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Why investors have confidence in Santos Ltd (ASX:STO)

Natural gas, oil and liquids miner Santos Ltd (ASX: STO) has won the confidence of investors in the last 12 months, with its share price surging up 87% from $3.97 at this time last year to sit at $7.43 at the time of writing.

There are several reasons for the prolonged rally and Santos’ most recent investor day report will probably ensure its share price incline continues for the time being too, after the company unveiled ambitious growth targets, with aims for 100 million barrels of oil equivalent by 2025.

Quadrant Acquisition

Recent news likely related to the upswing for Santos would include its acquisition of Quadrant Energy for US$2.15 billion, plus potential contingent payments related to the Bedout Basin.

The acquisition will be fully funded from existing cash resources and new committed debt facilities.

Quadrant holds natural gas and oil production assets in the Carnarvon Basin with its gas assets including significant portfolio overlap with Santos, which will provide an opportunity to realise material combination synergies estimated at between US$30 million and US$50 million a year.

The Quadrant uptake is closely aligned with Santos’ overall growth strategy to build on existing infrastructure to bolster the company’s core assets.

The full integration of Quadrant is expected by the end of the 2018 calendar year.

Cooper Basin

The Cooper Basin comprises 150 gas fields and 90 oil fields.

Increased drilling activity in the Cooper Basin will underpin a proportion of Santos’ future growth and includes the mobilisation of a fourth rig – but things will need to go smoothly for Santos to meet its hefty production forecasts.

Production is growing in the Copper Basin as Santos focuses on efficiencies, with oil production reaching its highest in four years, with unit production per barrel down 13%.

Santos said in August it expected 2018 production of 55-58 million barrels of oil equivalent on growing output from its Cooper Basin assets and maintained its sales volume guidance of 72-76.

Fundamentals

Santos impressed shareholders on the release of its half-year results back in August – reinstating dividends and managing to double its underlying profit to $217 million, upping free cash flow by 22%, reducing net debt by 17% and increasing product sales by 16%.

Santos prides itself on operating a “low cost operating model”, but it remains to be seen whether this is sustainable as its assets grow.

However, in terms of fundamentals Santos seems to be getting the formula right, and its balance sheet appears to be strong enough to support its growth strategy.

Santos did log a net impairment in the first half of $76 million in relation to the sale of its Asian assets – expected to be completed by the end of the second half – but the profit realised is likely to more than offset the first-half impairment.

Oil Prices

An overall surge in oil prices has no doubt contributed to Santos’ share price surge, but it’s unlikely this factor will be able to be relied upon for much longer, with oil prices tipped to fall in the medium-term.

A strong oil price has also seen share price rallies from the likes of Beach Energy Ltd (ASX: BPT) – up 1% at the time of writing to $2.19.

Oil Search Limited (ASX: OSH) and Woodside Petroleum Limited (ASX: WPL) shares are also on the up – 1.2% to $9.16 and 1% to $39.06 respectively.

Foolish Takeaway

While I wouldn’t buy into Santos at these prices, I wouldn’t sell either, and I think Santos has a good shot at meeting its production targets through to 2025, as long as it keeps its ducks in a row.

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Motley Fool contributor Carin Pickworth has no position in any of the stocks mentioned. 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 Scott Phillips.

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