Investors are underestimating the growth potential of the Australian oil and gas company Morningstar says, as coronavirus dampens oil prices.

Woodside shares - which features as a Morningstar Best Idea for February - have dipped to $33 from highs of almost $36 in mid-January. The global outbreak that hit in early February has slashed oil demand amid stalling manufacturing, travel bans and dwindling air travel.

"But we still think the market unwisely under-prices for growth potential," says Morningstar senior equity analyst Mark Taylor.

Woodside's shares are more than 30 per cent below what Taylor believes they're worth, trading at about $33 at the open on Wednesday versus a $50 fair value estimate.

Woodside Petroleum Ltd (ASX: WPL)

Morningstar rating: Four star | Price-to-fair value: 0.66 | Economic Moat: None

Taylor views Woodside as a standout energy investment at the right price.

"Gas is the fastest growing primary energy market behind coal, and the seaborne-traded LNG portion of that gas market grows faster still," he says.

"China is building several import terminals, and so demand is likely to pick up, helping to bring LNG prices in line with oil prices."

But natural gas is the main game for Woodside, comprising 60 per cent of Morningstar's fair value estimate. In line with this, Woodside's expansion of its gas production in Western Australia's Pluto facility boosted output by 43 per cent during the half.

The addition of a second LNG train added 38 million barrels to its existing 89 million barrels of gas production.

Last week's earnings result for first half 2020 was posted on the basis of the lower output figure. Taylor applauds this, given the period was marred by major maintenance on a couple of LNG projects and Cyclone Veronica, which smashed WA's Pilbara region in March.

Price comparison of Woodside, Santos and Oil Search

Source: Morningstar

Taylor also likes the way Woodside structures its LNG distribution, selling more into the spot market than competitors Santos (ASX: STO) and Oil Search (OSH), allowing more upside from higher LNG prices.

"But with the Japan spot price presently plumbing US$3 levels versus the average 2019 contract price above US$9, exposure obviously detracts," Taylor says.

"Despite this, net operating cash flow increased by 6 per cent to US$2.7 billion, aided by favourable working capital moves and lower tax payments."

Woodside's conservative debt levels are another positive, as net debt has declined 30 per cent to $1.6 billion.

This healthy balance sheet should support ongoing dividend payments, despite management's ongoing cash outlay for expansion programs.

"Both operating and free cash flows were better than we'd forecast," says Taylor.
Woodside declared a final dividend of US55 cents (82 cents) a share for the half, bringing the full-year dividend to US91 cents ($1.35).

Taylor expects a sustained 80 per cent payout ratio and a five-year average dividend of $1.60 a share, a yield of 4.8 per cent fully franked.