Santos: STO-OSH merger

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
20 December 2021, 9:00 AM
Sectors Covered:
Mining, Energy

  • We have moved our estimates to reflect the Santos (ASX:STO) - Oil Search (ASX:OSH) merger which has now been implemented.
  • STO has guided to US$90-$115m synergies but we see further savings in Alaska.
  • We see upside risk from potential transactions in PNG, Alaska and Australia.
  • After combining the two businesses we retain our Add rating with an (login to view target price).

Event: STO-OSH merger

The merger with OSH has seen our group EBITDAX estimate increase 54% to US$4,135m, indicative of the new earnings platform STO holds post-merger. While over the next three years it is likely STO will have to carry a neutral to negative FCF performance from the OSH business if it progresses development at Pikka (Alaska) and Papua LNG, with capex to 2024 of US$1.2bn combined expected.

Meanwhile STO also has its own development projects to fund (in particular Barossa and Dorado).

The ability for STO to navigate this wave of investment will be largely determined by its ability to sell down equity in select assets such as PNG LNG, Alaska and Dorado, freeing up balance sheet capacity and cutting required capex.

We expect both PNG LNG (to Papua operator Total) and Dorado as comfortably achievable transactions, while Alaska remains strained by its ESG-sensitive location in the arctic and persisting asset market weakness in oil in the region.

Analysis: Synergies could really impress

STO estimates synergies of US$90-$115m (ex-Alaska) after the merger, from organisational optimisation. We expect the reality will prove better than the promise, with STO’s 6-year track record of driving efficiency gains and lean approach at odds with OSH’s outsized corporate overheads (despite OSH only operating small parts of its business). 

Breaking down synergies. We expect as much as 80% of the guided synergies could be achieved from cost savings made at OSH’s comfortable Sydney headquarters alone, which we expect to be closed. This would also include corporate savings (board, listing costs, insurance/debt savings), with the remaining ~20% from economies of scale gains (operating leverage and procurement).

We have a high degree of confidence in STO’s ability to pull costs out of OSH’s business, but do not expect consensus to factor in these savings until they are visible.

Upside case on synergies. In addition to savings in Sydney and PNG, we also see potential for STO to give away operatorship of Alaska as part of any selldown of its 51% equity interest. This would trigger further savings as STO would move from operator to only a spectator in Alaska.

On back-of-the-envelope estimates only, based on OSH Alaska staff (136 employees plus 25 contractors) against group OSH employee costs in 2020, this kind of move could mean as much as a further US$20-$25m pa in cost savings when included with other expenses related to OSH’s Anchorage base.

Forecast and valuation update

We have now included the OSH merger into our STO base case, rebasing our earnings forecasts, growth project assumptions and new STO equity.

Net of these changes our new target price is (login to view).

Investment view

We view our target price as conservative, with a case for value upside from de-risking of growth projects and securing of synergies.

The merger leaves STO well positioned to control its own future in increasingly difficult ESG-driven debt and equity markets. We maintain our Add rating.

Price catalysts

2021 earnings result and guidance. Asset sales. Project progression.

Risk

COVID related risks to demand drivers for energy resources.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.


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