Why aren’t investors selling Santos Ltd shares?

The share market, for all its wonders, can be a bizarre place.

The more you watch it, the more you’ll notice events that don’t seem to make intuitive sense. For example, the way companies like QBE Insurance Group Ltd (ASX: QBE) can report a loss, but still pay a dividend.

Another example is the investor reaction to yesterday’s news that Santos Ltd (ASX: STO) will take a US$1.5 billion  ($1.96 billion) impairment (before tax) on the value of its massive GLNG investment. Poof, gone.

Considering that investors had collectively decided Santos was worth about $8.4 billion by market capitalisation before the announcement, it was puzzling to see the share price ignore the news to see the company’s market value increase.

After all, at some point real money (through debt and shareholders’ equity) had been used to build those assets and yet, rather than screaming out in disgust and dumping their shares, investors just shrugged it off.

What it means for investors

The disconnect here is that, theoretically, the impairment itself doesn’t impact the company’s intrinsic value. That being the present value of its free cash flows.

There clearly are significant implications to relative value measures. The reduction to the company’s book value for one, and the impact on the debt leverage ratio for another.

But as the Economist notes in this 2009 article, the actual impact on share price “depends on the extent to which the market has already absorbed the lost value.”

Investors had potentially already priced the company’s shares to take yet another huge hit in response to the change in energy cycle, focusing instead on what it says about the business going forward.

We firmly believe in the strong long-term growth of LNG consumption and demand globally” Chairman Peter Coates is quoted as saying. Perhaps investors believe him to be right and that the impairment signals better days ahead for company performance.

Either way, investors can now only hope that Santos has employed the tact suggested by management consulting firm McKinsey that when it comes to impairments “executives should record as much of the impairment or restructuring charges as possible in a single announcement.”

Time will tell.

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Motley Fool contributor Regan Pearson owns shares of QBE Insurance Group Ltd. 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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