Is Santos A Re-Rating In Waiting?

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The key highlights from Santos’ quarterly report were upgraded guidance and progress on two major projects the company will complete before switching focus to shareholder returns over growth.

-Santos’ 2025 production guidance upgraded, costs reduced
-Barossa gas and Pikka oil are on-track
-Dorado gas delayed, for now
-Increased dividends ahead for loyal shareholders

By Greg Peel

Santos’ ((STO)) strategy day last November excited brokers, underscoring across-the-board Buy or equivalent ratings. In recent times, noted Morgans at the time, a key point of differentiation between Santos and its larger local peer Woodside Energy ((WDS)) has been that Santos held a stronger growth profile, while Woodside enjoyed better earnings quality from its concentrated portfolio of high-quality assets.

The strategy day outlined that was about to change.

The focus of the 2024 annual investor briefing was the planned introduction of a new capital framework that would slow growth and increase shareholder returns. Macquarie described it as a simplified and more disciplined framework, while Morgan Stanley saw the shift as positive, improving comparability and signalling smoother returns from Santos’ growth profile.

The new framework will apply from the second half of 2026 when growth projects are commissioned at Barossa gas (offshore Northern Territory) in the September quarter 2025 and Pikka oil (Alaska) in the first half of 2026. The new framework will return more cash to shareholders than the current policy and confirms Santos will prioritise shareholder returns over committing to its available growth opportunities, including Papua LNG, backfill opportunities into PNG LNG, Dorado (offshore WA), Narrabri (NSW) & Beetaloo (offshore NT).

Last week, Santos released its December quarter production and sales numbers. Analysts are once again excited, albeit not so much by the quarterly performance, which was largely in line with expectation, but by the progress being made at Barossa and Pikka.

Upgraded Guidance

Santos reported a quarterly result in line with consensus expectations, albeit with sales revenues ahead due to stronger realised LNG pricing. The company released 2025 guidance, providing a positive outlook for 2025, with the midpoint of production guidance 4.5% ahead of consensus and the midpoint of unit production cost guidance -10% below.

The expected start of production from the Barossa field in the upcoming September quarter underpins the upgraded production guidance for 90-97 million barrels of oil equivalent (mmboe) this year, which compares with previous market expectations of 90mmboe.

Meanwhile, the inclusion of Barossa volumes is the primary driver of the guidance for lower unit operating costs. Guidance is for US$7.0-7.50 per barrel of equivalent (boe), compared with a prior consensus estimate of US$7.90 along with some older higher-cost projects reaching the end of their productive life.

The Barossa project was 88.3% complete at the end of December 2024, with drilling underway at the fourth and fifth production wells. Drilling results to date have been in line to ahead of expectations. The project remains on track versus the current budget and is still tracking to first gas production in the September quarter.

Given how difficult this project has been for Santos (permitting, and legal challenges from climate activist-backed groups), Macquarie believes first LNG is particularly significant.

Pikka is also progressing but it’s too soon to know if first oil flow will be this year, Jarden suggests. No formal update on timing was provided but management commentary stated “strong progress was achieved to date” in relation to winter season pipelay activities. Pipeline installation is on the critical path for the project and early completion could allow first oil to commence as soon as December, although management had targeted mid-2026.

Goldman Sachs continues to assume start-up in the June quarter 2026, slightly ahead of management expectations, reaching nameplate capacity in the September quarter.

Dorado Deferred

Significant to the outlook, suggests Macquarie, is that the Dorado gas project (offshore WA) appears to have been deferred. The project is a joint venture between Santos (80%) along with Carnarvon Energy ((CVN)) and Taiwan’s CPC Corp owning 10% each. While no mention was made of Dorado with Santos’ quarterly release, Carnarvon recently reported the project would not enter FEED (front-end engineering and design) at this stage.

The decision is consistent with Goldman Sachs’ assumptions and Santos’ strategic focus on shareholder returns over production growth (following the revised capital framework in November), and the broker believes Santos can phase the Papua LNG, Dorado and Pikka Phase 2 projects to maintain strong earnings and cash flow through the decade.

Goldman considers Dorado an attractive development opportunity and continues to model the project online by 2031. The broker does expect an investment decision would be supported by additional gas discoveries to bolster Phase 2 for potential LNG tolling.

The indefinite delay limits capital expenditure on growth, notes Ord Minnett.

Meanwhile, decommissioning in Western Australia continues with four of eleven wells plugged and abandoned (Mutineer, Exeter, Fletcher, and Finucane). Harriet Alpha platform removal is next.

Unlock Value?

Management was confident at its November strategy day of delivering Barossa and Pikka on time before the new capital framework, prioritising shareholder returns over growth for growth’s sake, kicks in.

In Ord Minnett’s view, the broader market is not positive enough on how keen Santos is to boost shareholder returns or its ability to generate strong free cash flow. This is also reflected in consensus expectations for a dividend yield of 6-7% over the 2026-28 period, versus the broker’s own estimates for a yield of 10-12%.

In the five years ending 2028, Citi estimates dividends per share increase at a 17% compound annual growth rate while gearing (ex-leases) falls some -330 basis points. This assumes Pikka Phase 2 and PNG backfill are both sanctioned, bringing production to in excess of 120mmboe. This suggests the portfolio is not being cannibalised to pay much higher distributions. Notably for Citi, this top line growth occurs at a return on invested capital some 300bps above Santos’ weighted average cost of capital. “This is the kind of oil business we want to own,” says Citi.

UBS lifts its 2025 capex forecast in line with new guidance and expects an update at the FY24 result on the cost-out initiatives and targets planned for 2025. Santos remains this broker’s most preferred Australian Energy exposure offering 8% compound annual growth in free cash flow over 2024-27 and 25% growth in dividends, while maintaining an attractive long-term growth outlook which UBS believes can support a re-rate over the next six months as the inflection point in free cash flow, when Barossa gas and Pikka oil come online, draws near.

A fork in the road is approaching, notes Macquarie. Santos has turned the corner on key growth projects, has outlined a (credible) path to stronger shareholder distributions, and yet the market continues to materially undervalue the company.

That perceived undervaluation has led to some hedge funds with sizeable shareholdings to push management for a demerger of the company’s Australian and PNG assets. This, they believe, will unlock significant value. Not all are convinced, nonetheless.

At the November strategy day, the Santos CEO admitted the company was assessing options to revive a “frustrating” share price.

With Dorado delayed, and WA decommissioning work progressing, a demerger looks to Macquarie to be a prudent path to realising full intrinsic value for shareholders — more than $10 per share on forward curve pricing.

Investors now await any further news at the upcoming 2024 result release. In the meantime, there is no change to Buy or equivalent ratings from the five brokers monitored daily by FNArena covering the stock; Macquarie, Morgan Stanley, Citi, Ord Minnett and UBS.

Nor have Goldman Sachs or Jarden shifted from Buy-equivalent ratings.

The consensus target among daily-monitored brokers is $8.16, up from $8.04 following the strategy update, while Goldman Sachs is on $7.90 and Jarden on $7.65.

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