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Why I believe Santos Ltd is a buy at this share price

Overnight, Saudi Arabia told the Organisation of Petroleum Exporting Countries (OPEC) that it had raised output back above 10 million barrels a day in February, substantially reversing previous cuts made by the world’s largest oil exporting nation.

Revelations that that Gulf nation reneged on oil cuts sent the price of crude oil tanking 2.7% overnight. Major oil and gas players on the S&P/ASX 200 Index (ASX: XJO), Origin Energy Ltd (ASX: ORG), Woodside Petroluem Limited (ASX: WPL) and Santos Ltd (ASX: STO) brushed off the falls overnight, trading relatively flat in early Wednesday trade.

However, with Santos’ share price dwindling near 52-week lows, I believe it is worth a closer look. Here’s why.

About Santos

Santos shareholders have endured years of pain as the once mighty oil and gas producer’s shares have lost 75% of their value from their 3-year highs of $13.43 a share.

Numerous asset sales, the cancellation of its dividend and discounted capital raisings have done little to ebb the flow of its dwindling share price, with the company constantly coming under pressure for its heavy debt load in the midst of a crumbling oil price.

Turnaround potential

Nevertheless, like all other oil and gas players, Santos ‘batoned down the hatches’ and dug deep to drive efficiency gains and reduce debt at astonishing rates.

In its 2016 full-year results, Santos reported net debt sat at US$3.49 billion, down 26% from the prior year. Revenue swelled 6% as higher production and sales offset a lower oil price. Pleasingly, operating cash flow increased 6% to US$857 million, despite the company reporting an EBIT loss of $1.2 billion due to non-cash asset impairments.

Future prospects

Whilst Santos did not pay a final dividend for 2016, management reiterated that cost reductions and a steady increase to oil prices should enable the company to further reduce debt and resume paying dividends in 2017.

Although this assertion relies on crude oil prices being maintained or increasing (something which is not helped when OPEC production cuts are reversed), I believe Santos’ strengthening balance sheet and strong cash flows should see it comfortably navigate the current climate.

Accordingly, at Tuesday’s close of $3.57, I believe the company presents a solid long-term buy opportunity.

Foolish takeaway

Investors must remember that crude oil is a fundamental ingredient for the production of plastics, clothing, food and consumer products.

Whilst the underlying price of crude oil may fluctuate on economic sentiment or OPEC involvement, given the essential requirement for crude oil, the long-term trend should almost always be upwards, as the limited resource grows in scarcity.

Although I can’t guarantee that stocks like Santos and Oil Search Limited (ASX: OSH) have bottomed, I do believe their current share prices represents substantial value for their long-term potential.

Accordingly, with Santos’ shares trading at a large discount to industry leader Woodside, and management recently recapitalising the South Australian producer, I believe Santos is currently the pick of the bunch for long-term oil exposure.

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Motley Fool contributor Rachit Dudhwala owns shares of Santos Limited. 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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