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Date : 19/01/2023

Santos

ASX :

STO

Market Cap : $24.38 Billion

Dividend Per Share : $0.227

Dividend Yield : 3.08 %

Buy

52 Week Range : $6.66 - $8.86

Share Price : $7.24

Santos is printing cash as energy markets continue to be on frenzy. Dividend expectations are also high. We recommend a 'Buy'.

Company Analysis

Santos (ASX: STO) explores, develops, produces and transports oil and gas products to homes and businesses in Australia and Asia. Its five core assets are located in Cooper Basin, Northern Australia and Timor-Leste, Papua New Guinea, Queensland and New South Wales, and Western Australia. Santos is well-positioned to deliver long-term value to its shareholders through its diverse portfolio of high-quality, long-life and low-cost oil and gas assets. The company has been in operation for 65 years and is based in Adelaide, South Australia.

Bullish demand outlook for gas

Natural gas has the lowest carbon intensity among fossil fuels. It burns cleanly and efficiently with very few non-carbon emissions. These natural gas characteristics have made it a transition fuel that supports the increasing use of renewable energy. It is an ideal partner with renewable energy sources like solar and wind power to ensure a consistent energy supply for when the sun doesn’t shine or the wind doesn’t blow.

While the green energy transition is expected to reduce gas usage in developed countries, demand for gas in developing countries is expected to increase as they move away from coal and replace it with gas for power generation.

In addition, more than half of the world’s natural gas consumption takes place in sectors other than power generation, with hardly replaceable usage in chemical and industrial sectors. All this has led to a bullish demand forecast for gas that expects a 20% growth by 2040, with global LNG demand leading the growth, forecast to increase by approximately 70% during this period. More than 80% of Santos’s revenue comes from gas and gas products, including LNG, with more than 50% share of the company’s total revenue. Therefore, the company is in a perfect position to benefit from the long-term growing demand for gas.

Santos is a free-cash-flow generating machine

Santos generated a record free-cash-flow (FCF) of $2.7bn from record sales revenue of $5.9bn in the nine months to 31 September 2022. It paid cash dividends of $543m and made on-market share buy-backs worth $323m during the same period. This indicates a 2022 yield of circa 5.2%.

Santos recently announced a further $350m increase in the company’s on-market buybacks, reflecting the management’s confidence in the outlook for the company. It had a strong cash balance of $3.64bn as of 31 September. The company forecasts available cash for returns to shareholders and unsanctioned development projects to 2030 of $17bn to $33bn. Santos has declared a payout policy of at least 40% of its FCF per annum. The company intends to increase shareholder returns to at least 50% of FCF generated per annum, once the Barossa and Pikka Phase 1 projects commence production, expected to take place in 2026.

Using the mid-point of the FCF forecast range of $17bn to $33bn to 2030, and assuming the company’s planned minimum payout ratio of 40% throughout this period, we can expect Santos to yield a shareholder return of on average 6.2% per annum for the next seven years, making it a potentially attractive investment case for yield junkies.

How to play Santos’s stock?

Santos’s share price has formed a support level at $6.80 (the green line on the chart), which appears to be backed by the company’s daily share buybacks. Santos has recently announced an additional $350m share buyback program, so we think this support level will likely hold for the foreseeable future. Therefore, we think prices near $6.80 are attractive.

Short-term traders can use a confirmed break below the support level of $6.80 as a stop-loss level. A confirmed break below $6.80 can open the way down to the next support level at $6.00 (the red line on the chart).

We recommend longer-term investors to use a wider stop loss level of $6.00 to reduce the chances of getting whipsawed out of their positions by the current volatile market. A confirmed break below the support level of $6.00 would indicate a bearish sentiment on the stock that can open the way down to lower levels in the short term. Our first target price is the resistance level of $8.80 (the blue line on the chart), with higher prices possible in the long term.

Santos, Weekly Chart in Semi-log Scale (Source: Metastock)

Our earlier coverage can be viewed by clicking here.

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