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Date : 30/09/2022

Santos

ASX :

STO

Market Cap : $23.01 Billion

Dividend Per Share : $0.227

Dividend Yield : 3.23 %

Buy

52 Week Range : $6.050 - $8.855

Share Price : $7.02

A strong, low-cost base oil and gas business with long-term plans to develop cleaner energy. Santos remains a “buy” for us.

Company Analysis

Santos (ASX: STO) recently announced its half-year results for FY22. The Company reported a record free cash flow of US$1.7 billion and an underlying profit of US$1.3 billion, an impressive threefold increase on PCP. Santos has strongly beneficiated from this year’s surge in energy prices. Results reflect significantly higher oil and LNG prices on PCP due to stronger global energy demand and greater interest in Papua New Guinea LNG (PNG LNG) following the Oil Search merger.

Santos to return US$605 million to shareholders

Also announced by Santos, the Group intends to return US$605 million to shareholders, equivalent to US18 cents per share under the Company’s capital management framework, comprising a 38% increase in the interim dividend to US7.6 cents per share unfranked of US$255 million. Moreover, the Company plans to increase its on-market share buyback from US$250 million to US$350 million. The US$350 million on-market buyback includes the US$250 million initial on-market buyback announced in April 2022, of which US$174 million had been completed by the end of June 2022. Santos intends to return the remaining US$176 million to shareholders via on-market share buybacks until the end of this calendar year.

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Source: Tradingview

We recommended Santos twice in the price range of $7 to $8. STO shares continue to trade in the $6.85 – $7.41 bracket, slightly above its long-term median level of $6.52. Year-to-date, Santos shares have outperformed the broad market by more than 21%, gaining 6.2%, whilst the ASX200 lost -14.8%. This clearly shows that the market sentiment remains positive toward Santos despite the challenging macro environment.

Santos continues to deliver record production amid rising energy prices

Santos has delivered record production, free cash flow and strong underlying earnings in the first half of FY22. Besides the higher commodity prices during the period, the Company also gained strong customer demand for its products. Demand for Santos’ products has remained elevated in both Australia and abroad. The demand trend was due to an increased supply shortage from producing nations due to global underinvestment in new supply. This shows that major economies are shifting their global energy policy towards energy security as a key priority.

This could further benefit Santos as the Company’s produced critical fuels could play a key role in the energy security of Australia and of many countries in Asia. Products from Santos are also affordable and reliable alternatives to progressively replace higher-emitting fuels.

Santos exhibits robust fundamentals and strong, diversified revenue streams from its five core assets

The FY22’s first half results confirm Santos’ fundamentals strength. The firm demonstrates a reliable capability to generate diversified cashflows and provide sustainable shareholder returns. Santos is well-positioned to fund new developments and be among the leading global players in transitioning to a lower carbon future.

Overall, we believe, in the long run, Santos is positioned to deliver higher shareholder returns given its ability to generate steady free cash flows. Hence, this allows the Company to offer increases in interim dividends and on-market buybacks.

Santos’ five core assets that deliver steady and diversified cashflows:

  • Cooper Basin: This site spans the borders of northeast South Australia and southwest Queensland. The Cooper and Eromanga Basins are Australia’s largest onshore oil and gas field development. Santos discovered the first commercial hydrocarbon resource (natural gas) in 1963 and the first oil in 1970. The Company now produces gas, ethane, crude oil and gas liquids from these regions. The Cooper Basin asset is strategically important, with its key infrastructure at Moomba in northeast South Australia. This Santos-operated infrastructure is integral to the processing and transportation of natural gas and ethane around the east coast of Australia, supported by substantial underground storage facilities suitable for natural gas, ethane and carbon dioxide. Natural gas liquids recovered at the Moomba plant are sent together with stabilised crude oil and condensate via a 659-kilometre pipeline to Port Bonython, South Australia, for further processing. Products including naphtha, crude oil, propane and butane are sold to domestic customers via road tanker and export customers via the ship loading facility.
  • Northern Australia and Timor-Leste: Santos is the leading Australian oil and gas exploration and production company in the Northern Territory, with a significant presence both onshore and offshore. The Company operates both the Darwin LNG plant and the Bayu-Undan facility. The Barossa gas field is 300 kilometres north of Darwin and will be the gas source to backfill Darwin LNG when Bayu-Undan ceases production. The Petrel, Tern and Frigate gas fields are located 250 kilometres west of Darwin, in the Bonaparte Basin, and are well positioned to feed into domestic or export markets. Santos also has a significant exploration position in offshore Northern Australia.
  • Papua New Guinea (PNG): PNG LNG is Santos’ integrated development that includes gas production and processing facilities that extend from the Hela, Southern Highlands, and Western and Gulf provinces to Port Moresby. The facilities are connected by over 700 kilometres of onshore and offshore pipelines and include a gas conditioning plant in Hides and a two-train liquefaction and storage facility near Port Moresby. Santos is positioned to grow its presence in PNG through PNG LNG backfill and expansion, including developing the P’nyang field and standalone opportunities. The Company’s exploration and appraisal position includes exploration permits in the Hides to P’nyang geological and Eastern Carbonate trends in the Gulf Province. In December 2021, Santos merged with Oil Search Limited. As a result of the merger, Oil Search’s PNG interests and assets became part of Santos, including operatorship of the Hides Gas-to-Electricity Project and all of PNG’s producing oil fields as the Company’s interest in the PNG LNG project.
  • Queensland and New South Wales: Santos’ East coast operations incorporate the development of CSG resources in the Surat and Bowen Basins in Queensland and the proposed Narrabri Gas Project in New South Wales.
  • Western Australia: The Company made its first discovery in the Carnarvon Basin in 1984, and today it is well-placed to leverage its established domestic gas hubs and strong portfolio position.

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Source: STO

Company Updates

Santos could get further tailwinds from rising oil prices due to the gas crisis in Europe

Santos and the energy sector could possibly benefit from a further uptick in oil prices. At the time of writing, Brent crude oil is trading for US$85.65 per barrel. Likewise, gas prices could likely spike in the coming weeks.

Gas has recently popped up everywhere in the news, making headlines from the recent event of the massive damage to the Nord Stream gas pipeline in Europe. Two explosions were reported in the Baltic Sea in an act that Western officials believe is Russian premeditated sabotage. This pipeline has been operational since 2011, supplying gas directly from Russia to Germany, where much of it is dispatched to other parts of the continent. The incident will likely disrupt for a long time the gas delivery, putting further upward pressure on energy prices.

Source: Tradingview: left: NatGas, right: Brent

Furthermore, the spectre of the recession still hangs over Brent prices, which have only rebounded modestly after recently falling to their lowest level since January. As of September 19, a barrel of Brent was trading at around US$91 against US$105 at the end of August. Weak oil prices reflect continued mobility restrictions in China that are weighing on fuel demand and signs that European countries are taking longer than expected to wean off Russian oil. We expect a slower rebound in crude oil. Although we believe crude oil prices will remain elevated with a price target for a barrel of Brent at the end of the year, around US$110. The Brent barrel should reach US$125 by March 2023 and stabilise around this level for a good part of next year. Even if it is slower, this expected rebound in oil prices reinforces our bullish confidence in Santos.

Santos is expected to receive $1.4 billion from state-owned Kumul for a 5% stake in Papua New Guinea LNG

The state-owned Kumul Petroleum Holdings is set to increase its Papua New Guinea LNG (PNG LNG) stake to 23%. To this day, Santos remains the biggest stakeholder in PNG LNG. Kumul has submitted an offer to Santos for a 5% stake in the PNG LNG. Exxon Mobil and JX Nippon operators have “rights” to match the offer.

Santos remains the largest shareholder in PNG LNG, which is regarded as one of the world’s lowest-cost LNG producers. The Company is expected to remain the biggest shareholder, with a 37.5% stake, even after the deal goes through. The $1.4 billion offer would bring Kumul’s stake in PNG LNG to 22.8%.

This deal will not impact Santos FY22 as the Company retains all the 2022 cash flows. Furthermore, it is worth noting that Santos has been committed to Papua New Guinea for over 40 years, and the Company is involved in more than 30 different licenses, with significant community partnerships and projects across this country.

As part of the proposed transaction, Santos and Kumul will negotiate a Heads of Agreement to further collaborate on the development of Kumul’s regional capacity and capability, including carbon emission reduction opportunities to achieve net-zero operations.

Investment Thesis

Sales volume, revenue and production on the upward trajectory

Santos reported a record FY22’s first-half free cash flow and underlying earnings:

  • Profits: Underlying profit of US$1,267 million, up 300%
  • NPAT: Statutory net profit after tax increased by 230% to US$1,167 million
  • EBITDAX: STO reported earnings before interest, tax, depreciation, depletion, exploration, evaluation and impairment (EBITDAX) of $2,731 million, up 122%
  • Free cash flow of US$1,708 million, up 199%
  • Merger synergies: Annual merger integration synergies target increased from US$110 million to US$125 million
  • Shareholder returns comprising:
    • A 38% increase in the interim dividend to US7.6 cents per share unfranked
    • An increase in the previously announced on-market share buyback from US$250 million to US$350 million

Source: STO

Profits increased threefold during FY22’s first half

Santos reported a 230% NPAT increase during FY22’s first half, which brought the first half net profit to $1.16 billion, compared with $354 million at half-year in 2021. The $813 million increase in net profit was predominantly driven through higher production and sales revenue due to the Oil Search merger and rising oil and gas prices. The Underlying profit of $1.26 billion includes adjustments after tax of a $100 million increase.

Sales volumes up 4% to a half-year record of 55.7 million barrels of oil equivalent

The Company’s rising profits during the first half were attributed to steady sales volumes, which increased by 4% to a half-year record of 55.7 million barrels of oil equivalent (mmboe). Santos beneficiated from the higher volumes, primarily due to additional interest in PNG production following the Oil Search merger. This high sales volume was achieved despite offsetting the lower average equity interest in BayuUndan combined with the expected field decline.

Product sales were up 85% compared to the previous first half as Santos has been able to realise significantly higher pricing for all its products, combined with higher volumes, mainly as a result of additional interests in PNG production following the Oil Search merger. The average realised oil price increased by 67% to US$116/bbl, and the average realised LNG price increased by 111% to US$14.19/mmBtu. During the period, Santos also ramped up by 9% its production to a record 51.5 mmboe, driven by additional interests in PNG production following the Oil Search merger.

On the 16th of August, Santos declared an interim dividend of US7.6 cents per ordinary share in respect of the 2022 half-year period. We continue to witness dividend growth in line with the Company’s earnings. Since 2021, Santos has consistently increased its annual yield. At the current market price of $6.86, the Company is offering a dividend yield of 3.31%.

FY22 onward outlook

Once again, Santos realised strong cash flow from its operating activities during the year’s first half. The Company reported net cash of $2.13+ million from its operating activities, which were 127% higher than FY21’s first half. In line with 1HFY21’s performance, Santos has provided guidance accordingly. The Company’s sales volume guidance is maintained in the range of 110 to 116 mmboe. Regarding production, Santos is targeting 102 to 107 mmboe for 2022.

Considering Santos’ ability to generate long-term steady cash flow and its last three years of revenue growth at a CAGR of 8.61%, we project the Company’s EBITDA percentage of revenue to be in the range of 65.8% to 75.5% from FY22 to FY26.

Two reasons why we think Santos is more than just another oil and gas company

  1. Australia’s largest domestic gas supplier Asia-Pacific leading LNG supplier: We do not exclusively see Santos as an Energy sector play amid the Energy crisis. Still, it is Australia’s biggest domestic gas supplier and a leading Asia-Pacific LNG supplier. We also like Santos’ diverse portfolio of high-quality, long-life, low-cost oil and gas assets. That is surely long-term value to shareholders.
  2. Focused on the future of energy: What we really like about Santos is its commitment to more sustainably supplying critical fuels such as oil and gas through decarbonising projects such as the Moomba CCS project. The Company is well-established with key stakeholders. Santos has been working for a long time with local communities, safely and sustainably developing its natural gas resources and powering industries and households. It also recognised early that customer demand has evolved. That is how Santos differentiates itself from its peers. Accordingly, the firm plans to grow its cleaner energy and clean fuels through carbon capture and storage, nature-based offsets, energy efficiency, and renewables in its operations.

Recommendation

Santos once again has proved it is a “well-oiled machine” capable of delivering quality products at low-cost operations. Additionally, the current energy crisis provides a medium-term bullish outlook for oil and gas prices, yielding dividends with significant boosts to the realised prices of the commodities. From the long-term perspective, with a strong, low-cost base business supplying oil and gas and plans to develop cleaner energy and clean fuels, we believe Santos remains resilient, value accretive and at the leading edge of the energy transition. We maintain our “Buy” rating on Santos.

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