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De-Risking Santos Looking For Catalysts

Australia | Oct 26 2022

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

With Santos shares looking relatively undervalued, brokers are divided on what catalysts might ignite a positive share price narrative.

-Santos reaps record year-to-date sales revenue of US$5.9bn
-3Q gearing drops to 20.8%
-Brokers not too fussed about Barossa court risk

By Nicki Bourlioufas

Higher gas prices have helped Santos ((STO)) reap record revenues, helping the company to reduce its debt and most brokers rate the company as a Buy with energy prices expected to remain high, which could push its share price over $10.

Santos posted record sales revenue of US$5.9bn over the nine months to September 30, up 86% with reported record free cash flow (FCF) of US$2.7bn, up 194% on the previous year.

During the third quarter, sales revenue rose to US$2.2bn thanks to a 14% rise in the realised LNG price (US$16.8/mmbtu) and a 9% increase in sales volumes (29.9 mmboe). Third quarter production rose to 26.1mmboe from 25.5mmboe in the second quarter, primarily due to increased domestic gas demand and reduced production downtime.

Boosted by FCF of over US$1bn, Santos reduced balance sheet gearing to 20.8%. Company management narrowed its 2022 estimated production guidance to 103-106mmboe.

Broker Responses

According to Morgans, Santos’s result highlights the quality of earnings and strong cash flows given higher energy prices.

The broker expects Santos’s gearing to trend lower, which will boost the overall investment appeal. The broker has an Add rating on the company with a $9.40 target price.

“While we have seen oil prices hit ‘pause’ on their upcycle over the last quarter, as the world digests slowing growth and a surging US dollar, we expect oil and gas price conditions to remain supportive with the upcycle intact,” Morgans said.

Similarly, UBS has a Buy rating on Santos with a $9.35 price target. Progression on projects in North America and greater capital efficiency have the potential to drive Santos’s share price higher by the year’s end. UBS expects gearing to fall to around 11% in the coming year following completion of the PNG LNG sell-down, providing capacity for further share buybacks.

Citi is even more upbeat with a target price of $10.70 and Buy rating.

Citi likes the prospects for Santos to de-risk its growth projects, including progression of the Barossa project, a final investment decision was reached for the Alaskan Pikka oil project in August, a final decision is expected for Dorado in the next 12 months.

“Growth can also be supported by Santos’s balance sheet without equity dilution, and we see the greatest potential for [earnings] growth coupled with return-on-invested-capital expansion in the sector,” Citi says.

Court appeal uncertainty priced in

Citi does point out the pending court appeal for the Barossa project is a risk for Santos.

Barossa drilling operations were recently suspended following a Federal Court decision to set aside the acceptance by the regulator of the drilling and completion activities environmental plan. Santos is appealing the decision with an appeal hearing expected to be held in mid-November.

Macquarie also rates Santos a Buy with a 12-month price target of $10.00. If the Barossa court appeal is successful, Macquarie expects this would allow drilling of development wells to resume promptly.

Macquarie lauds the company's "superior FCF growth profile, which really starts to differentiate from 2026E onwards”.

Macquarie expects regulatory and legal pressures to be resolved over the next six to 12 months. In terms of other risks, Macquarie notes PNG country risk. Santos’s interest in PNG LNG increased to 42.5% from 13.5% in late 2021 after it bought Oil Search to capitalise on LNG interests in PNG.

Jarden has a $8.35 target price on the stock and likes the company because it offers relatively better value than main competitor Woodside Energy, which is considered “nearly fully valued".

Jarden thus has a sector preference for Santos, pointing out its forecasts already factor in a 12-month delay for the Barossa project, which may yet prove pessimistic, the analysts suggest.

Credit Suisse is less upbeat. While this broker has a $8.35 target price on Santos, it prefers other energy stocks. The stock may now present "value" in comparison with peers, Credit Suisse acknowledges, but the stock "risks becoming a value-trap without the prospect of catalysts to reinvigorate the narrative” in the broker's view.

Simply put, Credit Suisse sees a more compelling catalyst driven risk-reward proposition for other stocks in the local oil and gas sector.

Santos will host an annual investor briefing day on Tuesday 8 November, which brokers are awaiting for further updates on production. FNArena’s consensus target price for Santos is $9.47, suggesting 24% upside to the last share price.

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