Australia | Aug 27 2019
This story features SANTOS LIMITED. For more info SHARE ANALYSIS: STO
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS
Santos is making progress on a number of developments and, as the oil company continues to deliver, brokers expect sentiment on the stock will improve.
-Focus on higher production at Quadrant, Dorado progress and Barossa de-risking
-Large amount of upside priced into the stock, despite a number of developments
-Questions over the sustainability of lower costs
By Eva Brocklehurst
Incremental improvement in costs and the benefits of scale are coming through for Santos ((STO)) as it makes progress on growth projects. Brokers suggest, as the company continues to deliver, sentiment is likely to improve.
Morgan Stanley expects further upside will be based on de-leveraging and the Dorado project. First half results were underpinned by higher production from Quadrant and output from PNG LNG. Quadrant synergies are tracking ahead of expectations and synergy guidance has increased to US$50-60m per annum.
Credit Suisse likes the potential upside from the progress at Dorado and the de-risking of the Barossa field. There is also an outside possibility that the Narrabri CSG obtains clearance, as Santos expects the environmental impact statement to be approved in the first quarter of 2020.
While GLNG and Narrabri may surprise over time, upside is not factored into Morgan Stanley's numbers. The broker also believes further expansion in northern Australia plus continued production improvements are difficult to forecast.
A large amount of upside is priced into the stock, Credit Suisse asserts, and the remaining upside is offset by downside risk, such as the long-term sustainability of onshore production, particularly at GLNG, and, in the near term, the political risk in PNG.
UBS agrees that most of the growth is factored into the share price, despite anticipating a number of developments over the next 12 months. The broker assesses the company should comfortably achieve its gearing target of less than 30% by the end of 2019 which will put it in a good position ahead of major growth expenditure over the next few years at Barossa, Dorado and PNG LNG.
Dorado
Morgan Stanley suggests the market may be materially undervaluing Dorado. The 2C resource estimate has increased by 68% to 310 mmboe, while FEED (front end engineering design) has been pushed to early 2020. The company holds an 80% interest in this discovery in offshore northern Australia. Citi now models Dorado as a liquid stripping project followed by domestic gas sales, as opposed to the smaller oil development.
Catalysts for de-risking in the second half include Dorado and drilling in the MacArthur Basin. Progress at the Dukas-1 well in the MacArthur Basin has been slow as higher pressure was encountered. Morgans notes this is still a positive given the pressure is associated with gas. The company has a decided to defer finishing the drilling until 2020.
The Barossa field, selected as the preferred backfill for Darwin LNG, continues to make progress and the company expects a final investment decision in early 2020. However, Morgans points out the current fields that feed Darwin LNG are likely to be depleted by 2022 and Barossa is not expected to be online before 2024.
The break-even oil price is reduced to US$31/bbl and Santos reiterated 2019 production, sales and production cost guidance, although 2019 capital expenditure guidance is reduced.
Management has highlighted that growth plans have not slowed and the lower expenditure guidance of US$950m-1.05bn versus US$1.1bn is largely because of reductions in average well expenditure in the Cooper Basin and Queensland. Sales guidance is 90-97mmboe and production guidance is 73-77mmboe for 2019.
Cost Sustainability
If it were not for some scepticism regarding cost sustainability onshore and concerns about PNG, Credit Suisse would take a more positive view, although accepts trends for costs and production are in the right direction and the ramp up at Roma East supports the company's claim to be on track for 6mtpa by the end of 2019.
However, the downturn in production costs appears to be levelling off in the Cooper Basin. The broker assumes onshore production costs decline for another year or so, but beyond that there is a need for technical improvement, while inflationary pressures may emerge.
Operating costs were lower than Macquarie expected in the first half. The broker acknowledges a large variance in reported profit versus estimates because of an assumed impairment in the Cooper Basin which did not materialise.
Morgans has upgraded to Add from Hold as Santos has demonstrated an ability to turn around over the past four years, rejuvenating its capital deployment strategy and moving free cash flow into positive territory. Gearing is also more manageable.
The Quadrant acquisition continues to prove transformational, assisting earnings and margins while lowering the company's oil price sensitivity. Santos continues to pay down its finance facility, with gearing being reduced to 31%. The improved cash flow is likely to be used for further de-gearing, Morgans asserts.
The broker has found it difficult to obtain an entry point to the stock over the last 12 months and assesses now is a good time to accumulate a position, as the company has demonstrated it can push its group earnings margin above 60% while making progress on growth projects and increasing diversity.
FNArena's database has four Buy ratings and three Hold. The consensus target is $7.62, suggesting 8.9% upside to the last share price. Targets range from $6.72 (Credit Suisse) to $8.20 (Macquarie).
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