Santos: Some drag on 2023

Author name:: By Adrian Prendergast
Job title:: Senior Analyst
Date posted:: 09 November 2022, 7:00 AM
Sectors Covered:: Mining, Energy

Santos' (ASX:STO) Investor Day outlined a 2023 that does not look as good as we (or consensus) had expected.
2023 production guidance was set at 91-98mmboe, vs consensus 99mmboe.
2023 group capex guidance set at ~US$2.7bn, vs consensus US$2.57bn.
We expect FCF breakeven to remain at a healthy ~US$45/bbl in 2023, after allowing for the lower production and higher capex.
Maintain Add rating with a revised (login to view) target price.

What we learned at Investor Day

STO set 2023 guidance for production and capex, both disappointed vs Morgans/consensus estimates.

2023 production guidance was set at 91-98mmboe for CY23, vs Morgans/consensus estimate of 100/99mmboe. The majority of the miss appears to be from an expected drop in production from WA Gas next year, with the Reindeer field nearing depletion and a quicker drop off in the Spar field.

2023 group capex of US$2.8bn came in above Morgans/consensus of US$2.1/$2.6bn. A bigger adjustment for our numbers, as we alter assumed timing of spend on Papua FEED, Pikka/Barossa development, and Santos Energy Solutions (CCS and decarbonisation).

The three La Nina events that have hit the Cooper Basin are hampering ongoing development. STO commented it has 30 drilled but not completed/connected wells.

Interesting in the Q&A session, STO’s comments made it obvious that it is cautious and taking the risk of the federal government lifting taxes on the industry seriously.

STO’s Narrabri gas project (located in NSW), could deliver a much needed 90tj/d of new gas supply committed to the domestic market.

STO flagged an ongoing interest in selling down equity in Dorado (STO 80%) and Narrabri (STO 100%) before considering sanctioning the projects.

Analysis

After adjusting for the ~5mmboe lower production and higher-than-expected capex we still estimate STO will have a cash flow breakeven in 2023 of US$45/bbl.

The decline in 2023 production estimates is likely to weigh on consensus, but not materially impact investment views or have a lasting impact.

On WA Gas, which was the weak point in the update, STO commented the acceleration of drilling the Spartan well, a 1Q23 tieback to Varanus Island that should help offset lost production from Spar. While the Cooper Basin activity (>100 wells per annum) is expected to recover immediately on better weather.

Logically we would not have expected the Federal Government to be considering hiking taxes on a critical industry like gas, where it is relying on producers to make significant and sustained discretionary investment to deliver much needed new supply, but it does seem like that is where we are headed.

Forecast and valuation update

Trimmed our 2023 production assumptions to accommodate the flagged decline in WA Gas volumes. We have also adjusted our group capex estimate for 2023-24 to US$2.7bn.

Post changes to our estimates we have revised our valuation-based target price to (login to view).

Investment view

A disappointing Investor Day update on balance, but STO remains an undervalued resource franchise with healthy medium-term upside from its growth projects in PNG, Alaska, NT and Narrabri.

We maintain our Add rating on STO, with a revised (login to view) target price.

Risks

Risks to economic conditions (energy demand drivers).
Execution risk to growth projects.
Risk of further State and Federal Government intervention in the gas market.

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