Like fellow oil & gas producer Woodside Petroleum Limited (ASX: WPL), Santos Ltd (ASX: STO) also reported hefty declines in revenue and profits today. Unlike Woodside, Santos doesn't appear to be a viable investment today – unless you believe oil prices are set to rise.
Here's what you need to know:
- Revenues fell 6% to $1,191 million
- Net Profit After Tax fell 3,780% to a loss of $1,104 million
- Underlying Net Profit After Tax fell $30 million to a loss of $5 million
- Production rose 10% to 31.1 million barrels of oil equivalent ("mmboe")
- $1.5 billion write-down on Gladstone LNG plant
- Unit production costs fell* 15% to $8.8/barrel of oil equivalent ("boe")
- Net debt reduced to $4.5 billion, nearest maturity in 2019
- Guidance maintained at 57-63 mmboe production for full year
- Targeting under US$40/barrel break-even level in the future
So What?
Things didn't get off to a good start for Santos in the first half, with the average realised price diving to $42.79/barrel, well below the group's break-even level of $47/barrel. Santos is targeting a break-even price of $43.50 per barrel for the full year 2016, but even this may not be enough if current prices persist.
Santos has also slashed its capital expenditure budget, and an interesting chart of safety performance and total hours worked (by employees and contractors) show the company's evolution over the last couple of years with the ramp up of GLNG and subsequent decline in oil prices.
The group made a small dent in its $4.5 billion pile of debt during the year, but with limited cash flows (due to low oil prices) and ongoing expenditure required, Santos is far from out of the woods. Notably, although it has potential to lift sales through its second LNG train at the Gladstone project, the recent $1.5 billion write-down of the GLNG asset shows that future earnings expectations from this business have been reduced.
Now What?
Unlike peer Woodside Petroleum, Santos doesn't really have the ability to buy growth via acquisition. Although management states it does have several billion dollars in available liquidity if necessary, this is not something that is likely to be spent while the company operates at below break-even prices.
Santos receives an increase of $30 million in operating cash flow for every US$1/barrel improvement in the oil price, and as such is well leveraged to rising oil prices. As a result I feel that any decision to purchase Santos is an implicit bet on the value of oil and gas prices – and this is not something done without thought.
The oil market
I wrote an article in December about how investors in oil shares were headed for disappointment in 2016. Although many companies stand to benefit significantly from higher oil prices, investors must contrast the scale of the gains that could be made with the likelihood of them occurring.
There are no guarantees that oil will head back to US$100/barrel, for example. Although it's all we've known for most of the last 15 years, over the longer term $100 oil looks more like an anomaly than a benchmark. Investors looking to make money in oil should consider a number of factors including the US rig count, as well as the regular updates from the International Energy Agency (IEA) and OPEC which are often widely covered in the financial media.
Although Santos does have attractive upside if oil prices rebound, I haven't seen any real evidence that this could be about to happen (sustainably). What investors are left with is a heavily indebted company trying to grind its cost of production down to fit underneath the value of its sales, which is not a sexy investment case.
I prefer Woodside Petroleum Limited (ASX:WPL) today.
