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Santos to board the yield train?

Oil and gas producer, Santos Limited (ASX: STO) may be about to jump on the “dividend yield train”, with chairman Ken Borda confirming that the board would review its dividend policy.

In an address to shareholders in Adelaide today, Mr Borda said “We want to reward shareholders as earnings increase,” but added, “We need to do so in a way that strikes the right balance between dividends and ongoing investment growth. Santos is a growth company, and as we change our dividend policy in line with higher earnings, that policy must be sustainable.”

Santos has paid a dividend of 30 cents per share over the past two years, at a low payout ratio, as it looked to invest cash flow into its various projects. Santos is involved in four separate LNG projects, including Darwin LNG, Gladstone LNG, PNG LNG – with Oil Search Limited (ASX: OSH) and Bonaparte LNG.

PNG LNG is over 80% complete and on track to produce its first LNG in 2014, while Gladstone LNG is more than 50% complete and scheduled to produce its first LNG in 2015. Darwin LNG has been producing for many years, while Bonaparte LNG is still in the development phase.

As PNG LNG comes on stream and drives an increase in cash flow, Santos is likely to up its dividends, returning cash to shareholders, following in the steps of fellow oil and gas producer Woodside Petroleum (ASX: WPL), which recently declared a special dividend, after cancelling its onshore Browse LNG plant. That suggests that Santos’ current dividend yield of 2.3% doesn’t  reflect the potential future dividends.

Of course it all depends on how much capital Santos wants to reinvest in its businesses. LNG plants are not cheap, and neither are drilling wells into the sea floor hundreds of metres below the ocean.

Foolish takeaway

With production of oil and gas expected to reach 85 million barrels of oil equivalent in 2020, compared to the company’s production of 52 million barrels in 2012, Santos’ cash flows are likely to overflow and shareholders may well be richly rewarded for their patience over the past few years. Santos is definitely one company worthy of addition to your watchlist.

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