Santos Walks A Fine Pipeline

This story features SANTOS LIMITED. For more info SHARE ANALYSIS: STO

-GLNG train 2 on track
-Tied to oil price movement
-Stronger AUD a negative
 

By Eva Brocklehurst

Production and sales for Santos ((STO)) in the March quarter were ahead of many forecasts, driven largely by Queensland's GLNG and strong output from the company's share in PNG LNG.

Brokers observe March quarter sales held up, despite a 21% drop in the LNG price, largely because of higher third party gas sales. Higher volumes meant forecasts were beaten, despite a 16% fall in the realised price of oil, at $51.30/bbl.

The rise in third party gas sales is a sign to UBS that Santos is taking advantage of opportunities to purchase east coast gas volumes, treating the gas at Moomba if necessary, to on sell to the LNG projects in Queensland during the ramp-up phase. Still, while this activity has boosted sales revenue it is relatively low margin gas. UBS estimates this margin is around 15%.

This also explains for the broker the large disconnect between 2016 production guidance (57-63mmboe) and sales guidance (76-83mmboe). The company has retained its 2016 capex guidance of $1.1bn and PNG LNG output continues to exceed broker expectations. The sale of the Stag field is yet to be finalised and UBS assumes the process will be completed in the June quarter, removing any further production from Stag from forecasts.

Sales under long-term offtake contracts with GLNG's foundation buyers commenced at the end of the quarter and the company has reaffirmed that GLNG is on track for first LNG from train 2 in the June quarter.

UBS expects further cost reduction initiatives will be announced over the coming months. The company remains the most leveraged in the sector to the oil price and the recent rally alleviates some concerns the broker had about the balance sheet. Nevertheless, the current share price factors in a US$68.16/bbl oil price and, hence, UBS retains a Neutral rating.

Production cost outcomes are good, running well below guidance, but Credit Suisse maintains this is not a cure and there is little opportunity for Santos to de-couple from its oil price leverage. The broker remains bullish for the second half and while struggling with longer term valuation, resolutely believes: if the oil price goes up so too will the stock price.

Macquarie suspects the quarterly report reflects a new management team's focus on re-building operating credentials. Commissioning at GLNG has been smooth so far, with gross LNG shipments ahead of expectations.

The broker suspects similar rates of performance could be maintained for the rest of the year. A slow ramp-up of train 2 and greater reliance on equity gas will mean unit costs are higher In the second quarter, but the broker believes the company could still positively surprise on cost guidance this year.

That said, while the company has seemingly used its position to take advantage of market opportunities in the LNG ramp-up, increasing third party sales, this is a margin business and this partly offsets the revenue benefit.

Citi remains bullish and expects a shift towards contracted sales should mean realised prices improve in coming months. The broker also suspects train 2 at GLNG could quickly reach nameplate capacity after its start up in the June quarter.

GLNG's train 1 is operating at 3.8mtpa with around 60% of the gas coming from third parties and the remainder from GLNG fields, Morgan Stanley observes. The broker expects volumes from the GLNG fields to increase over time.

Yet realised gas prices from the domestic gas business are falling, primarily reflecting a lack of floor in the gas contracts, with Morgan Stanley noting the realised LNG price across the three LNG projects – PNG LNG, Darwin and GLNG – averaged US$6.24/mmbtu.

The broker welcomes a slowing in exploration spending, given the balance sheet concerns, but believes this will have implications longer term. On the broker's modelling the company is at break even at an oil price of US$40/bbl but debt repayment and dividends require higher prices.

The broker remains cautious regarding oil prices in the near term. Ultimately more costs need to be taken out of the business, or oil prices need to be sustainably higher. One aspect the broker concedes is that the company has time on its side as there are no immediate debt refinancing obligations.

Besides the better production and sales outcome, Ord Minnett also welcomed the improvement in the balance sheet following receipt of cash from the Kipper sale. Negatives includes a strengthening Australian dollar.

Given the balance sheet is off the hook for now Ord Minnett removes a 30% risk weighting on the stock which results in the target rising to $4.00 from $2.75. But the strengthening currency could affect profitability, the broker maintains. Benchmark oil prices have increased materially since the start of the year but this has coincided with a rise in the Australian dollar. The broker retains a Lighten rating.

FNArena's database shows four Buy ratings, two Hold and two Sell. The consensus target is $4.54, suggesting 0.9% upside to the last share price, and compares with $4.33 ahead of the result. Targets range from $2.95 (Morgan Stanley) to $6.78 (Citi).
 

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