Santos - Morgans

Oil & Gas Exp & Prodn│Australia│Equity research│April 19, 2018

Santos Harbour offer dominant catalyst

REDUCE (no change) Current price: Target price: Previous target: Up/downside: Reuters: Bloomberg: Market cap:

A$5.98 A$4.55 A$4.31 -23.8% STO.AX STO AU US$9,683m A$12,457m US$33.89m A$43.32m 2,083m 99.8%

Average daily turnover: Current shares o/s Free float: Price Close

Relative to S&P/ASX 200 (RHS)

6.50

172

5.50

147

4.50

122

3.50

97

2.50 60

72

Vol m

40

20 Apr-17

Jul-17

Oct-17

Jan-18

Absolute (%) Relative (%)

1M 22.3 23.8

3M 14.8 17.4

a formal bid emerging from Harbour remains the key focus.

■ A larger impact on PNG LNG production from the 7.5 magnitude earthquake and a fall in production from GLNG combined to weigh on STO’s 1Q performance.

■ Meanwhile pricing conditions continue to improve, with STO posting a healthy average realised LNG price of US$8.19/mmbtu and oil price of US$71.60/bbl.

■ The major near term catalyst remains the A$6.50 equivalent Harbour offer. ■ We see a path for Harbour receiving FIRB approval, although it could come with a requirement for a compromise attached.

FIRB approval could be drawn out Given the national significance of STO’s interests, the FIRB review process on the Harbour approach is likely to be a drawn out process. The price offered for STO is clearly inviting, with management inviting Harbour into a data room to complete thorough due diligence (a condition of its informal offer). Government approval remains the key hurdle for Harbour’s offer. We expect Harbour’s plans to invest heavily in growing gas production is likely to be viewed favourably, while its control over domestically important energy infrastructure may be hard to accept.

PNG LNG hit harder than we expected

Source: Bloomberg

Price performance

■ A soft 1Q18 result versus our estimates, although understandably the prospects of

12M 62.5 62.1

In line with the quarterly result posted by its PNG LNG partner Oil Search (OSH, Add), STO reported worse than expected production losses stemming from the recent 7.5 magnitude earthquake in PNG. STO’s share of PNG LNG production came in at 2mmboe, vs 3mmboe the previous quarter. As a result STO has trimmed its 2018 production guidance to 55-58mmboe (from 55-60mmboe).

Adrian PRENDERGAST

Waiting for GLNG to ramp up

T (61) 3 9947 4134

STO continues to report low levels of capex investment and equity gas production from GLNG, which remains an area of long term concern for us as we have poor visibility on STO’s ability to keep a lid on upstream costs once it ramps up development activity and starts to step outside developed/appraised areas in the Surat. 1Q18 LNG production from GLNG (STO share) decreased to 348kt (from 477kt) although equity gas used rose to 48% (from 32%), declining after a strong 4Q where additional gas was sold to QGC during QGC’s plant shutdown.

E [email protected]

Dominant share price catalyst remains offer We expect STO’s catalysts will continue to be dominated by progression of the Harbour offer in the near term. Whether a formal bid emerges for STO from the current process remains uncertain, however we expect the price offered has been well received given STO management has engaged with Harbour to allow the latter to conduct thorough due diligence. Given STO is trading at a significant premium to our A$4.55 valuation-based price target (was A$4.31) we maintain our Reduce recommendation. The key risk to our call remains the potential for a higher or competing bid for STO. Financial Summary Revenue (US$m) Operating EBITDA (US$m) Net Profit (US$m) Normalised EPS (US$) Normalised EPS Growth FD Normalised P/E (x) DPS (US$) Dividend Yield EV/EBITDA (x) P/FCFE (x) Net Gearing P/BV (x) ROE % Change In Normalised EPS Estimates Normalised EPS/consensus EPS (x)

Dec-16A 2,627 1,146 -1,047 0.03 (7%) 140.1 0.00% 10.45 18.09 45.3% 1.33 0.87%

Dec-17A 3,172 1,334 -360 0.16 392% 28.5 0.00% 9.17 NA 37.9% 1.35 4.72%

Dec-18F 3,110 1,477 403 0.19 19% 24.0 0.00% 8.00 28.48 28.8% 1.28 5.49% (4.13%) 0.78

Dec-19F 3,425 1,720 548 0.26 36% 17.7 0.00% 6.49 NA 18.8% 1.19 7.01% 0.33% 1.01

Dec-20F 3,731 2,066 805 0.39 47% 12.0 0.066 1.42% 5.03 12.76 8.6% 1.11 9.57% (0.03%) 1.38

SOURCE: MORGANS, COMPANY REPORTS

IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS REPORT AND AN EXPLANATION OF RECOMMENDATIONS CAN BE FOUND AT THE END OF THIS DOCUMENT. MORGANS FINANCIAL LIMITED (ABN 49 010 669 726) AFSL 235410 - A PARTICIPANT OF ASX GROUP

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Oil & Gas Exp & Prodn│Australia│Equity research│April 19, 2018

Figure 1: Financial summary Date: Share Price: Year End:

19-Apr-18 5.98 31-Dec

Profit & Loss - US$m Revenue EBITDAX Exploration Expensed EBITDA D&A EBIT Net Interest Net Profit Before Tax Tax Expense/(Benefit) Adjusted NPAT (US$m) Abnormals - Post-Tax Reported NPAT (US$m)

Recommendation: Price Target: Valuation:

2016A 2,627.0 1,284.0 138.0 1,146.0 741.0 405.0 -281.0 124.0 61.0 63.0 -1,110.0 -1,047.0

2017A 3,172.0 1,428.0 94.0 1,334.0 742.0 592.0 -239.0 353.0 17.0 336.0 -696.0 -360.0

2018F 3,110.3 1,536.8 60.0 1,476.8 699.1 777.8 -201.6 576.1 172.8 403.3 403.3

2019F 3,425.1 1,780.8 61.3 1,719.6 781.7 937.8 -154.4 783.5 235.0 548.4 548.4

2020F 3,731.4 2,129.3 63.0 2,066.3 810.5 1,255.9 -105.6 1,150.3 345.1 805.2 805.2

2016A 857.0 -649.0 -222.0 733.0 -147.0 -43.0 543.0 1,178.0 208.0

2017A 1,248.0 -634.0 -534.0 141.0 783.0 -2,442.0 -1,518.0 -804.0 614.0

2018F 1,093.5 -553.6 -553.6 -200.0 -200.0 339.9 539.9

2019F 1,343.2 -695.7 -695.7 -1,522.0 -1,522.0 -874.5 647.5

2020F 1,599.9 -640.8 -640.8 -200.0 -185.4 -385.4 573.7 959.1

Balance Sheet - US$m Cash Oil and Gas Properties Exploration Assets Debts Liabilities Equity Net Debt / (Cash)

2016A 2,026 10,398 495 15,262 5,239 8,182 7,080 3,213

2017A 1,231 9,536 459 13,706 3,943 6,555 7,151 2,712

2018F 1,571 9,237 549 13,831 3,743 6,277 7,554 2,172

2019F 696 8,993 641 12,864 2,221 4,761 8,103 1,525

2020F 1,270 8,662 735 13,273 2,021 4,551 8,723 751

Earnings EPS - Adjusted (USD Cents) EPS Growth (%) DPS (USD Cents) Franking (%) Dividend Payout Ratio (%)

2016A 3.3 -7% 100% -

2017A 16.3 392% 100% -

2018F 19.4 19% 100% -

2019F 26.3 36% 100% -

2020F 38.7 47% 6.6 100% 17%

Production (mmboe) Cooper Basin GLNG PNG LNG WA Gas Northern Australia Other Total Production (mmboe)

2016A 15.1 9.5 11.9 8.9 4.2 11.7 61.6

2017A 13.5 8.1 12.4 9.5 4.1 7.5 55.2

2018F 15.0 9.4 10.0 11.0 4.5 7.0 56.9

2019F 18.9 10.1 12.2 10.7 4.4 7.4 63.8

2020F 9.9 5.1 6.1 5.3 2.2 3.7 32.3

Cash Flow Statement - US$m Cash Flow from Operations Capex (incl. Maint/Explor.) Cash Flow from Investing Incr/(Decr) in Equity New Debt Repayment of Debt Dividends Paid Cash Flow from Financing Net Change in Cash Free Cash Flow

REDUCE $ 4.55 $ 4.55

Key assumptions (Dec year end) USD / AUD exchange rate Brent Oil Price (US$/bbl)

2015A 0.74 53.7

2016A 0.74 45.1

2017A 0.77 56.6

2018F 0.76 61.5

2019F 0.74 67.5

Valuation Summary GLNG Cooper Basin PNG LNG Production/Development Northern Australia WA Gas Other Assets (Asia, NSW & WA oil) Total Producing Assets PNG Other Exploration (Various) Total Undeveloped Assets Total Operations Net (Debt) / Cash Corporate Total Valuation Discount Rate

Risk Weighting 100% 100% 100% 100% 100% 100%

US$m 1,894 1,338 4,687 391 1,214 171 9,694 126 63 189 9,883 -2,731 7,152 12%

A$m 2,525 1,784 6,249 522 1,618 227 12,925 168 85 253 13,178 -3,691 9,487

A$ps 1.21 0.86 3.00 0.25 0.78 0.11 6.20 0.08 0.04 0.12 6.33 -1.77 4.55

9,218 11,949 7,152 -23.8% 0.0% -23.8%

12,457 16,147 9,487

5.98 7.75 4.55

75% 25%

Market Capitalisation Enterprise Value Price Target Capital Growth Potential (%) 12-month F/cast Dividend (%) Total Forecast Return (%)

FCF vs Gearing

Gearing Net Debt / (Net Debt + Equity) Net Debt / Equity (%) EBIT Interest Cover (x) Net Debt / EBITDA (x)

2015A 38% 61% 1.5x 5.1x

2016A 31% 45% 1.4x 2.8x

2017A 27% 38% 2.5x 2.0x

2018F 22% 29% 3.9x 1.5x

2019F 16% 19% 6.1x 0.9x

Key Metrics / Multiples Adjusted P/E Ratio (x) EV / EBITDA (x) EV / EBIT (x) EBITDA Margin (%) EBIT Margin (%) Gross Profit Margin (%) FCF Yield Dividend Yield (%) ROIC (%) ROE (%) ROA (%)

2015A 167.8 12.2 36.5 35.7% 13.1% 4.4% -6.9% 6.6% 0.4% 0.6% 0.3%

2016A 180.3 10.5 29.5 43.6% 15.4% 4.7% 1.6% 0.0% 0.5% 0.9% 0.4%

2017A 36.6 9.2 20.2 42.1% 18.7% 11.1% 4.8% 0.0% 3.0% 4.7% 2.5%

2018F 30.9 8.0 15.4 47.5% 25.0% 18.5% 4.2% 0.0% 3.6% 5.5% 2.9%

2019F 22.7 6.5 12.7 50.2% 27.4% 22.9% 4.9% 0.0% 5.3% 7.0% 4.3%

Valuation Breakdown

700.0

70%

600.0

50%

2%

1%

1% 19%

12%

4%

500.0 30% 400.0

14%

10% 300.0 -10% 200.0

47% -30%

100.0 -

-50%

2016A

2017A 2018F 2019F Free Cash Flow Net Debt / Equity (%)

GLNG Northern Australia PNG Other

Cooper Basin WA Gas Exploration (Various)

PNG LNG Production/Development Other Assets (Asia, NSW & WA oil)

SOURCE: MORGANS RESEARCH, COMPANY

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Oil & Gas Exp & Prodn│Australia│Equity research│April 19, 2018

Changes to estimates 

We have cut our PNG LNG forecasts reflecting the updated guidance.



We have also rolled our model forward.

Figure 2: Changes to estimates Dec Year End

FY17A Actual

FY18E New

Previous

FY19E Change %

New

Previous

FY20E Change %

New

Previous

Change %

Revenue

3,172

3,110

3,173

-2%

3,425

3,442

-0%

3,731

3,742

-0%

EBITDAX

1,428

1,537

1,594

-4%

1,781

1,795

-1%

2,129

2,142

-1%

EBIT

592

778

803

-3%

938

937

+0%

1,256

1,258

-0%

Underlying NPAT

336

403

421

-4%

548

547

+0%

805

806

-0%

SOURCE: MORGANS RESEARCH, COMPANY

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Oil & Gas Exp & Prodn│Australia│Equity research│April 19, 2018

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