Santos: Alaska sanctioned while Dorado hits pause

About the author:

Author name:

By Adrian Prendergast

Job title:

Senior Analyst

Date posted:

18 August 2022, 9:00 AM

Sectors Covered:

Mining, Energy

• Strong 1H22 result close to estimates, while interim dividend trailed.
• Alaska sanctioned and Dorado stalls, although neither core projects. More importantly Santos (ASX:STO) has almost completed sale of 5% of PNG LNG (US$1.4-$1.5bn?).
• Maintain Add rating with positive view and unchanged (login to view) target price.

Solid 1H22 with changes to some projects

Overall a positive 1H22 result from STO, reporting a strong step up in earnings. 

1H22 EBITDAX was in line at US$2,731m (vs consensus $2,716m vs MorgansE $2,728m). Underlying NPAT was ahead at US$1,267m (vs consensus $1,099m vs MorgansE $1,189m), +300% vs pcp, aided by OSH merger and oil & gas prices. 

STO announced a US7.6 cent interim dividend. This trailed Morgans/consensus estimates of an US11 cent dividend, which we had based on an expectation STO might flex its payout ratio given the extraordinary oil/LNG price environment.

Limited by its franking credits STO opted to add another US$100m to its on-market share buyback, now US$350m. While we didn’t see the oversized dividend we expected, the STO board might be tempted to flex beyond its 40% payout of FCF in 2H22 with STO on track to finish 2022 with gearing of just 11% (currently 22%).

The big news in the result was the changes to some of STO’s growth projects with:

1. STO reaching FID (final investment decision) on Pikka Phase 1 oil project in Alaska.
2. STO announcing that Dorado FID was being put on the backburner following a deterioration in economics delivered by the inflationary environment.
3. STO flagging it was a couple months away from selling 5% in PNG LNG.

Production, sales and production cost guidance were unchanged.

Analysis

Alaska not that bad… We expect some of the mixed views on Alaska stem from previous owner OSH’s surprise 2017 entry into the asset. But based on STO estimates, which appears consistent with OSH’s earlier work, the US$2.6bn oil project can achieve a 19% IRR on a LT oil price of US$60/bbl (below consensus). 

…while Dorado drifts. Meanwhile STO also updated that at the end of FEED it had decided not to sanction Dorado at this stage, putting development on the backburner. STO attributed this to; 1) surging costs having eaten into Doardo’s return profile, and 2) the Pavo discovery warranting further work.

Putting the above into perspective. Neither Alaska nor Dorado are core projects for STO, it is certainly not that progress at Barossa had been impacted which might have changed our view on the stock (in fact STO reaffirmed in the result that Barossa was 43% complete, progressing to plan and largely insulated against inflation by its large proportion of fixed price contracts).

Also, we would much rather STO delay Dorado rather than just pushing it ahead at any cost. Instead it will optimally stagger its projects allowing it to continue deleveraging.

Nearing 5% sale of PNG LNG. More interesting in the result was the mention that STO was nearing the sale of a 5% interest in PNG LNG within a couple of months, for consideration consistent with “consensus” valuations.

Our valuation on PNG LNG indicates this consideration could be in the ballpark of US$1.43bn, which does appear consistent with STO management commentary.

Forecast and valuation update

We have increased our risk weighting on Pikka Phase 1’s valuation to 100% (from 75%) post FID, while reducing Dorado’s risk weighting to 75% (from 90%).

Updated our model for the result including tweaking opex/capex estimates post the result. Post these offsetting changes our Target Price is unchanged at (login to view).

Investment view

We maintain an Add rating on STO with an unchanged investment view post the solid result, not viewing factors such as the ADGSM as likely to undermine our investment view (consistent with STO management commentary).

Price catalysts

PNG LNG 5% sell down (<2 months). 3Q22 result (20/10).

Risks

COVID, global-macro, and US dollar factors (key oil demand drivers).

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