Is Santos Ltd a buy at this share price?

Should you put Santos Ltd (ASX:STO) at the top of your resources buy list?

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With the price of Brent crude oil rising from a low of US$27 per barrel in February to its current level of US$48, it is unsurprising that the share price of Santos Ltd (ASX: STO) has increased by 28% year-to-date. After all, Santos is a price taker just like resources peers such as BHP Billiton Limited (ASX: BHP) and Woodside Petroleum Limited (ASX: WPL), with its sales and profitability closely linked to the price of oil.

Oil price outlook

Undoubtedly, the future path of the oil price is difficult to predict. In my view, there is likely to be a major imbalance between demand and supply in the short run since neither are showing significant signs of rising or falling in the near term. However, with emerging market growth likely to be high and oil and gas set to be a key part of their energy mix in the long run, a higher oil price seems relatively likely over time.

Strategy

However, this cannot be guaranteed. As such, Santos seems to have the right strategy to cope with a low oil price environment.

I was impressed with the progress made in financial year 2015, where Santos reported positive 'jaws' in terms of production rising by 7% to 57.7 mmboe (million barrels of oil equivalents), while unit production costs per barrel declined by 10% to $14.4 per boe. In other words, Santos was able to improve margins and at the same time boost production so as to ease the pain of a lower oil price.

Since then, Santos has made further progress in this regard, which I think gives its investors reason to cheer. For example, production increased by 11% in Q1 of FY 2016 to 15.6 mmboe, while upstream production costs were reduced by 13% to $11.90 per boe.

Improving cash flow

Furthermore, Santos cut capital expenditure by 59% in Q1 to $209 million as it seeks to manage its cash resources more effectively. This strengthens its financial outlook alongside its capital raising of $3.5 billion from last year and the fact that it has $4.8 billion in cash as well as no material drawn debt maturities until 2019. In my opinion, this places it in a strong position to survive further challenges regarding the oil price.

Outlook

Clearly, Santos' income statement may endure another tough year following last year's net loss of $2.7 billion. Asset impairments as well as a lower average realised oil prices could continue to hurt profitability (in Q1, for example, the average realised oil price fell by 28%).

Furthermore, other resources stocks are more diversified and financially stronger than Santos. Meanwhile, others have lower cost bases in their respective industries, such as Rio Tinto Limited (ASX: RIO) in iron ore, while gold miners such as Newcrest Mining Limited (ASX: NCM) may be better protected than Santos against global economic uncertainty.

However, in my view Santos has a sound strategy, improving finances and in assets such as GLNG (which shipped 16 cargoes in Q1), the potential to continue its share price progress made in recent months over the medium term.

Motley Fool contributor Robert Stephens has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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