The hopper is full

RESULTS ANALYSIS

Need To Know

• PNG LNG selldown proceeds close, could precipitate a buyback at year end.
• Barossa environmental approvals possible by September.
• Significant free cash flow still building despite lower commodity prices.

Investment Implications

1H23 results overview (vs consensus):

Free cash flow from operations US$1,129m -34%

EBITDAX US$2,112m -23% on pcp, vs US$2,215m

Underlying net profit US$801m vs US$804m

Interim dividend US8.7cps unfranked, vs US10cps

The Board has held back on a buyback decision pending the 31 August expected announcement on the PNG LNG 5% selldown to the PNG Government. Buyback decisions will be made annually so a December announcement is now the time frame. The interim dividend payout ratio of 25% was conservative given the capital management framework.

Environmental approvals needed to move the Barossa project forward are well underway, but STO is now cutting into its contingency reserve. The project is already 60% complete and the Phase 1 cost is still US$3.6bn. The target free cash flow from Barossa over FY26-28 is US$550-850m pa based on an oil price of US$70-100/bbl and a gas price of US$10-14/mmbtu. The stakes are high, but as WDS pointed out this week, there is a greater industry understanding of what is now required for environmental approvals. As the Bayu-Undan asset nears the end of its life as a producing asset, bringing Barossa into production by FY26 is important to backfill the Darwin LNG plant. Bayu-Undan is undergoing work to transform it into a CCS (carbon capture and storage) business with highly promising prospects. FID for this will not be until 2025.

The Pikka Phase 1 development is also on track for first production in 2026 (US$2.6bn cost) and has similar FCF projections to Barossa. In tandem, these two projects alone will bump up grpup FCF (after tax) by US$1.6-1.7bn pa.

STO said the Narrabri Gas project has attained its approvals, but now faces a 3-4 month wait to attend to a Native Title challenge. STO added that the Hunter Valley Pipeline that will transport the gas also has its approvals and license process underway. It is the ‘last piece in the puzzle’ before Narrabri can provide the gas demand relief to NSW that its customers are clamouring for.

Outlook. Production guidance of 89-93mmboe was reaffirmed with upstream unit production cost guidance also unchanged at US$7.25-7.75/boe. Capex is still guided to US$2.7-2.8bn in FY23.

Investment View

CEO Kevin Gallagher said “the hopper for Santos is pretty full” referring to the company’s project pipeline. In that sense, investors know what is in store subject to execution and regulatory processes. If commodity prices remain buoyant, as they are expected, STO can look forward to the happy headache of dispersing a mountain of excess capital over an extended period.

The short term angst from the PNG LNG selldown is almost over, and if the regulatory pathway to a successful Barossa can be found, then FY23 is going to look substantially more positive. Throw in a potential selldown at Dorado, more progress in Alaska and even a quicker path to market for the hugely in-demand ~150TJ/day Narrabri gas project in NSW, and things will feel much better too.

The balance sheet is in excellent nick with gearing at 21.9% within the target 15-25% range (net debt US$4.1bn) and the major project capex budget for FY23 at US$1.5-1.6bn.

Figure 1: STO Free Cash Flow