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Santos Limited (STO)

Update: No-Moat Santos Continues to Impress, Breezing Through 1Q PNG LNG Interruptions

Recommendation: Hold Change: No Change

Santos reported a strong first quarter in 2018, PNG earthquakes notwithstanding. A precautionary temporary shutdown of PNG LNG infrastructure did crimp group equity output by approximately 1.0 million barrels of oil equivalent, or mmboe, to 13.8 mmboe. However, our AUD 6.15 fair value is unchanged, mid-way between our AUD 5.75 stand-alone fair value estimate and Harbour???s indicative AUD 6.50 takeover offer. PNG LNG is already back on line, earlier than originally anticipated, and higher-than-expected near-term energy prices are an additional counter to fair value detraction. We increase our 2018 and 2019 Brent oil price forecasts by 13% and 24% to USD 61.40 per barrel and USD 53.65 per barrel, respectively. Our 2018 and 2019 EPS forecasts increase by 5% and 43% to AUD 0.34 and AUD 0.52, 2018 mostly offset by the PNG LNG outage. Santos revised its 2018 production guidance to 55-58 mmboe from 55-60 mmboe and we sit at the upper end of the revised range.

With respect to near-term oil price, the probability of major supply disruptions has increased, especially in Venezuela and Iran. Economic malaise in the former has triggered precipitous output declines, and it isn???t clear how quickly this can be rectified, if at all. And the latter may face economic sanctions later this year, if President Trump refuses to continue waiving them as threatened. Outages in either arena could easily offset U.S. growth, however strong, and prolong the illusion that shale isn???t a threat. Our midcycle Brent price forecast, however, remains USD 60 per barrel in 2021 dollars.

Santos generated better-than-expected first-quarter free cash flow of USD 246 million and the surplus reduced net debt by 7% to USD 2.5 billion. The company is ahead of plan to reduce net debt by 20% to USD 2.0 billion by end 2019, and our target remains USD 1.8 billion. That would have net debt/EBITDA at just 0.8, versus 2.7 at end 2017. Forecast free cash flow break-even creditably remains USD 36 per barrel in 2018.