SSLZY - Santos: 3 Pronged Strategy Likely To Deliver Upside

2023-03-07 01:20:43 ET

Summary

• Santos is the AU $23B Australian energy player borne out of a recent merger with Oil Search.
• The combined firm has benefited from lofty natural gas prices.
• Its strategy focusing on natural gas, decarbonization and traditional oil plays provides a degree of de-risking.

General Overview

It is hard not to be excited about Santos ( STOSF ). The Australian energy player, reincarnated from its recent merger with Oil Search has positioned itself strategically at a juncture between growing Asian natural gas requirements and increasingly popular decarbonization initiatives.

Market volatility spurred by the Russian invasion of Ukraine offered a recent shot in the arm for revenues, helping the organization bolster cash reserves and pay down debt accordingly. That is why my outlook for the Australian energy producer remains bullish - a three-pronged strategy meeting shifts in energy needs, coupled with rock solid financials, and a compelling portfolio of assets not only provides an income opportunity but plausible gains.

Despite a cooling of global energy prices, capital discipline and selective project sanctioning are likely to provide a natural shield should lower prices impact financials. Let us discover more.

Company Introduction

Santos is an AU $23B Australian energy player, focusing on asset development, production, and marketing of hydrocarbons in Australia and Asia Pacific. Its portfolio of assets is concentrated across the Cooper Basin, Queensland, New South Wales, Papua New Guinea, the Northern Territory, Timor-Leste, and Western Australia. The Australian energy player also retains interest in an Alaskan energy play and focuses heavily on natural gas, liquified petroleum gas, carbon capture and storage technologies.

Santos has a rich history (Santos originally stood for South Australian Northern Territory Oil Service) marked recently by the ambitious acquisition of Oil Search - an Australian energy junior heavily focused on Papua New Guinea energy projects.

Santos has most recently boasted record operating performance, strong free cash flows, a robust reserve replacement program and disciplined capital allocation. The company's operating model continues strengthening the balance sheet, while cash generative operations have provided $1.5B in returns to shareholders in a mix of distributions and share buybacks.

New projects like Barossa FLNG, Pikka Phase 1 and Moomba carbon capture remain on track with prudent capital deployment being an underpinning theme. Most recently, there is lots to like about the Australian energy venture.

Production has accelerated following a combination with Oil Search's assets - up 12% from a year earlier. That meant the company produced just short of 105 million barrels of oil equivalent during that period. Unit production costs remained just as impressive, with the firm posting per barrel costs of $7.82.

The Cooper Basin

The Cooper Basin is a world class renewables zone supporting the development of low-cost renewables. Development works are ongoing, with a fifth drilling rig added. During 2022, 103 wells were drilled, helping the energy outfit beef up output.

Roughly 100M of carbon storage capacity and contingent resources have been booked, while capex spend remains sizable at $419M. The firm's Cooper Basin asset makes up part of an ambitious electrification program with Phase 1 high voltage lines presently being installed. The end objective is to electrify approximately 80% of SA Cooper gas assets with a mix of wind, solar and battery.

The Barossa LNG Project

Santos' world class Barossa Project will ultimately be a large -scale, low cost, liquified natural gas development. 55% of project works have been completed, marked by the delivery of subsea production hardware to Darwin, NT and solid progress on the FPSO (floating production storage & offloading) hull, topside and turret.

A gas export pipeline will channel LNG to Darwin before being shipped to clients based in Asia. A range of regulatory permits are still underway linked to environmental impact, particularly related to the Tiwi Islands. The fields will be developed by several partners SK E&S, a large Korean conglomerate and Jera Co, a joint venture between Tokyo Electric Power Company and Chubu Electric Power Company.

Pikka Project, North America

The $2.6B Pikka Phase 1 project is making solid progress. Santos detains a 51% stake in the Alaskan development that will ultimately produce 80K barrels of oil per day starting in 2026. Thus far, $800M worth of procurement spend has been committed as a focus on processing equipment and a vast drilling campaign taking center stage. Processing equipment modules will be completed in Indonesia, and the company is appraising the possibility of electrifying its drilling rig fleet.

Focus on Decarbonization & Clean Fuels

Santos is developing a range of large-scale, low-cost decarbonization initiatives across 3 hubs. The Eastern Australia hub is comprised of the Moomba carbon capture & storage project, targeting first injection in 2024.

The Western Australia hub presently has a feasibility study underway with third party industrial emitters for both Reindeer and Varanus Island. A CO2 storage permit has already been awarded. The Northern Australia and Timor-Leste hub is comprised of the Bayu-Undan gas field. A C02 storage permit has been awarded here too.

The company's strategy has 3 branches - the development of upstream gas and liquids via 3 large LNG projects aimed at capitalizing on growing Asian demand for cleaner energy solutions. The energy solutions business is primed to capitalize on carbon capture and storage along with other low carbon processing activities. The firm's fledgling North America business revolves around the Pikka Phase 1 project set to come online in the next 3 years.

Financials

Santos' stout financials are a testament to the depth and quality of its assets coupled with a compelling strategy.

The venture's record production helped post almost $8B in sales along with $3.6B in free cash flow. This enhanced the balance sheet with a deleveraging to the tune of $1.7B while providing $1.5B in returns to equity holders.

Santos generated healthy margins (27% FY 2022) - a doubling in 2021's performance. Notwithstanding, the combination of Oil Search and Santos assets played a meaningful role in the big increase in sales revenues and cash flow generation. Corporate focus remains on reducing the $5.5B in debt while deploying $2.3B in cash & cash equivalents to shareholders via dividends and buybacks. At least 40% of free cash flow from operations is currently identified for investor returns. Presently, the Australian energy producer posts a forward dividend yield of 4.71% on a 25% payout ratio, highlighting the conservative approach to allocating capital.

Most analysts following the Adelaide, SA based business have a positive outlook for the future. 7 hold a strong buy rating, with another 10 holding a buy rating. The average 12-month price target for the business is $9.22, almost 30% above the current stock price. ETF exposure is growing with 73 ETFs holding Santos' equity. That makes up $166M for US ETFs and about $770M for the total pool of ETFs.

A tapering of revenues is expected as price pressures linked to natural gas progressively ease. Yet disciplined and phased investment around existing infrastructure, coupled with targeted investments in the global energy transition, are likely to position the firm well in the future. Santos trades solely at 8x forward earnings, placing it below comparable Australian players such as Woodside (12x) and Origin Energy (23x)

Risk

Santos currently navigates a range of risks linked to big ticket project capital spend and higher commodity prices. Any abatement of commodity prices is likely to seep through to future results and long duration projects may come online at a time when energy prices find themselves under pressure. Carbon capture and storage remains somewhat novel and prone to political direction.

While the sustainability drive is providing strong tailwinds for decarbonization initiatives, risks around changes in public sentiment may radically impact future project values.

Santos is presently embarking on bringing capital intensive FPSO projects online often fraught with project delays and cost overruns - while this does not appear an issue presently, it is worth considering impacts linked to complex, costly energy projects.

The company's recent merger with Oil Search has seen $1.1B in goodwill posted on the balance sheet., having increased almost 3x over the past 3 years. Any future impairment on assets will immediately impact company valuations. The company remains heavily exposed to the US dollar, which could impact future results if eventual monetary easing starts to weigh on the Greenback.

Key Takeaways

Santos provides investors the opportunity to benefit from Asia's continued thirst for LNG projects while capitalizing on the growing decarbonization theme. The company's 3-pronged strategy provides a diverse set of revenue streams - natural gas driven by Asian power generation, carbon sequestration driven by shifts in people perception of energy & government policy and finally, traditional oil plays such as Pikka Phase 1. The company appears to have successfully transitioned through the Oil Search takeover and positioned itself as a challenger to the likes of Woodside, Origin Energy and Senex Energy.

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