STO Dividend, page-42

Report from MS today.........


Catalyst Driven Idea

2017 was a strong year for Santos with cost reduction and turnaround aided by increased oil prices. We think the Board will be thinking hard about the resumption of dividends, given greater profitability and free cash generation. We assume Santos resumes paying dividends in our Base Case.

What and when is the catalyst?
Santos will report its 2017 full-year results on 21st February 2018. We think Santos may decide to resume dividends, given progress on the turnaround in 2017, including lower costs and improved balance sheet. We forecast Santos will generate around US$600m of free cash in 2018 with net debt approaching US$2bn -- a year ahead of schedule.

What are the potential outcomes for this event?
We see two potential outcomes. Scenario 1: Resume dividend payments (we assign a 60% probability). We assume a 40% payout ratio, in line with previous payout ratios before 2016. A 40% payout ratio would equate to US$106m in dividend, or US$0.051/share, on our forecasts. Scenario 2: No dividends are paid (we assign a 40% probability) with the Board deciding to focus on further debt reduction in the near term.

What are the potential stock implications from these outcomes?
Scenario 1: We think the market would welcome dividends, as this would provide further confidence in the turnaround and cash flow generation from the Board's perspective. We think the stock would respond positively by around 3-4%. Scenario 2: We think the stock would trade slightly down if Santos decided not to pay a dividend. However, this would also depend on what other information is provided at the February result, including details on reserve progress and growth plans for the Cooper Basin and GLNG assets.

What is our base case expectation for this event?
We assume dividends resume at 40% payout ratio in our Base Case, which would equate to US$106m, or US$0.051 cps.

Our price target of A$5.48 is based on DCF valuation. We set our price target at a 0% discount to our DCF valuation. We often apply discounts or premiums to our DCF valuations. For Santos, we apply a DCF discount similar to that for other larger Australian energy companies. Our DCF valuation captures 2P reserves using the Brent forward curve for three years and a long-term oil price of US$65/bbl. We discount at a post-tax WACC of 10% on average. Non-producing assets are valued at book value or on other industry accepted yardsticks, where relevant.

Downside risks to achieving our price target: 1) Balance sheet could deteriorate if lower oil prices were to retrace below US$40/bbl on a sustained basis; 2) reserve write-downs at GLNG; 3) production performance from coals within GLNG project.