From Credit Suisse:
A brave new world. The question that anyone looking at Santos must ask themselves is, when is cheap too cheap? With eyes wide open, we believe that point has been reached today and upgrade to OUTPERFORM. This should not be confused as being an epiphany on the stock, suddenly viewing it as high quality. The reality remains that most of the assets are bottom quartile; GLNG has huge issues sourcing gas to honour its contracts when ramped-up and financial and operating leverage remain high. However, risk/rewards are more in your favour. EPS changes reflect adjustment of our treatment of debt over the forecast period.
■ Micro factors for 2016 less likely to be negative. Fixing the Santos of 2020 remains a huge challenge. However, ex that little factor called the oil price, we see few negative catalysts for Santos over the next year. Whilst some pressure may come on reserves, we don’t expect any meaningful reserve downgrade in Feb. A big impairment is likely in Feb, but the share price tells us no one believes book value anyway. Outside of this, whilst LNG markets remain precarious, GLNG benefits from the market modelling a slow ramp-up (albeit GLNG commissioning is a risk). Outside of GLNG, it’s really only PNG LNG that matters.
■ Has corporate activity finished? Mystery still surrounds Scepter’s bid for STO. How credible was it? It is hard to know. However, in today’s share count it was a ~$5.70/sh bid that, if Hony isn’t a blocking stake, would be hard for the Santos board to defend if it resurfaced. We note with interest the clause in Hony’s escrow agreement that nullifies the escrow if Santos’ stake in PNG LNG is <10%.
■ Still a leveraged call on oil. Santos remains the quintessential call on oil. Run $50/bbl to perpetuity and our NPV is ~$2.20/sh; at $70/bbl it is ~$6.20/sh. Sitting at $45/bbl Brent today, clearly the equity market isn’t pricing in $50/bbl. Logic would suggest that if oil rises, even if only moderately, in the absence of the stock-specific factors that we think are likely to be absent in 2016, Santos will go up too. The clear risk is that this call is too early, but with the rest of the sector now harder to justify, Santos at last stacks up to us at least.
Meh. Too early. The real risks to STO are not even cited. They are:
- a much lower oil price as the end of cycle accident draws near with special attention ahead for commodity debt;
- the erosion and breaking of “take or pay” contracts, and
- the distinct possibility of volume cuts as spot prices fall below the cash breakeven prices in the next few years.
The only reason to own this stock is as takeover play. Making better sense, CS also downgraded WPL to neutral.
