Company overview - Santos Limited is a natural gas company. The Company is engaged in the exploration, development, production and sales of natural gas both onshore and offshore. The Company produces liquid petroleum gas (LPG), ethane, methane, Coal seam gas (CSG), Liquefied natural gas (LNG), shale gas, condensate and oil. The Company's segments comprise its five key assets/operating areas: Cooper Basin; Gladstone LNG (GLNG); Papua New Guinea (PNG); Northern Australia, and Western Australia (WA) gas. The Company operates in Australia and Asia. Its Other Assets include Indonesia, Vietnam, East Coast Australia Gas, Western Australia oil, Victoria and onshore Northern Territory. The Cooper Basin produces natural gas, gas liquids and crude oil. GLNG produces LNG for export to global markets from the LNG plant at Gladstone. The Company's business in Papua New Guinea is centered on the PNG LNG Project. In Northern Australia, Santos has interest in the Bayu-Undan/Darwin LNG Project (DLNG).

STO Details
 
Delivery of gas into southern domestic market: Santos Ltd (ASX: STO) has signed a location swap agreement facilitating the delivery of at least 18 PJ (Petajoule) of gas per annum into the southern domestic market. Under the three-year agreement with an option to extend for a further year (which takes effect in January 2018), Santos will take delivery of gas at Wallumbilla and provide an equivalent quantity of gas at delivery points in the southern domestic market. With this, Santos will be able to facilitate additional gas supply into the southern domestic market and the transaction demonstrates the ability for the industry to efficiently work together and support the Federal Government in bringing more supply into the domestic market to mitigate gas supply concerns. Further, Santos will continue to proactively pursue transactions and extend delivering competitive wholesale gas supply to east coast domestic gas market end users.
 
Humboldt South 1 corehole spuds in Mahalo Block: Joint venture partner, Comet Ridge Limited (ASX: COI) has announced the spud of the Humboldt South 1 corehole on 26 August 2017 in the north-eastern part of the Mahalo Block in central Queensland. Comet Ridge holds 40% equity in the Mahalo Block with Santos and APLNG each holding 30% equity. The hole was drilled to 131 meters and 7” diameter casing is currently being cemented. The well will then be cored through the coal section from the base of the cased hole through to the total depth. Humboldt South 1 is located approximately 240 km west of Gladstone and 6 km to the east north-east of the Mira pilot scheme. Mira has been the focus of field work for the past several weeks where three pilot wells were successfully under-reamed and one well was prepared for a horizontal well intercept. The field program has now shifted into a two-well drilling phase, with the start of the drilling program at Humboldt South 1. The corehole is expected to reach a total depth of approximately 280 meters and is programmed to core through and recover all coals in the Bandana Formation. The well is being drilled to gather further data on net coal thickness, gas content and reservoir productivity. Key technical information for an updated 2P and 3P reserves assessment for the Mahalo Block is said to be provided by the company.
 

Northern Mahalo Block area showing the Humboldt South 1 corehole; (Source: Company reports)
 
H1FY17 impacted by impairment charges: Santos reported a 24% (year on year) growth in revenue at US$1,496 million, led by higher LNG sales volumes reflecting the ramp-up of GLNG and strong performance from PNG LNG. EBITDAX (Earnings before interest, tax, depreciation, depletion, exploration, evaluation and impairment) grew 46% yoy to US$718 million. However, the company posted a net loss of US$506 million, impacted by US$689 million after-tax net impairment. Excluding the net impairment and other significant items, the company recorded an underlying profit of US$156 million, a substantial improvement on the underlying loss of US$5 million in the corresponding period. Further, free cash flow breakeven reduced to US$33 per barrel and net debt reduced to US$2.9 billion while US$302 million was generated in free cash flow in the first half. Moreover, substantial reductions in drilling costs in the Cooper Basin and GLNG are unlocking more gas supply. The company also increased 2017 sales volume guidance to 77 to 82 million barrels of oil equivalent, driven by solid volumes from the core assets in the first half and better forecast of domestic sales volumes.
 

Financial summary; (Source: Company reports)
 
Focused on five core and long-life natural gas assets: The company is focused on Cooper Basin, GLNG, PNG, Northern Australia and Western Australia Gas while other assets (Asia, NSW and WA oil) have been packaged and run separately for value as standalone businesses. In H1FY17, production from the core assets increased by 2% to 25.3 mmboe, primarily due to the ramp-up of GLNG and stronger PNG LNG production. Further, core asset sales volumes were up 5% to 36.1 mmboe, driven by the ramp-up of GLNG and higher WA gas and PNG sales volumes, partially offset by lower Cooper Basin sales. However, production and sales volumes from other assets decreased to 4 mmboe due to the sale of the Victorian, Mereenie and Stag assets. The average realized oil price was up 28% to US$54.79 per barrel and the average LNG price was 26% higher at US$7.21/mmbtu. Notably, LNG sales revenue was up 44% due to the ramp-up of GLNG and strong performance from PNG LNG.

On the other hand, upstream production costs dropped by 12% to US$239 million (US$8.08 per boe), primarily due to cost savings and efficiency gains across the core assets and the sale of non-core assets. Other operating costs increased by US$19 million to US$189 million, primarily due to higher LNG plant costs following the start-up of GLNG train 2 in May 2016, higher pipeline capacity charges, and higher royalty and excise cost due to higher average commodity prices. All core assets delivered higher EBITDAX, except for WA Gas, which benefited from a settlement under a revised gas sales agreement in the corresponding period.
 

Revenue and EBITDAX by asset; (Source: Company reports)
 
Strengthening the balance sheet: STO has reduced its net debt to US$2.9 billion as at 30 June 2017, down from US$3.5 billion at the start of the year. Net debt was reduced through a combination of free cash flows generated by the business, asset sales and a share purchase plan during the first half. As a result, the company’s gearing ratio improved to 30%, down from 33% at the prior year end.  In May 2017, S&P Global Ratings reaffirmed Santos’ BBB- credit rating with stable outlook. As previously announced, STO is exercising its option to redeem Euro 1 billion Subordinated Notes on the first call date in September 2017 as it has ample cash and liquidity of US$4.2 billion to fund the redemption. The Notes to be redeemed are Santos’ most expensive debt instrument and replacing them with more efficient long-term debt funding will reduce the company’s forecast free cash flow breakeven oil price. The company has also undertaken prudent capital management, with net debt reducing towards the target of US$2 billion by the end of 2019 with oil price hedging in place for 2017 and 2018. Further, Santos has several debt funding options available to support liquidity and extend the debt maturity profile as debt markets remain buoyant.

H1FY17 result includes a net impairment charge of US$689 million after tax, primarily due to lower oil prices. Impairment charges were recognized against the GLNG (US$867 million) and AAL assets (US$149 million), partially offset by a positive net write-back to the Cooper Basin of US$336 million, where lower forecast development costs and higher production more than offset the impact of lower oil prices.
 

H1FY17 movement in net debt; (Source: Company reports)
 
Strategic relationship with ENN and Hony Capital to support growth: Recently, Santos announced a strategic relationship with ENN Group (ENN) and Hony Capital (Hony). ENN and Hony are associated shareholders of Santos with an aggregate relevant interest of 15.1% of Santos shares. The strategic relationship will remain in effect for so long as ENN and Hony have a relevant interest in 15% or more of Santos shares. Importantly, the relationship is based on mutual cooperation and assistance to support the growth of Santos, and it is the intention of ENN and Hony that Santos will be the primary investment vehicle for material investment by them in upstream gas reserves and LNG production in Australia and PNG.
 
Stock Recommendation: The stock declined 16.3% in the past one year (as at August 29, 2017), owing to subdued financial performance at the back of low oil prices and the framework for the Australian Domestic Gas Security Mechanism to curb LNG exports. However, the H1FY17 operating performance demonstrates the company’s focus on robust asset portfolio that can generate substantial free cash flow even in a lower oil price environment. The stock has thus risen 10.9% in last one month. Given the progress on reducing costs, lowering net debt coupled with improving production outlook, we give a “Buy” recommendation on the stock at the current market price of $3.77
 

STO Daily chart; (Source: Thomson Reuters)
 

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