Santos: The barrel is more full than empty

Whilst abnormal losses flagged in the first half pulled the statutory profit into the red, Santos’s core Net profit after tax (NPAT) at US$336m was 5% ahead of our forecast of US$323m. It was also above January analyst consensus forecasts, but these were subsequently revised upwards to US$348m leading into the result, so on that basis it was a slight miss.

Looking beyond the headline numbers, some key operational metrics impressed:

• Upstream unit costs which had already reduced significantly over the past 12 months, declined a further 4% to US$8.07 per barrel,
• Other operating costs also declined by 5%, and
• Core production volumes were at the top end of guidance.

And these items have driven a solid outcome at the cashflow level, where operating cashflow was up 49% to $1,248 million and more importantly, free cash flow was up 200% to $618m.   This latter improvement enabled Santos to pay down debt by a further 22% to $US$2.7bn.

What the market is missing

This places Santos on the cusp of realistically considering capital management opportunities (read dividends, buyback etc). So in short, the noise around the company’s operations and balance sheet are largely dissipating.

This allows investors to focus on 2 key elements: growth opportunities and the outlook for their underlying commodities.

Growth opportunities

We are more optimistic than some on the outlook for growth.  

Santos holds the leading position in the Cooper Basin. With technology advancing at a rate of knots and drilling costs imploding, Santos is well positioned to develop previously marginal resources on a wide scale. 

This will also assist productivity in the GLNG associated fields. Darwin LNG backfill, PNG expansion and the longer-dated Narrabri projects also provide strong growth options to complement the core underlying production assets.

Commodity outlook

Most analysts have been proven categorically wrong, with both the oil price and the sloped LNG prices proving significantly more robust than forecast.

LNG is more material to Santos, and despite the well-reasoned arguments as to why a global surplus would decimate prices, the opposite has occurred. This is largely due to the speed with which Chinese and South East Asian companies are able to convert/build power and storage infrastructure.

In effect, it is a case of "provide it and they will use it". We remain optimistic on the outlook for LNG over any timeframe.

Too rich for now at 24 times 

Of course, this has not been missed by astute investors who have been rebuilding positions ahead of the result.  This, combined with the mooted approach by off-shore acquirers, has pushed the share price back through $5. At this level, the stock is on a trailing PER of 24x which is too rich for a cyclical.  

However, if management can continue to deliver and hit the 2018 consensus of $631m (US$498m) it will be priced on 17x. This is reasonable for a company with long life assets, an improving balance sheet, and ample growth options.

More insights from results

For more insights from Livewire's contributors on what the market missed in other company results including a2 Milk, BHP, Telstra, CSL, Challenger, and JB Hi-Fi, please click here: (VIEW LINK)