Huntleys' Stock of the Week

Recommendations: Accumulate

STO's current stock prices

WPL and STO, Growth or Debt

Investment Rating:

STO is a major Australian oil and gas exploration and production company with interests in all Australian hydrocarbon provinces, Indonesia, PNG and North Africa. Reliance on declining Cooper Basin assets and years of exploration inactivity saw STO under production pressure. Stronger energy prices supported earnings. The requirement for a replacement cornerstone asset looks to be coal seam gas (acquired under former MD Ellice-Flint) and associated proposed LNG development. STO is still a higher risk, lower quality proposition than rival Woodside, despite a pristine balance sheet. The Sidoarjo mud disaster in Indonesia adds environmental liability uncertainty. Attractive near term PE multiples and lift of the archaic shareholder cap lend price support.

Event:

• How do you choose between these two Australian oil majors? The market seems convinced that STO will soon be on the receiving end of a takeover bid. Its share price has risen 80% from $10ps October 2008 lows. Removal of the archaic 15% shareholder cap some time ago opened the door. WPL by comparison is only marginally above its $35ps October levels, although it did subsequently fall to $27ps in November when aversion to debt reached a crescendo. The company is now 40% above those lows. WPL is viewed as a greater FIRB risk to takeover. It is operator of 40% of Australian oil and gas output via the NWSJV, and would-be suitor and major shareholder, Shell, has been knocked back once before. STO's relatively open register also sits in stark contrast. But is this alone sufficient to justify STO's significant premium compared to WPL?

Impact:

• To summarise: On fundamentals our preference remains for WPL. It is larger, more liquids rich, higher margin, has superior historical EPS growth and a better medium term ROIC outlook. Reserve life is greater at over 20 years and it is trading at a significantly larger discount to NPV versus STO. WPL has higher debt levels but this is simply because it is further down the LNG development path, closer to reaping the rewards. WPL is largely master of its own destiny and has an enviable LNG development culture and history. STO will be calling on PETRONAS expertise and tackling new problems, unique to coal seam gas derived LNG, never done before. An argument can be mounted for STO to command a takeover premium given its greater corporate vulnerability and presently strong balance sheet. But a takeover is not a given. We think it better to value stocks on stand-alone fundamentals and let the rest take care of itself. We retain our Accumulate recommendation on STO and Buy on WPL, preference residing with WPL both on value and quality grounds.

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