Santos hits the gas pedal

Whilst the Cooper has been instrumental in establishing Santos as a major resources player, it could also be argued that it was also holding the company back. Until the arrival of MD John Ellice-Flint, that is.

In our view, Ellice-Flint is the type of bloke you want running a company – hard-working, honest and straightforward. The fact that he 'rediscovered' about a hundred oil and gas fields disregarded by previous management only adds to this appeal.

Motivating

Having set about motivating employees and imbuing management with a focus on shareholder returns, Santos is now implementing its growth strategy with renewed vigour.

That's why in issue 95/Jan 02 (Long Term Buy - $5.77), just after the company announced a $40m writedown – it discovered it had 18% less proven and probable oil reserves - we saw it as a good buying opportunity.

In our view Ellice-Flint was being very open and understood where the company was placed long term. Indeed, since issue 105/Jun 02 (Long Term Buy - $6.21) the price has gained 4%. So, what does the future hold?

Reserves in the Cooper Basin are declining and Santos is searching elsewhere. It recently got involved in the US after spending $150m on on-shore exploration acreage in the Gulf of Mexico. Indonesia, PNG and the Timor Sea are the locations of other important foreign assets.

These nations, in particular, highlight the grand theme in Santos' strategy. Ellice-Flint believes the 20th century was all about the making of oil and that the 21st will belong to gas.

In the full-year result ended December 2001, gas represented 68% of production but only 42% of revenue but, as global demand for gas picks up, so too should the price and, as a result, its share of Santos' revenue.

Expansion

The strength of the balance sheet is also encouraging. After a share buyback and preference share issue last year, net debt-to-equity stands at 39%. For the year, $692m in operating cash flow was generated. Santos can afford to expand.

With a return on equity of 16% and 30 cents in fully-franked dividends paid out again, we can't find any reason to reverse our previous view. But this is not an investment without risk, so let's examine where those risks lie.

As part of its aggressive approach, Santos is drilling more wildcat (high risk/high reward) wells and is winding down its reliance on hedging strategies.

That means the company's current and future oil and gas production will have increased exposure to the volatility of the Australian dollar and the oil price. Middle eastern conflict, OPEC fiddling with production levels and currency fluctuations will all impact profit.

That, though, is the nature of the beast. Santos' failed cash bid for Orogen earlier this year demonstrated the fire power on the balance sheet and a 4.7% fully-franked yield isn't bad either. LONG TERM BUY.