Like a phoenix rising from the ashes shares in oil and gas producer Santos Ltd (ASX: STO) are finally starting to rise from their decade low level as the oil price rebounds.
Shares are up 13% in the last month to almost $8, but are still down 41% on 12 months ago. Yet over this time the company has grown both production and assets significantly so for investors looking for value it's worth asking: "Is Santos cheap, and should I buy today?"
Is Santos cheap?
The answer to the first question certainly appears to be 'yes'. In fact looking at the company's price-to-book (P/B) ratio the company looks like a bit of a steal. With a market capitalisation of around $7.98 billion, and a book value (the company's net-assets) of $9.413 billion, Santos sells for a P/B ratio of just 0.85.
This compares to a P/B ratio of 1.75 for Woodside Petroleum Limited (ASX: WPL) and suggests either that investors expect further asset write-downs, or that the company has been over-sold.
Another measure of relative cheapness is enterprise value to 2P energy reserves (EV/2P). Santos has an EV/2P ratio of 12.4 which also looks like good value compared to Woodside Petroleum on 21, meaning we can buy Santos' energy reserves for a lot less than Woodside's.
Should you buy today?
So the company appears cheap. But it is harder to assess Santos' future earnings. The company's high exposure to oil-linked pricing makes earnings volatile and hard to predict. Santos estimates that every US$1/barrel change in the price of oil has an impact of around A$20 million on Net Profit after Tax (NPAT).
Falling capital expenditure, growing production and a 10% reduction in unit production costs are all positive, but it is the company's significant debt position which concerns me.
Santos' level of gearing was 44% at 31 December 2014, compared to slimmed down Woodside Petroleum with gearing of just 9%, and this will require a big chunk of free cash flow over the next few years, while energy reserves have been in decline requiring more investment. This makes me uncomfortable with the volatile oil prices, and keeps me from adding the company to my portfolio.
