Oil and gas producer Santos Ltd (ASX: STO) may have finally turned a corner for investors.
After years of battling low oil prices and high debt the company even refers to itself as "The new Santos".
It would be fun to think of this as some kind of great corporate redemption story. But let's not forget the massive wealth destruction shareholders have faced leading to this point. Over the last three years billions of dollars have been wiped out.
To understand the company today we need to remember where Santos has come from. It's also worth taking stock of some timeless investment lessons we can learn from the Santos experience.
Santos was staring into the abyss
After the price of oil started falling in 2014, Santos was staring into the abyss.
Not only had the company loaded up on debt to fund its share of the US$18.5 billion GLNG project, but it had wagered big on oil-linked pricing rather than less volatile, long-term 'take or pay' style contracts.
Interest payments began chewing up more and more cash as revenues slid.
Santos tried every trick in the book to recover. It extended bank credit lines. It slashed capital spending. It raised capital. It got rid of the CEO. It sold assets. It raised more capital and it found a strategic partner.
By the time it was done, in December 2016, Santos had raised more than $4.74 billion through investors and asset sales and shares outstanding shifted seismically from 978 million at 31 December 2014 to 1.798 billion at 31 December 2016.
An investor who failed to take part in the capital raisings over that time would have had their ownership in the company diluted by almost half.
Valuable investment lessons
I'm not sure whether it's because the company's decline was so slow burning, or because there was no legal negligence, but I think Santos too easily escaped critical review.
At the very least, we can take lessons as investors to prevent losing money on the next 'Santos';
- Commodity prices are volatile and unpredictable. Debt amplifies this volatility on risk and return.
- At most, a company can make a 'best guess' on where future commodity prices might be. Even then they can get it wrong.
- Always understand how a company expects to pay for its growth plans.
- Consider how falling earnings could impact a company's ability to repay debt or cover interest payments. The 'Interest coverage ratio' is useful here – the number of times a company can cover its interest obligations with Earnings Before Interest and Tax (EBIT)
- Portfolio diversification is really, really important if you want to grow your wealth for life.
Time will tell if the 'New Santos' can take advantage of higher oil prices and provide an acceptable risk adjusted return for investors going forward.
