Santos Limited (STO)
Update: No-Moat Santos 3Q on Track; No Change to FVE
Recommendation: Accumulate Change: No Change
Our AUD 5.75 fair value estimate for no-moat Santos stands, with our longer-term assumptions intact. In the nearer term, our 2017 EPS forecast falls to AUD 0.22 from AUD 0.28, due to a decline in Brent crude price expectation to an average USD 53 per barrel from USD 56 prior. Considerable earnings price leverage is to be expected, with Santos still in recovery from a low base, but the magnitude is exacerbated by LNGs price realisation coming at a four-month lag to oil. Our fiscal 2018 EPS forecast is little changed at AUD 0.26, assuming unchanged USD 48 Brent before recovery to our USD 60 midcycle forecast.
Santos reported marginally higher third-quarter production of 15 million barrels of oil equivalent versus the second quarter, close to our expectations. LNG output increased 5% to 5.1 mmboe, more than offsetting softer crude volumes of 1.6 mmboe. Crude suffered natural field decline in the Cooper Basin, but growing upstream GLNG well development, along with new-compressor-boosted PNG LNG enhancements, hoisted LNG output. We expect GLNGs ramp-up to continue and PNG LNGs cost-effective capacity improvements to persist. Our little-changed 2017 production forecast of 59 mmboe is at the midpoint of marginally upgraded 58-60 mmboe guidance. Our forecast for 2018 remains 66 mmboe, benefiting from the tail end of Gladstones ramp-up. The plant's annualised third quarter LNG run-rate of 5.1 million tonnes was at 63% of the ultimate 8.0 Mtpa nameplate, and our estimated long-term average assumption.
We still don't credit a moat for Santos, given that PNG and Gladstone's LNG trains were built at the peak of the resources investment boom. In our base-case oil price regime, the company is not expected to generate midcycle returns on invested capital above its cost of capital, and our high fair value uncertainty rating also stands. But the price the market currently asks shareholders to pay for Santos could equate to more-than-healthy returns for an investor.
STO Price at posting:
$4.28 Sentiment: Buy Disclosure: Held
