Is the Santos share price worth $7.30?

The wild year of negative oil

2020 was a year of many firsts for financial markets. The coronavirus pandemic wrought untold damage on global economies and countries, the US Fed printed money at a rapid click (debasing the greenback at an equally expedited pace), and oil, arguably the world’s most important commodity, turned negative for the first time during a chaotic April.

That anomaly in oil prices was driven by a few things: A nasty supply demand-shock drove oil prices lower during the first-part of 2020. As oil prices dove and WTI futures contracts moved towards expiry, futures traders were met with a stark reality: the need to take physical delivery of the oil. Liquidity dried up and physical storage space all but ran out.

That culminated in WTI’s May futures contract hitting negative US$40.32 a barrel on April 20 2020 – an event that market participants likely thought impossible or at the very least highly improbable.

For broader context, the equity of energy stocks had already been hammered during the March sell-off; and interestingly, energy stocks had already begun to recover to a degree when ‘negative oil’ rolled around. For example, despite its size, Santos (STO) – Australia’s second largest oil and gas company – saw its share price shredded amidst all this. After trading close to $9 per share in February, by late March the stock traded down to $2.73 per share – a shockingly fast decline by any measure.

Santos has since rebounded firmly – rising about 160% from those lows to last trade at $7.15 per share. In between that though – the fair value of its equity was a highly contested manner, and the outlook and potential recovery of oil prices and even more contested matter.

But oil eventually recovered. WTI and Brent both last traded above US$50 per barrel and Morgan Stanley (MS) recently said that they saw STO’s fair value at $7.30 per share – a shade above the stock’s last traded price. What’s the investment bank’s thesis?

While STO missed on MS's revenue estimates as part of its most recently released operational update, its production figures came in slightly ahead if the investment bank's estimates, hitting the top of the energy giant’s previously guided production range.

As Morgan Stanley put it:

‘Santos outperformed peers in 2020 and we think there is room for further outperformance if oil stays around US$55/bbl in line with our bull-case assumption. Balance sheet likely to improve in 2021 from the SK and JERA selldowns.’

MS has a $7.30 price target and Overweight rating on STO.

Santos posts record results

Looking at Santos’ most recent results in more depth, the oil player reported solid production growth, record sales figures, while also reiterating its previously stated 2021 guidance.

This resulted in STO reporting record production figures of 89 Million Barrels of Oil Equivalent (MMboe) – representing a year-over-year increase of 18%.

From a quarterly perspective, during the December quarter STO produced 25.4 MMboe – representing a quarter-over-quarter increase of 1%. On the sales volume front, STO reported sales volume of 107.1 MMboe.

Those sales flowed strongly into a robust top-line performance, with the oil giant reporting US$3.4 billion in revenues for the full-year.

Beyond that, from a cost perspective, it was noted that the company’s ‘disciplined operating model’ resulted in '2020 upstream unit production costs of ~US$8/boe at the lower end of the US$8.00-8.50/boe guidance range.’

In commenting on these results, the Santos CEO, Kevin Gallagher said:

'Our consistent and successful strategy combined with the disciplined, low-cost operating model continues to drive strong performance across our diversified asset portfolio and position us for disciplined growth.'

'2020 saw us ride through the bottom of the cycle while still generating free cash flow and deliver a record 4.3 million tonnes of Santos-equity LNG sales. We remain focused on controlling our costs and living by our disciplined operating model so we are set up to sustain our base business and remain resilient through the cycle even as we see the welcomed strengthening in prices over the past months. Our LNG projects currently have 10 spot cargoes scheduled in Q1,’ Mr Gallagher added.

Looking forward, the company noted that the 2021 guidance previously provided to the market remains unchanged. Some of the key figures here include:

• Total production of between 94 to 91 MMboe and total sales volumes of between 98 to 105 MMboe.
• Total CAPEX of around US$1.6 billion – made up of base-business CAPEX in the realm of US$900 million and growth CAPEX of around US$700 million.

The company did however note that these guidance figures 'assumes sell-down of 25% interest in Bayu-Undan and Darwin LNG to SK E&S occurs in the first half of 2021.'

Santos is set to hold its next AGM on April 15.

Over the last five trading sessions the Santos share price has fallen around 2.58% – suggesting that investors remain uncertain what to make of these results and the oil market more broadly.

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