Treasure Chest: Why Santos Is A Gas

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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 Greg Peel

While Santos’ ((STO)) share price is virtually unchanged over twelve months, the past six have seen a rally from the depths from around $13 to around $15. This includes a nice pop on the release of the company’s interim result.

The result went down as a “beat” at the headline, but given an adjustment for the Petroleum Resource Rent Tax, the underlying result was closer to expectation. However the market, and brokers, largely ignored the result per se and instead focused on an unexpected dividend increase. The increase was more symbolic than substantial but was offered earlier than brokers had forecast.

The recent start-up of PNG LNG was the reason Santos increased its dividend, even though commercial cargoes were yet to be sold. The result announcement also provided another update on progress at the Gladstone LNG project, which was again deemed to be on budget and on track for a “mid 2015” start-up.

Lower margins at the legacy Cooper Basin operations were signalled out for attention by brokers, as was guidance to a higher level of sustaining capex for the LNG projects. Indeed, Credit Suisse maintained its Underperform rating on the stock post-result because of this increase. But while other brokers, too, made note of these issues, Credit Suisse remains a lonely Sell amidst the five other Buy (or equivalent) ratings on the FNArena database.

Macquarie summed up the feeling by noting that with GLNG now 85% complete, the market will begin to “warm” to the story of what has been a very long and rocky road. The upshot is that with PNG LNG up and running and GLNG soon to be up and running, and development capex thus now starting to wind down, Santos will soon be swimming in free cash flow (FCF).

JP Morgan forecasts Santos’ FCF yields to steadily rise over the remainder of the decade as GLNG ramps up, peaking at 18% in FY19 at which point PNG LNG, GLNG and Kipper should all be running at peak output. This compares favourably to energy major peers, given the broker forecasts 11-13% for Oil Search ((OSH)) and 9-12% for Woodside Petroleum ((WPL)).

This excessive FCF will allow Santos to pay down its $6.8bn of debt over the course of the decade, while still leaving room for substantial dividend payments. JP Morgan assumes a 50% payout ratio in forecasting yields of 6-8% ahead, fully franked.

One caveat would be if Santos were to sanction any major new projects in the interim, such as a third train at PNG. Santos nevertheless remains JP Morgan’s preferred energy exposure.

The broker suggests there are three upcoming events that have the potential to move Santos’ share price materially. The first is the November investor day, at which 2015 production and capex guidance will be provided and, presumably, a start-up date assumption for GLNG will be refined. The second is February 2014 reserve report and the third is confirmation of the Hides resource (STO 25%) in PNG, due early 2015.

JP Morgan has set a $16.01 target on Santos which contributes to an FNArena database consensus target of $15.77. This is not as enthusiastic a target as that of Deutsche Bank ($17.80), but then we also have Credit Suisse sitting at a lowly $11.50. Take out CS and consensus rises to $16.62.
 

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