It will require a little time and patience for the newly-merged company to unlock the treasures within and turn the opportunity into a virtuous circle of growth funded by free cashflow. Just as importantly, there will plenty left over for shareholders too.
The Oil Search merger dominated STO’s agenda for most of the year, but it was completed just 3 weeks before the end of the financial year. As a hint of things to come, STO said that the combined entity would have reported free cashflow of US$2.3 billion for a full year. Likewise, the merger has added 416 mmboe in 2P reserves (now 1,676 mmboe total) and created some significant opportunities to optimise the portfolio. STO is contemplating asset sale proceeds of US$2-3 billion in this regard, and this will help to reduce gearing below 25% through the cycle (a little higher than we had hoped) while still enabling major growth projects (approx. US$1,150-1,300m).
The asset sales being referred to are likely to be a sell down of PNG LNG and (hopefully) the Pikka Unit in Alaska. The former requires patience given the sensitivity that needs to be applied in PNG and the early stages of STO now in post-merger status.
Post the asset sell downs, there will be huge capacity for returns to shareholders. With a sale of say 12.5% of PNG LNG, net debt could disappear by the end of CY22 leaving notional headroom of up to US$3 billion (gearing at 25%).
The merger has already captured US$30 million of synergy gains and is targeting US$90-115 million per annum at full integration.
Record production of 92.1 mmboe in FY21 and a higher average realised oil price of US$76.11/bbl and an average LNG price of US$9.25/mmBtu generated revenue of US$4.8 billion and EBITDAX of US$2,805 million, up 48% on FY20.
Investment view
The FY21 result was predictably messy given the merger accounting required, but that is a minor concern.
The new mantra at STO is the ability to self-fund its growth and still generate increasing amounts of free cashflow. This is the honey-pot from which shareholders will be handsomely rewarded.
There are still some steps needed to get to that position, but it is well within STO’s control and capability to achieve it.
This is all occurring at a time when global oil prices are rising not just because of geopolitical tensions but from a fundamental imbalance in supply and demand.
It is not picture perfect, but STO is as close to an ideal E&P company as could be wished for.
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 and our strong preference for STO over WPL in the Australian oil and gas sector.
