Brokers Await Clarity On GLNG Progress From Santos

This story features SANTOS LIMITED. For more info SHARE ANALYSIS: STO

-Cost guidance conservative
-Roma wells slower than expected
-Over reliance on Fairview?
 

By Eva Brocklehurst

Cost reductions are well underway at Santos ((STO)), with brokers encouraged by indications that further progress is being made. Maintenance issues at PNG LNG offset the ramp up of Gladstone LNG production in the June quarter, Macquarie observes, while strong rises in oil prices were offset by the lag to weaker LNG prices.

Morgan Stanley maintains that as the company’s realised LNG pricing is lower than other Australian companies, this may reflect a higher proportion of spot sales and/or limited downside protection in its LNG contracts. The broker expects Santos will beat full year guidance on production costs, given the first half performance. The company has updated guidance on upstream production costs to US$9.50-10.00/boe.

Deutsche Bank attributes the miss on revenue in the quarter, relative to its estimates, to much lower third-party sales, a lag between production and sales, and a skew towards lower-priced domestic gas in the numbers.

There was no change to full year production guidance of 57-63mmboe and 31.1mmboe has been recorded to date, with GLNG now ramping up. This suggests to Ord Minnett there is potential upside to full year production. The broker also suspects cost guidance is now conservative. Unit costs in the June quarter were below the guidance range, suggesting the savings measures are gaining traction.

Ord Minnett commends the company for the cost performance, but remains concerned about what further rationalisation decisions may need to be made over the medium term to reduce through-the-cycle costs to the low US$30 barrel range.

While Credit Suisse contends the move to US dollar reporting makes changes to guidance confusing, assuming spot FX, it seems the company has downgraded both production costs and FY16 capital expenditure by 5% and 10% respectively. Hence, the broker awaits the half year results to obtain more clarity.

Meanwhile, the broker observes, 26 wells were drilled in the quarter. Admittedly this is an acceleration but Credit Suisse highlights that just 74 development wells have been drilled in the past 18 months. Given compression capacity constraints, the broker cannot accept this as a positive sign of performance. Roma needs more than 1,000 wells to be drilled to run at capacity, the broker calculates. To date, just 300 have been drilled.

Credit Suisse suspects that joint venture partners are slowing upstream capital expenditure as well, slowing the ramp-up. For now the stock is a play on the oil price, the broker maintains, and there is around 6-9 months of waiting before longer-term challenges and resolutions, hopefully, will drive the share price.

Production beat UBS estimates as output was better than expected from both the Cooper and Carnarvon Basins. The broker expects spending to pick up in the second half as activity increases in the Cooper Basin and GLNG. UBS concurs that cost reductions remain central to the thesis, given the company's high sustaining costs. Further cost cutting measures are needed in order to reduce break-even free cash flow, but the broker anticipates the targets can be achieved without major reductions.

UBS expects higher volumes in the coming quarters as contracted deliveries increase, retaining a 3-year ramp up in forecasts for GLNG. Still, the broker maintains a view that GLNG's over-reliance on the Fairview field for equity gas supply will lead to additional investment being required in the future, as output from the plant is increased and Fairview declines. Up to 90% of GLNG's current equity gas supply is estimated to be sourced from Fairview.

Morgan Stanley agrees Roma and Fairview production remain the swing factors for GLNG during the ramp-up stage of train 2, given fixed third-party supply arrangements. The broker assumes train 2 ramps up slowly over 2016 and 2017 and full production is reached in the final quarter of 2017.

Citi just suspects the company is keeping its good news until the first half results in August. The broker considers cost guidance conservative and, by August, expects Bechtel will have handed over GLNG train 2 operations to Santos, resulting in higher production. The broker had hoped flow rates from Roma would be higher by now but expects the asset will be run harder once Bechtel hands over.

FNArena's database has four Buy ratings for Santos, two Hold and one Sell (Ord Minnett). The consensus target is $5.04, signalling 5.8% upside to the last share price. Targets range from $4.10 (Credit Suisse) to $6.44 (Citi).
 

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