ANALYST’S NOTE

Santos (STO) delivered a solid first half 2018 (1H18) results, with the company declaring its first dividend since 2016. .

However, largely overshadowing this was the announcement that STO has agreed to purchase Quadrant Energy for US$2.15bn, beefing up STO’s natural gas assets with the deal increasing its reserves by more than +26%, will deliver around +17% free cash flow accretion on a per share basis and +30% EBITDAX accretion.

In our view this acquisition makes strategic sense and the fact that the Company declared a dividend whilst announcing this acquisition speaks to the confidence in the Company’s outlook.

Key headline numbers for 1H18:

1. Product sales up +16% to US$1.68bn;

2. EBITDAX up +23% to US$883m;

3. Underlying NPAT up +99%;

4. The Company has maintained its full year sales target of 72-76 mmboe.

We maintain our Neutral recommendation. We believe the stock offers significant leverage to the oil price relative to peers, business has been repositioned and now focused on growth opportunities available (rather than survival).

• 1H18 key points.

1. FCF. First half saw free cash flow increase by +22% on previous corresponding period (pcp) despite a negative impact of $70m from PNG due to the earthquake. Management expect 2018 free cash flow breakeven price of US$35/bbl.

2. Net Debt. Net debt reduced -17% to US$2.4bn (from to US$2.7bn).

3. NPAT. Underlying NPAT was up +99%.

4. Earning. Operating earnings excluding exploration (EBITDAX) were up +23% on pcp, driven by higher commodity prices and revenue.

• Dividends reinstated. In our view, this was the key highlight from the 1H18 results as it speaks to management’s confidence in the outlook and current operating assets. Given management now have successfully repositioned the business to a low-cost operating model, paid down debt and invested in growth opportunities, the Board has declared STO’s first dividend since 2016. The Company will pay an interim dividend of US3.5cps.
• Quadrant Energy acquisition. Overshadowing the first half result and announcement of the first dividend since 2016 was the announcement to acquire 100% of Quadrant Energy for US$2.15bn. In our view, this appears to be an attractive acquisition at fair value. It will increase 2P reserves by 220 million barrels of oil equivalent, around +26%. Annual production will increase by 19 million barrels of oil equivalent, around 32%. In the first full year of ownership, it will deliver around +17% free cash flow accretion on a per share basis and about +30% EBITDAX accretion. The asset will also lower STO’s free cash flow breakeven to US$32 per barrel. There is significant portfolio overlap between STO and Quadrant, and management see opportunity to capture synergies of US$30 – 50m p.a.
• Keeping an eye on debt levels. STO will fund the acquisitions from debt facilities and existing cash. Management expects pro forma net gearing to be approximately 34% on completion and then fall below 30% by the end of 2019, with a medium-term target of less than 25%. Whilst we are positive on energy prices in the short term, we do believe this potentially represents some risk should oil prices decline significantly.