF) to shareholders. If the sector adopted a capital allocation strategy more akin to what the global oil majors have done, we believe the Australian energy sector could see a significant rerating.
In our view, investors are increasingly prioritising cash returns over long-dated production growth. This is particularly in those sectors like oil where the long-term demand outlook, and therefore the return on equity capital, could be challenged by a move to lower carbon intensity energy sources.
With earning results from STO and WPL still ahead of us, we see an opportunity for Wilsons Australian Focus List member STO to revise its capital management framework.
At spot energy prices, with a revised payout ratio from 30% to 50%, STO dividend yield would lift from 3% to 5.5-6.0%. Global energy giant Shell last week took steps to increase shareholder returns, similar to what we believe STO needs to do. We think the timing is right for Santos to streamline and revise its capital management policy.
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Written by
John Lockton, Australian Equities
John is a leading investment strategist with 20 years experience.