Confidence In Santos Is Growing

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

An acquisition, lower costs and the rebound in oil prices have all provided increased confidence in the outlook for Santos, which has outlined a new production target for 2025.

-70% of the target involves the Quadrant acquisition
-Further growth in the Cooper Basin requires more drilling
-6mtpa expected from GLNG by 2021
 

By Eva Brocklehurst

Santos ((STO)) has outlined a path to a production target of over 100mmboe by 2025 and the acquisition of Quadrant is expected to deliver a significant portion of this growth. Incremental increases are also expected at GLNG, the Cooper Basin, Barossa and PNG LNG. The delivery of the Dorado oil project, acquired under the Quadrant deal, is expected to kick production along.

Morgan Stanley suggests the company has managed to lower costs significantly and improve well economics via drilling efficiencies. Santos has also been fortunate with a rebound in oil prices, reducing concerns regarding the balance sheet. The broker expects the trend to continue and, coupled with a new focus on costs and the large acreage, anticipates reserves and production will continue to grow across several assets.

Growth is largely within the company's control, UBS observes, given around 70% of the target is driven by the proposed acquisition of Quadrant and a further 10% related to the ramping up of Cooper Basin and GLNG equity fields.

UBS expects growth in the Cooper and GLNG to be driven by increased drilling activity, and the increase in well numbers across several assets means risk is spread more widely. Nevertheless, the Western Australian gas business is set to do the heavy lifting in terms of production growth, as Quadrant is set to add around 19mmboe (2018) plus 15mmboe from the development at Dorado.

Citi calculates that, in a scenario where the company can execute perfectly on all its assets, production could amount to around 140mmboe. This is not the broker's forecast but merely a reflection of existing guidance.

Morgan Stanley finds the target achievable and believes a further re-rating of the stock is likely, should oil prices stay near current levels. The acquisition of Quadrant also lowers the break-even point on free cash flow and arguably makes the business more defensive.

The broker suspects the market will focus on the de-leveraging profile and asserts Santos has articulated its growth plans well. Over time the growth plan should be incorporated in consensus valuations. The company has also made a well-timed acquisition in Quadrant although capital expenditure will start to increase and Morgan Stanley warns that the sector does not always perform in this environment.

Because the shares do not factor in the downside risk to operations UBS maintains a Sell rating. If the broker were to include projected production life then, all else remaining equal, valuation would lift to around $7 per share, suggesting the market is already incorporating the proposed 2025 target to some degree already. UBS bases its valuation on an implied oil price of US$70/bbl from the second half of 2018.

Cooper Basin

UBS acknowledges the continued decline in the cost base but suspects the market may not have factored in all of the risks associated with growth. UBS considers growth of 2-3mmboe in the Cooper is very likely, with a fourth rig being mobilised.

Additional wells will increase the resource base and production from the mature field. Yet, further out, growth in the Cooper Basin requires successful drilling to identify and develop 250-300mmboe of resources, given current 2P reserves imply less than 10 years of field life.

Citi points to capital expenditure guidance of US$300m for the next two calendar years in the Cooper and suspects the company is either being conservative in its guidance, productivity is declining, or there is simply a preference to grow resources and reserves via exploration and appraisal.

Management has guided towards 17-19mmboe by 2025 and Macquarie accepts that, in order to achieve the higher production, capital expenditure is likely to be above forecasts. The broker increases both gas and oil production forecasts, noting the focus will be on the performance of the Moomba South development where the company is targeting around 42mmboe of net 2C resources within the Patchawarra.

Morgan Stanley maintains an Overweight rating and confirms its conviction around the 2C resource conversion is increasing, suspecting it likely that consensus valuations for the asset will increase over time.

GLNG

Meanwhile, GLNG is ramping up the gas. By 2021 GLNG production is expected to reach 6.5mtpa of which equity gas will constitute 4.1mtpa. The company has indicated that gas has been re-directed to the domestic market from exports until the end of 2020.

The company is expected to spend around US $200m per annum over 2019/20 as production ramps up from Roma East, Scotia and Fairview. UBS considers 6mtpa challenging, albeit possible, given the availability at Fairview is lower than forecast and gas is being re-directed to the domestic market.

Management believes the Barossa will be the main back-fill opportunity for Darwin LNG. Santos expects to spend US$1-1.2bn over four years prior to first gas, well above broker expectations. Meanwhile, the company's expectations for PNG LNG are in line with its partners. The project is now producing above pre-earthquake levels at 9mtpa.

FNArena's database shows two Sell ratings, two Hold and one Buy (Morgan Stanley). The consensus target is $6.63, suggesting -9.8% downside to the last share price. Targets range from $5.59 (Morgans, yet to comment on the new target) to $8.30 (Morgan Stanley).

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