Santos Takes The Helm At Darwin LNG

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Santos has obtained a majority share and will become the operator of key LNG assets in northern Australia.

-Acquisition provides a path to a final investment decision on Barossa
-Will consume a lot of cash for expansion, particularly from 2021
-Brokers remain cautious about the long-term outlook
 

By Eva Brocklehurst

Santos ((STO)) is now in the driver's seat at Darwin LNG, emerging as the buyer for ConocoPhillip's northern Australian interests, comprising the Darwin LNG, Bayu-Undan, Barossa and Poseidon projects.

The transaction will give Santos a majority share and it will become operator of these key upstream and infrastructure assets. Santos will pay US$1.44bn, comprising US$1.39bn up front and a contingent US$75m subject to a final investment decision on the Barossa-Caldita project.

The purchase will be funded from existing cash resources and a new debt facility of US$750m. This will mean pro forma gearing rises to 35% at completion of the transaction, declining to 30% by the end of 2020.

Santos expects the transaction to be 16% accretive to earnings per share and 19% accretive to operating earnings (EBITDAX) in 2020 at a US$65/bbl oil price. However, UBS points out this accretion calculation does not include an equity sell-down of Darwin LNG to SK E&S and, hence, overestimates the outcome.

Santos expects the transaction to reduce the company's break-even cash flow by -$4/bbl in the next 2-3 years but UBS also notes a higher equity interest in Darwin LNG will result in higher abandonment liabilities as Bayu-Undan approaches the end of life in 2022.

With the benefit of the expected synergies, Citi calculates the acquisition is accretive by 4% to valuation at a US$55/bbl oil price, increasing to 8% at US$65/bbl.

More Control

Macquarie considers the acquisition a significant positive step for the company as it provides more direction for the development of Barossa. Moreover, Santos appears not to be paying a premium for operating control of the portfolio.

On deal completion, Santos will subsequently have a 68.4% interest in Darwin LNG and Bayu-Undan and 62.5% interest in Barossa. A sell-down of 25% of Bayu-Undan and Darwin LNG to SK E&S is envisaged, as per an agreement, to align interests across the NT assets.

The acquisition should provide a path for a final investment decision on Barossa, and the operating status will allow Santos to pursue further growth through brownfield expansion and commercialise its gas resource in the region. Hence, UBS is increasingly confident management can deliver on its growth production target of over 100mmboe by 2025.

Citi highlights a quirk of the Darwin LNG agreement, in that the operator has the right to dictate which gas enters the plant. Santos now has an ability to monetise its gas resources over competing fields. However, whether the joint operating agreement would extend to expansions is unclear.

Morgan Stanley accepts this is an asset Santos understands and there will be synergies, but it will consume a lot of cash for expansion, particular from 2021. The broker calculates Santos will generate very little free cash from 2020 to 2022 at US$60/bbl. This means gearing will stay in a relatively tight range.

Ord Minnett downgrades to Hold from Buy based on valuation and Morgan Stanley also downgrades, to Equal-weight from Overweight. The latter believes the free cash story is diminishing and investors will be required to invest for a medium-term production uplift.

Risks

Meanwhile, risks are building across the LNG industry and Santos now appears fully valued so Morgan Stanley suggests now may be a good time for investors to take profits, given the changing cash profile.

Santos stock is up 43% in the year to date versus Woodside Petroleum ((WPL)) and Oil Search ((OSH)). The broker expects Santos will farm down the Dorado asset and, if it can sell above market – the asset is currently valued at around US$1.7bn for an 80% share – the market may take this kindly.

Morgan Stanley currently assumes no value for Narrabri CSG, so some value is available should the company make progress on that front. On the other hand, the balance sheet has limited ability for further leverage, unless the commodity price moves higher or other assets are sold.

Morgan Stanley is becoming increasingly cautious about the long-term outlook for oil amid a deteriorating global macro outlook. Macquarie also notes, while revenue is well spread across the portfolio, an increase in production derived from LNG is occurring.

There are five Hold ratings and two Buy for Santos on FNArena's database. The consensus target is $7.96, signalling 2.9% upside to the last share price. Targets range from $7.24 (Credit Suisse) to $8.80 (Macquarie).

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