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Date : 13/04/2022

Santos

ASX :

STO

Market Cap : $27.33 Billion

Dividend Per Share : $0.195

Dividend Yield : 2.41 %

Buy

52 Week Range : $5.84 - $8.37

Share Price : $8.00

Santos operates diverse, high-quality, long-life, low-cost oil and gas assets. We reiterate our “Buy” recommendation.

Company Analysis

Santos (ASX: STO) is a low-cost global producer of oil and gas committed to cleaner energy and fuel production with operations across Australia, Papua New Guinea, Timor-Leste, and North America. Santos has been supplying reliable and affordable energy to Australia and the Asia-Pacific for over 65 years.

We recommended Santos last year on the 4th of October. A buy at the price of $7.08 per share. Since then, Santos shares have appreciated by more than 11%.

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Source: Tradingview

Why do we like Santos?

First, it is a very well established company with a long history. Furthermore, Santos is already Australia’s biggest domestic gas supplier, a leading Asia-Pacific LNG supplier. More importantly, it is committed to supplying critical fuels such as oil and gas more sustainably through decarbonising projects such as the Moomba CCS project, certainly an edge in this highly competitive industry.

Another aspect that we like about Santos is the Company’s diverse portfolio of high-quality, long-life, low-cost oil and gas assets. That is surely long-term value to shareholders.

Santos is well-established with key stakeholders. Hence, the Company has been working for a long time with local communities, safely and sustainably developing its natural gas resources and powering industries and households.

Santos also recognised early that customer demand has evolved. That is how the Company differentiate itself from its peers. Accordingly, Santos plans to grow its cleaner energy and clean fuels through carbon capture and storage, nature-based offsets, energy efficiency, and renewables in its operations. Moreover, 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.

Santos delivered a consistent and successful strategy, producing record cash flow and higher dividends

We could surely say that FY21 has been a remarkable year for Santos. Thus, we have seen Santos’ successful merger with Oil Search Limited, completed in December 2021. We believe that this merger has certainly transformed Santos into a company with the size and scale necessary to fund sustainable growth. Furthermore, this will also enable the Company to transition to a lower-carbon future and deliver strong returns.

Santos now has a diversified portfolio of long-life, low-cost assets leveraged to strengthen global energy demand. Had the merger been in place for all of 2021, the combined asset portfolio would have generated more than US$2.3 billion in free cash flow for the year.

We are confident in the Company’s ability to leverage its asset portfolio. Hence, Santos exhibited strong discipline, managing a low-cost operating model which could generate unrivalled growth opportunities and support the Company’s vision of becoming a global leader in the energy transition.

Onward 2022, The Group plans to further optimise its portfolio by reducing gearing and reviewing its capital management framework, including returns to shareholders.

FY21 was a year with great achievements for Santos, which could be a springboard for strong growth going forward. Santos delivered strong results during the last financial year with:

  • The completion of the merger with Oil Search Limited.
  • Record annual production, sales revenue, free cash flow and underlying net profit after tax.
  • Final investment decisions on the Barossa LNG and Moomba CCS projects.

Source: STO

Regarding the dividend, Santos resolved to pay a final dividend of US8.5 cents per share, franked to 70%, bringing the total dividend for 2021 to US14 cents per share, up 97%. The dividend equates to 20% of the merged entity’s full-year proforma free cash flow. The distribution was in-line with Santos’ sustainable dividend policy, which targets a 10% to 30% free cash flow payout.

Santos is well-placed to lead the energy transition

Santos has acknowledged that the world will accelerate its demand for reliable, sustainable and affordable energy. Accordingly, the Company is now committed to delivering net-zero equity Scope One and Scope Two emissions by 2040, and this through decarbonising its base business whilst investing in clean fuel projects and technologies of the future.

Santos will initially focus on lower-carbon technologies where they have a competitive advantage. The Company’s infrastructure-led carbon capture and storage or CCS strategy will potentially provide more than 30 million tons of carbon dioxide storage capacity annually. The first critical step was taking the final investment decision on Phase One of the Moomba CCS development, located in the Cooper Basin in Australia. This project will inject 1.7 million tonnes of carbon dioxide per year and is on track for the first injection in 2024. The Moomba CCS project is one of the world’s lowest-cost CCS projects and an important enabler in transitioning to cleaner energy and clean fuels such as hydrogen and ammonia and potential carbon removal technologies such as direct air capture.

Overall, we think that Santos has now developed into a major Australian energy producer with a portfolio of high-quality, long-life, low-cost assets across Australia, Timor-Leste, Papua New Guinea and North America. We are also convinced that Santos’ portfolio is well-diversified, resilient and correctly positioned to benefit from recovering commodity prices. And finally, we believe that its portfolio provides a strong platform for sustainable growth and future returns as the world transition to a lower-carbon future.

Source: STO

The Five Core Assets that define Santos

  1. Cooper Basin: Spanning the borders of north-east South Australia and south-west Queensland, the Cooper and Eromanga Basins house Australia’s largest onshore oil and gas field development.
  2. Northern Australia and Timor-Leste: Being the only Australian partner in Darwin LNG, Santos has a large discovered resource base across Northern Australia and Timor-Leste.
  3. Papua New Guinea: Santos acquired a 24% interest in PDL-1 in 1998. This gave the Company access to a significant part of the giant Hides gas field and resulted in Santos becoming a founding partner in the PNG LNG project.
  4. 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.
  5. Western Australia: Santos 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.

Company Updates

FY22 onward outlook: Santos to become the global leader in the transition to clean fuel and cleaner energy

2021 brought the global energy industry into the spotlight with skyrocketing fuel prices and a supply crunch in the wake of a low level of investment since 2015, exacerbated by the pandemic demand crisis. With global fuel markets and supply chains increasingly integrated, this threatens to impact natural gas, oil, coal and electricity markets across Europe, America and Asia, putting a fragile global economic recovery at risk. Considering these issues, Santos focused on supplying critical fuels more sustainably to meet society’s demand as the world transition toward decarbonisation. Unlike the oil crises of the 1970s, today’s energy security crisis is centred on natural gas, with robust demand for pipeline gas and LNG, causing record-high prices. This is particularly the case in the developed economies, such as in Europe and America, where electricity firming is increasingly dependent on natural gas to support renewables. We believe there is nowhere else for consumers to turn.

Therefore, while Santos collaborated with its customers to build market demand for clean fuels such as hydrogen, the Company focused on supplying natural gas to meet ongoing demand whilst minimising carbon emissions. That is why Santos is now fully involved in developing CCS projects and, for residual emissions, high-quality offsets. Countries worldwide are re-evaluating energy and fuel price stability and supply security risks, finding critical considerations on the journey to Net-Zero. With natural gas playing a central role in decarbonising energy markets and balancing renewable energy, and with the European Commission and Korea moving recently to recognise the importance of gas in their economic activities for sustainable energy, more investments are needed to ensure supply can keep pace with demand. Moreover, it is vitally important that new supply investment happens sustainably. Santos has recognised early the importance of sustainability to remain relevant in this highly competitive sector. The Company knows that the energy industry will soon be subject to ESG scrutiny by its investors. Santos is aware that energy companies would have to report transparently on their carbon emissions and climate transition plans. We believe Santos is well ahead and is best placed to sustainably supply critical fuels.

Santos recently published last month its 2022 Climate Change Report. In this report, the Company describes its approach to managing the risks and opportunities associated with climate change and its action plan to achieve net-zero emissions by 2040 and play a global leadership role in the energy transition. In this report, Santos highlighted not only its future plan but also reported its achievement and remarkable progress during the CY21. One of the great achievements was Santos’ final investment decision on the 1.7 million tonnes per year Moomba CCS project in South Australia’s Cooper Basin, which will deliver one of the world’s biggest CCS projects. Santos is also one of the first companies globally to book CO2 storage resources of 100 million tonnes in the Cooper Basin. We believe that the CO2 storage capacity is a strategic competitive advantage in evolving cleaner energy, clean fuels and carbon markets, with CCS a critical technology for the world to achieve its climate goals. Moomba is the first of a series of CCS hubs that Santos plans to develop around its current infrastructure. These hubs will deliver new revenue streams and a step-change in the Company’s ability to reduce carbon emissions from its production. Another advantage of these hubs will be the added capabilities to develop new clean fuels such as hydrogen and deploy emerging technologies such as post-combustion and direct air capture.

In addition, FY21 saw Santos continuing to take concrete steps to improve its operational efficiency and reduce emissions, including decreases in fuel use, ongoing electrification of its facilities and deployment of more renewable energy. In December, the Company completed its merger with Oil Search Limited, adding to its diversified portfolio of high quality, long-life, low-cost producing natural gas assets across Australia, Timor-Leste and Papua New Guinea. It is also worth noting that this merger also lowers the emissions intensity of Santos’ portfolio production and provides the Company with the scale and financial capability to invest in its Climate Transition Action Plan. With a strong, low-cost base business supplying natural gas to meet ongoing customer demand and a clear action plan to develop cleaner energy and clean fuels, Santos remains resilient, value accretive and at the leading edge of the energy transition to a low-carbon future.

Investment Thesis

Santos is on track to achieve all three 2025 targets by the end of 2022

Santos has defined three distinct key targets to be achieved by 2025. Although we have been positively surprised that the Company has already achieved two of its three targets well before its expected deadlines.

Target One: Grow liquefied natural gas exports to at least 4.5 million tonnes per annum by 2025:

  • Santos’ equity LNG exports were 4.56 million tonnes in 2021, a 6% increase on 2020 volumes.
  • Gladstone LNG in Queensland achieved LNG sales of over 6.4 million tonnes in 2021. With a capacity of 8.6 million tonnes per annum, there is potential for sales growth of 2.2 million tonnes above 2021 LNG sales.
  • Santos continues to focus on sustaining its existing infrastructure in Australia and PNG to meet customer demand, taking a final investment decision on the Barossa offshore natural gas project in northern Australia in March 2021 to backfill Darwin LNG. The decision followed a binding long-term LNG Supply and Purchase Agreement with Diamond Gas International, a wholly-owned subsidiary of Mitsubishi, for the supply of 1.5 million tonnes per annum of LNG from the Barossa project for ten years with extension options. The agreement delivered a firm LNG offtake arrangement representing over 80% of Santos’ equity Darwin LNG.
  • The Bayu-Undan gas field will end its field life in 2023, reducing LNG sales until the Barossa backfill project comes online in 2025.
  • At current equity levels across Santos’ three LNG projects, the forecast LNG production for 2025 will be approximately 7.15 million tonnes per annum.

Target Two: Feasibility study and investment in technology to deliver a step-change in emissions:

  • Santos’ assessment and investment in step-change technology has been and continues to be focused on CCS. Santos achieved this target by taking a final investment decision on the Moomba CCS project in 2021.
  • To date, Santos has invested over US$24 million in equity shares in developing the Moomba CCS project.
  • The Moomba CCS will be one of the world’s largest and lowest-cost CCS projects, storing up to 1.7 million tonnes of CO2 per annum at a lifecycle cost of less than US$24 per tonne. Costs are expected to decrease with scale, and previous studies have concluded that the Cooper/Eromanga Basins have the potential to store more than 20 million tonnes of CO2 per annum.
  • Santos has also entered into a research and collaboration agreement with Australia’s national science agency, CSIRO, to trial direct air capture and post-combustion capture technologies at Moomba.

Target Three: Economically reduce emissions by more than 5% across operations in the Cooper Basin and Queensland from the 2016-17 baseline by 2025:

  • Santos saw its projects deliver approximately 260,000 tonnes of CO2e per annum of reduction since 2018, which is about a 4.4% reduction. During FY21, the Company achieved over 100,000 tonnes of CO2e reduction delivered in 2021. These projects included solar and battery conversions of beam pump on oil wells, incorporation of solar energy in facilities and integration of a heat-recovery steam generator at Moomba.
  • These Projects continue throughout 2021 and into 2022 and will reduce fuel, flare and vent emissions by over 150,000 tonnes of CO2e per annum. These include 24 more wells converted to solar and battery.

Source: STO

Santos achieved record annual production, record sales revenue and record free cash flow

We have identified three catalysts that are driving Santos shares appreciation:

  1. Santos’ record annual production, record sales revenue and record free cash flow
  2. Santos’s demonstration of disciplined and phased growth
  3. The Merger with Oil Search completed

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Source: STO

In a nutshell, Santos has achieved a strong base business performance and delivered a record annual production of 92.1 million barrels of oil equivalent (mmboe), inclusive of 1.7 mmboe from the Oil Search assets from the 11th of December 2021. The stronger commodity prices coupled with higher sales volumes allowed Santos to deliver a record quarterly sales revenue of US$1.5 billion, up 34%. The Company achieved as well during the period record annual sales revenue of US$4.7 billion, up 39% year on year. With such a volume of sales increase, Santos generated a strong free cash flow of around US$1.5 billion, more than double the level in 2020. Santos’ portfolio average realised LNG price increased by 32% in the quarter to US$13.64/mmBtu.

Overall, Santos delivered record annual production and sales revenue during FY21, as its strong base business performance positioned the Company to benefit from higher commodity prices. This was possible as Santos’ disciplined, low-cost operating model continues to drive strong performance across the Company’s business and has positioned the firm to take full advantage of the increase in commodity prices. Moreover, during the period, Santos completed its Oil Search merger allowing the firm to capture the size and scale necessary to deliver even stronger outcomes in 2022 and beyond. Santos also completed 20% of the Barossa project and continues to make excellent progress. Other key achievements are the Company’s announcement of the final investment decision on the Moomba carbon capture and storage project, the solid development of the Dorado Phase 1 and the progress of Pikka Phase 1 projects toward the Final Investment Decision due this year.

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Source: STO

Western Australia: The domestic gas production and sales were slightly lower than the previous quarter due to a planned maintenance shutdown at Varanus Island. Tie-in and start-up activities for the two remaining dual lateral wells in the Van Gogh Phase 2 infill program were successfully completed and under budget. WA oil production and sales were higher in the fourth quarter due to incremental production from the wells. The Varanus Island Compression and Spartan projects continued to make good progress in support of developing additional reserves back to Varanus Island. The Varanus Island Compression Project started up during the quarter. Pre works activities commenced on the John Brookes Platform to tie back Spartan and prepare for the first offshore campaign planned for early 2022. The Dorado development has continued to progress with the planned Front End Engineering Design work for the Floating production storage and offloading and Wellhead Platform. The Stage 1 Offshore Project Proposal (OPP) phase has closed, and the Stage 2 OPP has been submitted to National Offshore Petroleum Safety and Environmental. The initial development phase will involve gas reinjection to maximise liquids recovery ahead of the second phase of gas export from the field. This future phase of gas export offers backfill supply to Santos’ existing domestic gas infrastructure in Western Australia.

The project is targeting a final investment decision around mid-2022. The Noble Tom Prosser rig is currently drilling the Dancer prospect, located seven kilometres from the Reindeer field. This will be followed by drilling the Pavo and Apus prospects in the Bedout Basin, located 35 to 40 kilometres east of the Dorado field.

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Source: STO

Cooper Basin: The Cooper Basin production was slightly lower than the previous quarter due to natural field decline and higher gas downtime due to planned upstream events and unplanned train outages in the Moomba Plant. Oil production was stronger than the previous quarter due to new oil wells in the Limestone Creek area and improvement in downhole’s well losses. Nineteen wells were drilled, and 14 wells were connected across the Cooper Basin in Q4-2021. The horizontal well program continued with drilling three oil and two horizontal gas wells. The horizontal oil wells were drilled in the McKinlay, Hobbes and Frostilicus fields. Of the two horizontal gas wells, one was drilled in the Moomba South field and the other in the Beanbush field, drilling ahead. The Moomba project is now in the execution phase and will have the capacity to capture and permanently store 1.7 million tonnes of CO2 per annum, with the first injection expected in 2024. The Moomba CCS project is an important enabler for the production of hydrogen. Engineering, commercial and marketing studies are progressing on the Moomba hydrogen project, intending to position the project as Australia’s lowest cost and one of the largest commercial hydrogen opportunities.

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Source: STO

Queensland & NSW: The GLNG joint venture achieved record annual LNG sales of 6.4 million tonnes in FY21 and shipped 109 cargoes. Sales were higher than LNG production in the year, primarily due to the timing of shipments. Gross GLNG operated upstream sales gas production was 690 TJ per day at the end of Q4-2021. Production continues to build with field and facility improvements in Arcadia, delivering 100 TJ per day in December. Scotia is increasing to 77 TJ per day due to recent developments. Roma averaged 197 TJ per day, holding steady at peak to deliver record quarterly production, whilst production at Fairview averaged 318 TJ per day. Fifty-five wells were drilled, and fifty-nine were connected across the GLNG acreage in the fourth quarter. During Q4-2021, work commenced on the Arcadia Phase 2 project with awarding and contracting of facility packages, mobilisation of crews to begin construction of well pads and access tracks, and the drilling of the first of approximately 200 wells. Facility construction is in progress. Santos’ share of capital expenditure is approximately $90 million, with the first well expected online in the second half of 2022. Santos’s non-operated Eastern Queensland production share was consistent with the prior quarter.

Source: STO

Papua New Guinea: As a result of the merger, Santos’ interest in the PNG LNG project increased to 42.5%. Strong production at PNG LNG was maintained during the quarter. The project produced 8.4 million tonnes of LNG during FY21 and shipped 110 cargoes, slightly lower than the previous year due to the COVID-19 impact of deferral of maintenance activities from 2020 to 2021. The PNG LNG operator continues implementing COVID-19 management plans to support stable production and shipping. During the fourth quarter, the Papua LNG project continued to progress on several fronts, such as technical, commercial, regulatory, social and environmental activities. A coiled tubing campaign commenced on the operated Moran and Agogo fields to deliver incremental production in 2022. A Front End Engineering Design entry decision is targeted for the first half of 2022. This follows the execution of the P’nyang Gas Agreement Heads of Agreement in September 2021. The PRL3 operator continued negotiations with the PNG government to finalise terms. We can expect that the P’nyang Gas Agreement will be executed in 2022.

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Source: STO

Northern Australia & Timor-Leste: The gas and liquids production at Gross Bayu-Undan was slightly lower than the prior quarter as the contribution from the Phase 3C infill wells offset the natural field decline in existing wells. The Phase 3C infill wells contributed to Darwin LNG, producing 3.2 million tonnes of LNG for the year, 5% higher than the prior year. Darwin LNG shipped 11 cargoes in the quarter, all priced on a Japan Korea Marker basis. Santos’ share of Bayu-Undan production in the fourth quarter was lower than the prior quarter due to the slightly lower gross production combined with a lower net entitlement under the Bayu-Undan Production Sharing Contract due to higher realised commodity prices.

The US$3.6 billion gross Barossa gas and condensate project to backfill Darwin LNG is 20% complete and remains on schedule and on budget. The first gas production is expected in the first half of 2025.

Floating production storage and offloading hulls and topsides are now under construction in Korea and Singapore. Manufacture of the subsea hardware progressed, and the first subsea tree arrived in Perth to undergo integration testing. Manufacturing of remaining subsea trees, infield flowlines and the gas export pipeline are well progressed. Preparations for the development drilling campaign, expected to start by mid-2022, and the pipeline installation campaign by late-2022 are well advanced.

The Darwin LNG Life Extension project remains on schedule and budget with preliminary civil works completed on site. Santos signed a binding sale and purchase agreement to sell a 12.5% interest in the Barossa project to JERA. The effective date of the sale is the 31st of March 2020, and completion is expected in the first half of 2022. Upon completion, JERA will reimburse Santos for its share of capital expenditure on the project from the effective date to completion, with the total consideration due to Santos at completion expected to be approximately US$300 million.

During the quarter, technical, commercial, and regulatory engagement activities continued for the proposed carbon capture and storage project at Bayu-Undan. A Front End Engineering Design-entry decision is targeted in the first half of 2022. In the onshore McArthur Basin in the Northern Territory, the Tanumbirini 3HST1 well reached a total depth of 4,857 metres MDRT, having intersected more than 1,000 metres of lateral section within the Velkerri Formation B Shale target interval. The well encountered excellent drill gas shows and has been cased and suspended. This is the second of two horizontal wells in EP 161 this year. A program of multi-stage fracture stimulations in Tanumbirini 2HST1 and Tanumbirini 3HST1 was successfully completed, and flow testing of both wells is currently in progress.

Santos Valuation: An undervalued energy giant

Despite a retrace in oil prices recently, the Santos share price has been up by 5.7% since the last month. Santos shares closed the first week of April at $8.01 and are currently trading for $8 per share. While that already represents a 26.7% gain year-to-date, despite soaring oil and gas prices, we think that Santos remains consequently undervalued. Hence, it is not the rocketing oil prices that have convinced us to consider the energy giant to be undervalued, but rather the Company’s significant oil discovery announced last month at its Bedout Basin project in Western Australia, coupled with a strong balance sheet gearing toward growth.

Currently, Santos holds the project in a joint venture with Carnarvon Energy Ltd (ASX: CVN). Before last month’s discovery, the Bedout Basin already held proven reserves of some 200 million barrels of liquids and 1.1 trillion cubic feet of gas.

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Conservatively, we forecast Santos’ revenue to reach US$4.76 billion by FY24. We expect the EBITDA to be superior to US$1.8 billion, which will support a stable annual free cash flow of $179 million to $2.65 billion in the next 5-year period. Our approach to Santos’ valuation is based on Discounted Cash Flow method (DCF) based on Revenue Exit multiple to calculate the Terminal Value after five years. We have used a conservative Discount Rate of 7% and a Terminal Growth rate of 2.75%, based on Australia’s GDP annual growth rate.

We estimate Santos to be valued at $51 billion, at an implied share price of $13.60, a 70%-plus upside potential at the current market price.

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Technical Analysis

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Trend

Since we recommended Santos last October, STO has retraced back to around $6 per share in late December. Although STO pulled back by 14% since our first recommendation, the energy giant share had recovered tremendously above the key level of $7.80 per share, gaining 32% in just a few months.

Since the beginning of this year, a very clear pattern has developed on the daily chart. We can clearly see the development of an ascending channel, which is a strong bullish pattern.

Key price levels

The levels to watch are:

  • The $7.8 key support level. This level is also the 23.6% Fibonacci retracement from the recent swing high, which can offer a solid ground to build long-term buy positions.
  • The $8.40 level is the nearest resistance level. We believe that once a breakout occurs above the $8.40 – $8.50 price range, STO will catch enough momentum to reach the pre-COVID high of $9 per share.

Volume and momentum

Volume has slightly decreased since the last 200-day with the 20-day volume average down by -4.28%. The price action remains bullish in the near term, evolving between $7.80 and $8.40 per share.

Trade consideration

  • Market participants might be interested in entering at key support levels: $7.80 and $7.50
  • Primary target price above $10 per share
  • Secondary target price at $13 per share
  • Consider reducing exposure below $7 per share
  • It is recommended to exit the trade below $6 per share

Recommendation

We really like Santos’s diverse, high-quality, long-life, low-cost oil and gas assets. Additionally, the Company is substantially improving its edge in a highly competitive industry. Santos plans to grow its cleaner energy and clean fuels through carbon capture and storage, nature-based offsets, energy efficiency, and renewables in its operations. 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 consider Santos to be undervalued for a next-generation energy giant. Therefore, we reiterate our “Buy” recommendation.

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