Santos Share Price: Is ASX: STO Undervalued or Overvalued?
Santos Limited’s (ASX: STO) Barossa cash flows 18 months away and dividend surprise.
Mentioned: Santos Ltd (STO)
Key Morningstar Metrics for Santos (ASX:STO)
Data from Morningstar Direct as of 22 February 2024
What we think of Santos’ Shares
We expect a bright future for Santos, forecasting production to double to around 180 million barrels of oil equivalent, or mmboe, by 2028 thanks to east-coast coal seam gas to liquid natural gas and Papua New Guinea, or PNG, LNG projects, and more recently via the Quadrant and ConocoPhillips acquisitions and Oil Search merger. Santos' 180 mmboe growth target includes greenfield development Dorado and exploration. Santos boasts some of Australia's largest and highest-quality coal seam gas reserves. East-coast LNG attracts export pricing and indirectly drives domestic prices in the direction of export parity. The potential to direct east-coast volumes to higher-priced Asian markets has pressured prices upwards locally. Near-term debt concerns have abated, with capital injections and cost control having reduced net debt.Â
Santos Share Price (ASX: STO)
Source: Morningstar Direct. Data as of 22 February 2024
Santos Economic Moat Rating
Given a lower energy price paradigm, we don't expect Santos to generate returns sufficiently in excess of its cost of capital, meaning that it has no moat. LNG projects in Papua New Guinea and Gladstone will see Santos generate improved returns based on our long-term oil price of USD 60 per barrel. Santos has 20-year contracts that tie the gas price to the oil price--USD 60 per barrel equates to USD 8.40 per gigajoule. However, returns will now be insufficient to support a moat. Returns on invested capital, or ROICs, have been in the single digits and below the weighted average cost of capital, or WACC, since the mid-2000s. Santos suffered industry cost inflation without the benefit of higher international pricing because of a heavy weight of domestic gas contracts. In addition, the construction phase of Gladstone and Papua New Guinea LNG projects further crimped returns precommissioning. We expect the trend to improve with ramp-up from Gladstone LNG and domestic gas contracts rolling off.
With the USD 60 per barrel midcycle Brent oil price, however, we expect ROICs to only marginally exceed the cost of capital. Less-than-stellar returns are driven by PNG LNG and Gladstone being constructed at Australian energy boom inflated capital cost, permanently bloating the invested capital base and detracting from returns.
Access our full research report to continue reading about Santos’ (ASX: STO) moat rating.
Santos Risk and Uncertainty
Our Morningstar Uncertainty Rating for Santos is High, with moderate debt levels in support of an 11.0% cost of equity. High enterprise risk reflects commodity price volatility. To put the rating in perspective, we rate all Australian resource and energy exposures as being at least high-risk, including BHP Billiton, despite its greater commodity and geographical diversification, along with its increased scale advantages. Santos faces environmental and operational risks, which are a given with the oil and gas industry, as well as country-specific risks associated with some of its non-Australian assets. It is also a comparatively small player in a world of oil and gas supermajors.
Material ESG exposures create additional risk for E&P investors. In this industry, the most significant exposures are greenhouse gas emissions (both from extraction operations and downstream consumption), and other emissions, effluents, and waste (primarily oil spills). In addition to the reputational threat, these issues could force climate-conscious consumers away from fossil fuels in greater numbers, resulting in long-term demand erosion. Climate concerns could also trigger regulatory interventions, such as fracking bans, drilling permit suspensions, and perhaps even direct taxes on carbon emissions, already in place in some jurisdictions.
