Santos Disappoints And Pays The Price

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This story features SANTOS LIMITED.
For more info SHARE ANALYSIS: STO
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

The recent good news of the upcoming removal of the 15% shareholder cap for oil and gas major Santos ((STO)) has quickly been forgotten and brokers are cutting forecasts and in some cases their rating following the company’s quarterly production report released yesterday.

Actual production and revenue weren’t the problems as both came in broadly in line with market expectations but a revised drilling program in the Cooper Basin meaning production should be at the lower end of previous guidance and an adverse tax ruling are forcing brokers to adjust their numbers for this and coming years.

Among the more aggressive in cutting its estimates was JP Morgan, the broker reducing its current year forecast by 3% but taking 16% off its 2008 estimate and 15% from its 2009 figure.

The broker notes the adverse tax ruling against previous exploration expenditure means the company has begun paying a Petroleum Resource and Rent tax earlier than had been anticipated, with Macquarie estimating it adds $50-$60m to the company’s tax liabilities.

JP Morgan also points out the group’s Cooper Basin production continues to decline rather than increase, which supports its move to cut its earnings. Macquarie agrees, as it notes the plan now is for less wells and an increased focus on exploration rather than development options.

As the broker had been forecasting less output from the area than management had suggested its forecasts are not significantly impacted, but it points out more aggressive forecasts in the market will need to be (and are being) scaled back.

Merrill Lynch is an example as the broker has cut its 2007 earnings per share (EPS) forecast by 7% to 84c, followed by a 3% cut for 2008 to 86c and a 4% cut in 2009 to 59c. Macquarie stands at 82c, 63.1c and 59.4c respectively, while JP Morgan’s revised numbers are 79.8c, 63.7c and 78.7c.

By way of comparison the pre-report median EPS forecasts according to Thomson One Analytics were 97c, 84c and 79c respectively.

Not surprisingly the lower earnings forecasts have corresponded to some ratings downgrades, with both JP Morgan and Citi lowering their ratings, the former to Underweight from Neutral and the latter to Hold from Buy. Citi does suggest any share price weakness could offer a buying opportunity.

Merrill Lynch remains the only broker with a Buy rating on the stock among those in the FNArena database, taking the view over the long-term the company has enough growth options to deliver upside.

These include potential LNG projects in Gladstone in Queensland and Papua New Guinea, while JP Morgan notes there is scope for stronger gas prices going forward. Merrills suggests these projects should be valued at levels in line with peers.

Valuation is the issue for JP Morgan in particular, the broker suggesting after the earnings cuts and the resulting 11% fall in its valuation to $10.48 the stock remains the most expensive in the sector among the companies it covers.

Even allowing full value for the potential new projects the broker’s valuation would only increase to something just over $14.00 per share, so it continues to prefer Oil Search ((OSH)) and Queensland Gas Company ((QGC)).

The FNArena database shows the stock scoring one Buy, five Holds and four Sell ratings, with an average price target of $12.87, down from $13.08 prior to the quarterly. Again for comparative purposes, Thomson One shows a median price target of $12.73.

Santos shares this morning are weaker in response to the earnings revisions and as at 11.30am were down 50c or 3.3% to $14.49.

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