3 reasons to buy Santos shares today (and 3 not to)

Is it time to stock up on shares in the energy giant? Our Motley Fool writers present the bull and bear cases.

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Santos Ltd (ASX: STO) is one of the largest oil and gas companies in Australia, with a market capitalisation of more than $23 billion. It has been operating for over 60 years and recently became much larger after merging with Oil Search Limited.

The company's share price has managed to stay in the green in the year to date, trading around 3% higher, and is roughly at the same level as it was 12 months ago, as seen on the chart below.

As an ASX energy share, Santos' fortunes are inextricably tied to prices for the underlying commodities it produces. It is also subject to tightening environmental requirements and new tax regulations.

So, are Santos shares worth adding to your portfolio in the current climate? We asked two Motley Fool writers for their views. Here's what they had to say.

Growth potential, resurgent energy prices, and fat dividends

By Bernd Struben: Three reasons I'm bullish on Santos shares are the ASX 200 energy company's growth potential, a broadly forecast move higher in oil and gas prices, and Santos' juicy dividends.

On the growth front, Santos is currently undertaking the required steps that I expect will see its $5.8 billion offshore liquified natural gas Barossa Gas Project come online on – or near – the target date.

First gas at the Northern Territory project is targeted for 2025. On completion, the project will provide a new source of gas to the Darwin LNG facility, of which Santos is a majority owner.

Source: Santos

There has been some regulatory red tape thrown up in recent months as the Australian government tightens its carbon emissions rules for LNG projects. While that's caused some delays, Santos hopes to recommence drilling before the end of the year.

According to Morgans, Santos' "recent acquisition increasing its stake in Darwin LNG has increased our confidence in Barossa's development". The broker has an add rating on Santos shares and an $8.75 price target, some 20% above the current price.

Santos says its first gas target still stands, with construction now more than half completed.

Passive income

The second reason I like Santos shares is for their dividends.

Atop spending big on new projects, Santos paid out 33 cents per share in dividends over the past 12 months. That equates to a trailing yield of 4.3%. The share price is up 3.8% over that time as well.

And those dividends should keep on flowing. Citi forecasts Santos shares will deliver dividends of 49 cents per share in FY23 and 40 cents per share in FY24.

Higher energy prices

The third reason I'm bullish on Santos shares is that I agree with a range of analysts forecasting a significant uptick in oil and gas prices in 2023 and into 2024.

The Brent crude oil price has cratered 33% over the past 12 months, currently trading for US$76 per barrel. Globally, natural gas prices have tumbled even further.

But Goldman Sachs believes that will turn around in the second half of the year. The broker forecasts US$86 per barrel for Brent crude in December. That's 13% above current prices.

And with China poised to open up the economic stimulus taps, I believe Brent could yet reach US$90 this year, which would offer some solid tailwinds for Santos shares.

Santos' carbon plans are capturing negative attention

By Tristan Harrison: Santos shares are almost exactly where they were a year ago, and I don't think much is going to happen for the foreseeable future.

The oil and gas giant saw an increase in profitability in FY22, but the first quarter of 2023 saw a decrease in production and sales revenue of 13%. The company put this down to lower sales volumes and lower LNG and oil prices.

There are worries about a potential economic downturn, and lower demand could lead to weaker prices, which is my first reason to avoid Santos for now. I don't think it'd be wise to expect gas prices to rise strongly from here in the foreseeable future.

Another of my main worries for the Santos share price is the heat that gas producers are getting with higher taxes. Changes to the Petroleum Resource Rent Tax (PRRT) could be a headwind.

Federal Treasurer Jim Chalmers said:

The Government will act on Treasury's key recommendation to achieve a fairer return from offshore LNG projects by introducing a cap on the use of deductions from 1 July 2023. Specifically, the change will limit the proportion of PRRT assessable income that can be offset by deductions to 90 per cent.

This change will bring forward PRRT revenue from LNG projects.

Gas producers are also facing government heat on the development of new gas projects around Australia, pushed on by the Greens. It was recently reported in the Australian Financial Review that companies will "need to spend billions of dollars more on offsets and carbon capture technology on new projects to meet the new emissions reduction goals".

The CEO of the oil and gas producers lobby Australian Petroleum Production and Exploration Association (APPEA), Samantha McCulloch, made the following comments:

New gas supply investment needs policy and regulatory certainty but instead, the Labor-Greens deal creates additional barriers to investment, further diminishing the investment environment and adding to the growing list of regulatory challenges facing the sector.

The Australian Financial Review also reported that Santos' Barossa gas project is the "biggest target" of the escalated restrictions on gas projects. It reports the CO2 content of Barossa is 18%, while other gas projects in the works are in much lower CO2 fields.

I'm not a gas project approval expert but if Barossa were to be blocked for longer than expected, or even entirely, it would be damaging for the company.  

Finally, profit projections on CMC Markets suggest the Santos share price is valued at nine times FY23's estimated earnings and that profit will fall slightly in FY24.

If we look at the chart below, we can see the forward price/earnings (p/e) ratio is as low as it has been in the last few years.

However, I think one of the best pieces of advice to consider here is what one of the world's greatest investors once said. Peter Lynch commented that cyclical businesses at a low valuation ratio are typically overvalued, but on a high p/e ratio, they could be cheap. Lynch said: "Cyclicals are like blackjack: stay in the game too long, and it's bound to take back all your profit."

With that in mind, I don't think Santos shares are a buy unless I could know that energy prices are going to be stronger for a long time.

Motley Fool contributors Bernd Struben and Tristan Harrison have no position 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 Scott Phillips.

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