Own Santos (ASX:STO) shares? Top broker thinks it ‘can pay higher dividends’

One broker thinks the oil and gas giant can up its payouts.

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Key points

  • Santos is 12% in the green sine January 1
  • With energy prices soaring, Santos is poised to deliver a period of high free cash flow
  • Morgan Stanley reckons this can be redistributed to investors via a healthy dividend, if Santos chooses
  • The broker tips Santos as a buy and values the company at $10.40 per share.

The Santos Ltd (ASX: STO) share price finished Tuesday in the green, up 0.14% on the day to close at $7.07.

Investors have rewarded Santos since late December amid renewed strength in oil and natural gas markets.

These strengths saw Santos realise high free cash flow and boost cash reserves on its balance sheet into 2022 — points that haven’t gone unnoticed by Morgan Stanley.

The broker is bullish on Santos and reckons the oil and gas giant could potentially increase its dividends as a result. Let’s take a look.

Can Santos pay higher dividends?

The team at Morgan Stanley reckons Santos should re-evaluate its dividend policy this year, particularly given forward estimates in global energy markets for natural gas and oil.

It reckons the next few years “could see materially higher energy prices”. As such, the brokers says any strategy that “rewards investors during such a period could be more attractive to investors”.

Morgan Stanley notes that if Santos were to adopt the strategy, it would signify a meaningful drift away from the company’s current push to grow material production after 2025.

In its own modelling, Morgan Stanley submits that Santos’ gearing would slide in under 20% if Brent crude were to average US$70/bbl and if it were to sell off assets in its Alaska operations.

In fact, if current trends in the energy markets such as LNG persist, “free cash yields would approximate 10-15% and potentially near 20%”.

If the energy market delivers, the broker reckons “this would give Santos the capacity to pay higher dividends”. It notes the company could even double its current 15 cents per share trailing dividend should it return 50% of free cash flow to investors.

If it were to return 50% as a payout ratio, this would be a substantial jump from the 20%-30% payout ratio that Santos currently incorporates in its dividend program.

Fellow broker Morgans is also bullish on Santos, valuing the company at $8.65 a share with an add rating to investors.

Santos share price summary

The Santos share price has had a challenging year, slipping 4% into the red these past 12 months.

Things are looking up this year to date, however, with the Santos share price charging 12% higher since January 1.

Should you invest $1,000 in Santos right now?

Before you consider Santos, you'll want to hear this.

Motley Fool Investing expert Scott Phillips just revealed what he believes are the 5 best stocks for investors to buy right now... and Santos wasn't one of them.

The online investing service he’s run for over a decade, Motley Fool Share Advisor, has provided thousands of paying members with stock picks that have doubled, tripled or even more.* And right now, Scott thinks there are 5 stocks that are better buys.

*Returns as of January 13th 2022

The author has no positions in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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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