Company Overview: Santos Limited (ASX: STO) is a domestic gas supplier with a portfolio of high-quality liquefied natural gas (LNG), pipeline gas, and oil assets. STO is mainly involved in the production of natural gas (LPG, ethane, methane, CSG, LNG, shale gas, condensate) and oil. STO has 30 mtpa of carbon storage capacity across three Santos-operated hubs - Cooper Basin CCS; Northern Australia and Timor-Leste CCS; and Western Australia CCS. The company was listed on ASX on 1 October 1954.

STO Details

Progressing Growth Projects to Support Future Growth: With its disciplined low-cost operating model, STO continues to generate decent free cash flows from its base business while making progress on its growth projects. Over the past few months, the company achieved key milestones on major growth projects.

• FID taken for Barossa Project: In March 2021, STO took its Final Investment Decision (FID) for the Barossa project. STO has already commenced manufacturing of subsea and export flowlines, and the assembly of subsea trees at the project. At the project, STO is targeting cash cost of production of ~US$2.00/mmBtu and to hit production in the first half of 2025.
• Entered FEED for Dorado: STO has made significant progress on its exciting Dorado project with FEED entry on an integrated oil and gas project taken in June 2021. At Dorado, STO is targeting FID in mid-2022 on the first phase of liquids production.
• FID for Moomba expected in Q4FY21: At Moomba Carbon Capture and Storage (CCS) project, the FID ready, subject to eligibility for Australian Carbon Credit Units, which is expected in Q4FY21.

H1FY21 Result Highlights:

• Rise in Production: For H1FY21, the company reported total production of 47.3 mmboe, up 23% on the previous corresponding period (pcp).
• Increase in Sales Volume: Sales volume for H1FY21 stood at 53.8 mmboe, up 15% on pcp.
• Increase in Product Sales Revenue: As a result of higher oil prices, STO witnessed 22% YoY growth in its product sales revenue, which stood at US$2,040 million.
• Rise in NPAT: The net profit after tax for H1FY21 stood at US$354 million, up 222% on pcp, mainly due to impairments included in the previous half-year results.
• Rise in Interim Dividend: For H1FY21, STO has declared interim dividend of 5.5 US cents per share, up 162% on pcp. The dividend has a record date of 23 August 2021 and a payment date of 21 September 2021.

NPAT Trend (Source: Analysis by Kalkine Group)

Key Metrics: Gross margin for H1FY21 stood at 29.7%, up from 28% in H1FY20. Net margin for H1FY21 stood at 16.8%, up from a negative 16.7% in H1FY20.  Current ratio for H1FY21 stood at 2.16x, up from 1.90x in H1FY20, demonstrating that the company has improved its ability to pay short-term obligations.

Liquidity Profile & Profitability Metrics (Source: Analysis by Kalkine Group)

Top 10 Shareholders: The top 10 shareholders together form around 30.04% of the total shareholding, while the top four constitute the maximum holding. United Faith Ventures, Ltd. and The Vanguard Group, Inc. are holding a maximum stake in the company at 9.97%  and 5.07%, respectively, as also highlighted in the chart below:

(Source: Analysis by Kalkine Group)

Compelling Proposed Merger with OSH: STO recently sent a non-binding and indicative merger proposal to Oil Search Limited (ASX: OSH) to acquire all shares of OSH in exchange of 0.6275 new Santos shares for each Oil Search share held. The Board of OSH intends to unanimously recommend its shareholders to vote in favour of the Proposal, in the absence of a superior proposal.

• Diversified Portfolio: The merged entity will have a unique diversified portfolio of long-life, low-cost oil and gas assets which will generate strong cashflows.
• Rise in Resource base and Production: The merged entity will result in combined 2021 production of approximately 116 million barrels of oil equivalent and a combined 2P+2C resource base of 4,983 million barrels of oil equivalent.
• Commenced Due Diligence Process: On 6 August 2021, STO and OSH commenced a mutual due diligence process in relation to their proposed merger. The due diligence process is expected to take approximately 4 weeks.

Key Risks:

• Change in Oil and Gas Prices: The company is exposed to the risks related to the fluctuations in the prices of oil and gas as it could impact the company’s financial performance.
• COVID-19 Uncertainties: The COVID-19 uncertainties and associated restrictions could disrupt the company’s operations and hamper its supply chain.

Outlook: For FY21, the company expects its production to be in the range of 87-91 mmboe and sales volume to be between 100-105 mmboe. Upstream production cost expected to be between US$7.90-8.30/boe in FY21. If the proposed merger will OSH is implemented, the combined entity will have a diversified portfolio of high quality, long-life, low-cost assets across Australia, TimorLeste, Papua New Guinea and North America with significant growth optionality.  With its cash-generative base business, diversified portfolio, and disciplined approach to capital allocation, STO seems well placed to drive free cash flow and sustainable shareholder returns.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

Source: Analysis by Kalkine Group

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks.

Stock Recommendation:  Over the last three months, the stock has corrected by ~11.52%. The stock has a 52-week’s high and low level of A$7.84 and A$4.64. The stock has been valued using an EV/Sales multiple-based illustrative relative valuation method and arrived at a target price of low double-digit (in percentage terms). The company might trade at a slight premium to its peers’ average EV/Sales (NTM trading multiple), considering significant progress made at its growth projects, modest outlook, and expected benefits of the proposed merger with OSH. For the purpose of valuation, peers like Woodside Petroleum Ltd (ASX: WPL), Beach Energy Ltd (ASX: BPT), Cooper Energy Ltd (ASX: COE) have been considered. Considering the company’s diversified portfolio, disciplined approach to capital allocation, improved H1FY21 results, and upside potential as indicated by the valuation, we give a “Buy” rating on the stock at the current market price of $6.18, up by ~0.324% as on 18 August 2021.

STO Daily Technical Chart, Data Source: REFINITIV

Note: Purple color line reflects RSI (14-Period). 

Note 1: The reference data in this report has been partly sourced from REFINITIV

Note 2: Investment decisions should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the analysis has been achieved and subject to the factors discussed above alongside support levels provided.

Technical Indicators Defined: -

Support: A level where-in the stock prices tend to find support if they are falling, and downtrend may take a pause backed by demand or buying interest.

Resistance: A level where-in the stock prices tend to find resistance when they are rising, and uptrend may take a pause due to profit booking or selling interest.

Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices.

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