Santos may be taking its time, but the wheels are turning towards some asset sales. The free cashflow is already finding its way back to shareholders, but there is much more to come. The share price continues to be in denial.
Advanced discussions are underway to sell a 5% stake in PNG LNG. STO said shortlisted counterparties have shown strong interest in the sale which the company says is in-line with consensus valuation. On that point, we believe consensus says a 1% equity stake in the mature, world class PNG LNG business is worth approximately US$280-285 million (ex-project finance). By implication, STO’s 42.5% stake is worth approximately US$11.9 billion which represents about 70% of STO’s market capitalisation. If a sale of 5% can generate say US$1.5 billion, it would reduce gearing to below 15% if applied to debt (STO target gearing range is <25%).
The Final Investment Decision (FID) was taken to develop the Pikka Phase 1 project in Alaska. We are disappointed that this has happened before the 51% stake was sold down and leaves STO committed to its US$1.3 billion share of the development to first oil. We are none-the-wiser about the state of the sale process, but the scope of this development is not so large to be of real concern.
The 1H22 result itself was replete with big numbers in all the right places. Revenue and free cashflow had been released with the 4Q22 production report. EBITDAX of US$2,731 million was 122% higher than the same period last year and underlying profit came in at US$1,267 million, an increase of 300%. FY22 major project capex guidance has been bumped up by around US$300 million to US$1.4-1.5 billion to accommodate the Pikka project. Base capex is steady at US$1.1 billion for FY22.
The Board declared an increased interim dividend of US7.6cps (unfranked) and lifted the existing $250 million share buyback to US$350 million. That buyback had achieved US$174 million by 30 June 2022.
STO has hesitated on the timing of the Dorado oil and gas project. The company pointed at the inflationary cost environment and supply chain uncertainty as being unsupportive of FID in 2022. Apart from the delay, the project remains attractive with the nearby Pavo field to be tied back into Dorado.
The Narrabri Gas Project is awaiting FID with first gas from phase 1 due in 2026. The East Coast gas market could clearly benefit from this project, but STO is not in control of the political agenda.
The Barossa LNG project is 43% complete and the Darwin LNG life extension project is underway to accommodate the Barossa gas.
Investment view
STO included an excellent chart in its presentation showing sources and uses of cash from 2022 to 2030 (Figure 2). It sets out the committed projects (including Pikka Phase 1) utilising about US$7 billion of approximately US$23 billion of free cashflow generated assuming an oil price of US$65/bbl – STO’s base level for paying 10-30% of free cashflow to shareholders. That would leave around US$16 billion of surplus cash available to return to shareholders if that was the Board’s decision.
If the oil price assumption is increased to US$100/bbl, an additional 11 billion (~US$27 billion total) of free cashflow would be available. For reference, STO will return US$605 million in 1H22 alone (US$255m dividend, US$350m buyback) representing 35% of free cashflow in the period.
The upshot of this projection is that STO could potentially return a minimum of 100% of its market capitalisation over the next 8 years assuming an oil price of US$65/bbl, or 150% at US$100/bbl.
Like your Uncle Arthur, the Pikka asset has become an awkward guest at the family dinner. Too much attention has been wasted on the issues surrounding this asset when the centrepiece PNG LNG asset is being overlooked.
The implied consensus value of PNG LNG suggests that about 80% of the STO share price is being attributed to an asset that accounts for about one-third of group 2P reserves. As the robot in Lost In Space would say, “That does not compute”. The corollary to this absurdity is that the rest of STO is therefore being valued on an EV/2P basis of about US$7/bbl, which is equally as daft. As our note title hints, sometimes you shouldn’t look a gift horse in the mouth.
Risks to investment view
Oil prices remain subject to volatility and operational risks are always present for oil and gas companies. If STO cannot execute on its strategy to optimise the merged portfolio and develop its major growth projects, then earnings and value could be lost.
Recommendation
We have retained our Buy recommendation.
Figure 1: 1H22 result
Figure 2: ~US16-27bn forecast cash surplus out to 2030
