A rock and a hard place
The Federal Government's threat to impose export restrictions on LNG producers who are net gas consumers (i.e. GLNG) has increased the pressure on Santos (STO). In response we expect the company could either:
- step up development of its CSG fields (which would see capex/breakeven rise), or:
- buy LNG on the spot market to meet obligations to its LNG customers.
In either scenario we see an increase in costs for GLNG/STO. All of this is unfortunately unfolding at a time of unexpectedly weak oil prices. These factors could combine to materially dent STO's near-term free cash-flow potential.
Could Santos need more capital?
With a growing need to increase spending across core assets (especially GLNG), minimal cash flow generation at current spot prices, and with gearing still around 40% (net debt to equity), there is some potential for STO to once again find itself in a position where it requires additional external capital if oil prices do not recover in the short term. This comes despite STO having already raised in excess of A$4bn in new capital over the last two years, and the hasty rejection of an A$6.88ps takeover offer in late 2015.
Adjustments to oil/assumptions
We have lowered our FY17 oil price forecast to US$54.90/bbl (from US62.30/bbl). Meanwhile we have also carried out a review of opex and capex assumptions across the business and increased both (particularly for GLNG and Cooper Basin) on the expectation that activity will have to pick up to offset field decline and gas requirements. These changes have been largely offset by a recent upgrade to our PNG LNG T1 & T2 forecasts. The net impact to our SOTP valuation has been a 5% decrease to A$3.96 (was A$4.19).
Reliant on oil price recovery
While we are hopeful that oil prices might improve next quarter, we find it difficult to rely on that assumption alone given the amount of downside risk if weak oil prices persist. The size of oil sensitivity to cash flow, in our view, impacts its investment appeal. Meanwhile, a potential positive catalyst could be the sale of STO's non-core assets. As a result of STO's heavy dependence on short-term oil price moves, we have set our 12-month share price target at a 20% discount to our SOTP valuation.
With STO trading at close to our revised share price target, we retain our Hold recommendation.
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