Company Overview - Santos Limited is an oil and gas company. The Company is engaged in the exploration for, and development, production, transportation and marketing of, hydrocarbons. The Company develops major oil and gas liquids businesses in Australia and operates in all mainland states and the Northern Territory. The Company has exploration-led Asian portfolio, with a focus on three core countries: Indonesia, Vietnam and Papua New Guinea. The Company operates in four business units of Eastern Australia, Western Australia and Northern Territory, Asia Pacific and Gladstone liquefied natural gas (GLNG). The Asia Pacific operating segment includes operations in Indonesia, Papua New Guinea, Vietnam, India and Bangladesh. The Company is a producer of natural gas, gas liquids and crude oil in eastern Australia. Santos produces domestic natural gas in Western Australia and is also a producer of gas liquids and crude oil.
Analysis - Santos (STO) reported its 2014 full-year underlying profit to be up 6% to $533 million. EBITDAX went up 8% to $2,153 million. STO further stated that operating cash flow was up 13% to $1,843 million. The net loss of $935 million indicated non-cash after tax impairments of $1,563 million as specified earlier. As per the Company, the impairment charge is related to the lower oil price environment and is a non-cash accounting adjustment concerning the historical book value of STO’s assets. STO conveyed that the final dividend was maintained at 15 cents per share with the full-year dividend to 35 cents per share indicative of an increase of 5 cents. The final dividend looks flat on prior corresponding period. The Company has a strong funding position given the availability of about $2.9 billion in cash and undrawn debt facilities at the end of 2014.
2014 Full-year Financial Result (Source – Company Reports)
Production was reported to surge by 6% to 54.1 mmboe with 12% increase in sales revenue to $4 billion. It is noted that the ramp-up of production from the PNG LNG project and Cooper Basin production were partly balanced by lower oil prices. The Company reported that the average realised oil price for the year of US$103 per barrel was 11% lower than the prior year. A little concern boils down to an increase in production costs in comparison to prior year which resulted from the production from PNG LNG project, full-year of production from Fletcher Finucane, maintenance in the Cooper Basin and the planned shutdown of Bayu-Undan/Darwin LNG.
As per the highlights, PNG LNG start-up has been reported to be ahead of schedule with the project shipping 55 LNG cargoes in the year. More than 90% completion was reported for GLNG with on track progress for first LNG due in the second half of 2015. The 2P reserves at GLNG have been found to be up 3.6%. The 2P reserves along with third party gas are 7,831PJ with a certainty of about 7350PJ. The short of reserves seems to be a possibility is such a case. Burden thus may pass over to the 2C resource of 1,200PJ to fill this insufficiency. The Company’s effort with regards to opex and capex efficiency looks good and thus it appears to be well funded to complete GLNG given the reported cash and undrawn debt. There may not be any requirement to raise equity for completion of the project under the challenging oil price scenario. Thus, PNG LNG and GLNG based robust production growth and extensive discount to risk-weighted fair value is supportive of STO’s position as per the market expectations in general. Main achievements at GLNG entail completion of Fairview Hub 5 which is now operational while Fairview Hub 4 and Roma Hub 2 are close to completion. The Company also stated that the Fairview is exceeding expectations and Roma capacity is increasing in line with expectations. Further updates included completion of the gas transmission pipeline, setting of all LNG train modules, and completion of LNG tanks and jetty with commissioning of the downstream plant still ongoing. GLNG is expected to be free cash flow positive at oil prices greater than US$40/bbl.
Development Projects (Source – Company Reports)
A few concerns with regards to reserve reduction do prevail. STO highlighted the probability of having reduced material reserve at Gunnedah which is mostly linked to the $566 million asset impairment. Total 2P reserves in the Cooper Basin have also been reported to be weakened by 13% to 222mmboe. The downgrades were mainly driven by re-assessments of reservoir performance. This reduction appears to be associated with the $482 million in asset impairments in the Cooper Basin.
2015 Guidance (Source – Company Reports)
With regards to Hides F1 (Hides Deep) well, STO with 24% interest in the exploration component reported that a total depth of 4,633 metres has been reached. The Company has encountered thick argillaceous sandstone intervals in the exploration target, the Koi-Iange Formation. However, wireline evaluation established a lack of reservoir quality. STO further conveyed that the exploration component of the well will be abandoned. Moreover, the development section will be completed as a gas producer for the PNG LNG Project. Mainly, this has brought a setback both for STO along with Oil Search with regards to the gas ambitions in Papua New Guinea. It has been reported that the exploration well found water instead of gas which has largely overturned the cost-effective expansion of the project. The sands at the Hides Deep well otherwise targeting a deep reservoir beneath the existing Hides field were found to be water-bearing. The shallower section is thus now being used as a development well for the PNG LNG venture. The companies have expressed little disappointment while conveying that success at the Hides Deep could have led to a cheaper expansion of the project.
2014 Highlights (Source – Company Reports)
We see a positive potential with the recent announcement about STO entering into a contract to supply natural gas to Alcoa, which is one of the biggest alumina producer in Australia. The commencement of the contract has been scheduled for 2018 under which STO will supply 82 Petajoules of gas to Alcoa over an initial contract term of five years from the John Brookes field. The Company has also expressed the existence of a flexibility for two five-year extension options under mutual agreement. This deal may serve as an indication for further similar deals.
Capital Expenditure (Source – Company Reports)
As per the 2015 production guidance, the Company maintained the same at 57 to 64 mmboe. The capital expenditure without capitalised interest guidance has been upheld at about $2 billion. The Company underscored that this capital expenditure in 2015 is forecast be to 44% lesser than that of 2014. The production costs are also expected to be reduced per barrel by 10%.
STO Daily Chart (Source - Thomson Reuters)
We understand that certain risks prevail around fluctuating oil prices, project delays, unplanned outages and exploration failures. The Company is still poised to take appropriate steps to manage few such barriers. For instance, the Company responded to the softness in oil price by identifying approaches including but not limited to reduced supplier and contractor costs through 5-30% savings on subsurface contractor works and 10-20% savings on surface contractors; limiting drilling activity depending on requirement and reduction in Cooper Basin rigs from 7 to 3; reduction in headcount; and reduced capex from $2.5bn to $2bn for 2015. In 2015, the growth in dividends may look less probable but going forward (i.e., from 2016) GLNG may contribute towards yield growth and STO may be able to provide better returns.
Based on the foregoing, we put a BUY recommendation for this stock at the current price of $7.33.
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