Australia | Apr 22 2013
-Strong progress on developments
-Ramp up in production from year end
-Risks skewed to the upside
-Major beneficiary of east coast gas pricing
By Eva Brocklehurst
The year is shaping up as a busy one for diversified oil and gas major Santos ((STO)). The company has made strong progress on development with the partners in the PNG LNG and Gladstone LNG (GLNG) projects. The Fletcher Finucane field is expected to come on stream with first oil production mid year and maintenance in the Cooper Basin has been carried out in preparation for the larger volumes that will flow to GLNG from 2015 .
The company's main focus is on delivering the GLNG project in Queensland, in which it is the operator and 30% JV partner. UBS marks out this project as having upside risk. If the project runs on time for a mid 2015 start, and is on budget (current budget is $20.5bn versus UBS' estimate of $22bn), this would add 43c per share to valuation. The question for UBS is the availability of gas supply, as there has been no update on the building of gas delivery to the project. The broker expects there will be enough to fill the first train but asks how long it will take to fill the second train, and whether third party gas volumes will be required. Suspecting the answer to third party gas volumes is yes, this is likely to be sourced from the Fairview field, in UBS' view.
BA-Merrill Lynch notes the PNG LNG is progressing and first cargo flights from the Komo airstrip are expected next month. The broker thinks the market is awaiting further news on supplemental debt on this project but, given Exxon's co-lending decision and the substantial de-risking that has occurred, this should be secured soon. With Komo almost ready for operations, UBS is more confident of first PNG LNG deliveries in 2014. Moreover, the broker expects that progressive ramp-up in production and revenues from the base business and LNG should procure a dividend increase to $1.00/share in 2017. The broker is monitoring the progress of the key pipeline between Kutubu and Hides as this remains the risk to the project being completed on time.
Bustling activity and the latest production numbers have triggered a broker review across the FNArena database, with the result the company has six Buy ratings and two Hold. Risks appear mainly skewed to the upside and no one wants to recommend a Sell on this stock. Macquarie views Santos as the cheapest stock in the large cap sector and maintains a Buy rating. The latest production numbers may have been a bit disappointing for the broker but this has been swept aside by the progress on the growth projects. For Deutsche Bank too, while the March quarter production was lower than expected, comfort is drawn from the fact the company maintained FY13 guidance.
JP Morgan notes the production shortfall was mainly to do with the Moomba gas plant, in preparation for a step-up in throughput in 2015. The broker thinks profitability will improve, starting with Fletcher Finucane oil in the second half of this year, PNG LNG in the second half of 2014 and then GLNG in 2015. UBS is of a similar view. Investor caution may weigh for some months but the attraction of future earnings will override this at some stage. This should, according to UBS, start to happen by the end of the year.
Citi rates Santos an attractive Buy proposition based on the PNG LNG and GLNG growth, and margins from higher domestic gas prices at the Cooper Basin legacy asset. Notwithstanding oil price fluctuations, BA-Merrill Lynch anticipates risks skewed to the upside too. Despite political issues with CSG, particularly in NSW, the broker believes Santos can rest its case on Queensland, where projects are being built and gas is starting to flow. Credit Suisse is the main outlier, downgrading from Buy to a Hold rating. The main reason is the broker finds the shares have outperformed large cap mining peers so there's not yet a compelling valuation case. The other Hold rating is CIMB.
Curbing enthusiasm somewhat is the fact that LNG execution risk is high. Investors are expected to remain cautious in the construction phase, given the large capex increases in both the GLNG and PNG LNG last year. UBS notes Santos is investing $4 billion in 2013, the peak investment year, and over 80% of this is going into LNG development and future LNG supply projects. Nevertheless, cost over-runs are highly likely in UBS' view. UBS expects spot gas prices on the east coast to rise to over $10/GJ in 2016 and Santos stands as the major beneficiary with its large portfolio in Cooper Basin (unconventional) and Gunnedah Basin (CSG).
Looking closely at Santos' strategic positioning in the Browse Basin, Western Australia, makes Citi think that the company has been sharp. It farmed down a 20% equity stake in WA-274-P to Inpex in 2006 and farmed in with Total in the adjacent block. Inpex and Total are foundation partners in the Ichthys LNG project. The project's pipeline to Darwin has spare capacity for a third LNG train and additional exploration and appraisal success could see Santos positioned to participate in this train. Citi, having modelled this scenario, estimates Santos' 30% share of WA-274-P could be worth $1.68 a share un-risked.
On the database, the price targets range from a low of $13.25, held by Credit Suisse, to a high of $17.30, held by Citi. The consensus target on the database is $15.36, suggesting 30.4% upside to the latest share price. Santos offers a dividend yield of 2.5% based on the consensus FY13 earnings estimates and 2.6% based on FY14.
In 2012 the company's total production was 52.2 million barrels of oil equivalent, split between natural gas (69%), oil and condensate (23%), liquefied natural gas and liquefied petroleum gas (8%), and as at 31 December 2012 proved and probable reserves stood at 1,406 million barrels of oil equivalent.
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