EUR 850.00 For Business Accounts Only

Morningstar | Solid 3Q from Santos Adds Credibility to Production Growth Targets. FVE Unchanged.

Our AUD 7.85 per share fair value estimate for Santos is unchanged and our 2018 EPS forecast of AUD 0.43 similarly stands. We only recently increased our fair value estimate by 12% to AUD 7.85 per share after the company laid out the path by which it intends to grow group production by 40 million barrels of oil equivalent, or mmboe, or about 65% to over 100 mmboe by 2025.

Third-quarter production increased 6% to 15 mmboe in line with our expectations. Very strong output from PNG LNG offset a softer Gladstone LNG result. Our 2019 EPS forecast increases by 30% to AUD 0.83, but only after factoring-in higher near-term energy prices and a weaker Australian dollar. We now assume a 2019 Brent crude price of USD 82 per barrel and an AUD/USD exchange rate of 0.71. Longer-term assumptions including a USD 60 per barrel midcycle Brent crude price are substantially unchanged. Other quarterly positives include net debt reduction to Santos’ stated target of USD 2.0 billion more than a year ahead of schedule, higher sales, production and revenue contributing.

Santos has narrowed production guidance for 2018 to 56-58 mmboe, lifting the range low-end from 55 mmboe following the solid third quarter. Our higher 61.0 mmboe production target credits a quarter’s contribution from Quadrant, which Santos’ numbers do not. The USD 2.15 billion Quadrant acquisition is still subject to regulatory approval, but unlikely to run into road-blocks in our opinion, and we include it in our fair value estimate and earnings forecasts. Quadrant adds an annual 19 mmboe to Santos’ existing production base.

Capital expenditure guidance for 2018 has been lowered by around 6% to USD 725-775 million from USD 775-825 million, though simply reflecting timing changes. Importantly, there is no deviation for drilling guidance for the Cooper Basin and Gladstone LNG in 2018, staying at 85-90 and around 300 wells respectively.

Our fair value estimate equates to a little changed 2023 EV/EBITDA of 6.9, crediting five-year non-third-party group revenue CAGR of 11.4% to USD 3.8 billion. This supports five-year EPS CAGR of 27% to AUD 0.70 by 2023 for a nominal P/E of 10 at the current AUD 7.00 share price, or 16 when discounted at WACC. We think the shares are undervalued at the current price, the market likely not even closely crediting Santos’ 2025 100 mmboe production target. As it stands our midcycle production forecast of 90 mmboe itself is short of Santos’ 100 mmboe, conservative enough.
We include Quadrant, slowed depletion rates across Santos’ existing onshore gas assets, 5% capacity creep to 8.4 million tonnes per year at Gladstone LNG by 2023, and growth from Barossa. In the third quarter, Santos confirmed a final investment decision on the Barossa project to backfill Darwin LNG is targeted for end 2019, success of which would extend life for more than 20 years and deliver around 9.0 mmboe average annual net production to Santos, more than double the current around 4.0 mmboe rate. But we don’t yet factor-in Dorado’s oil, and we still credit just one additional 3.7 Mtpa PNG LNG train, rather than partner Oil Search’s more aggressive 8.0 Mtpa expansion aspirations via three new 2.7 Mtpa trains. Each 2.7 Mtpa train would add 2.8 mmboe net to Santos. These largely account for our 90 mmboe production target versus Santos’ 100 mmboe. We think waiting for greater clarity on these projects prudent before crediting full value. But the market’s even more dovish position, overly discounts CEO Kevin Gallagher’s growing record for delivery in our opinion.
With Quadrant’s inclusion, we expect Santos net debt to jump to USD 3.9 billion, though net debt/EBITDA a still manageable 2.1, and on our forecasts likely to fall back to below 1.0 before end 2019.