We knew a poor result was coming and, at least in that respect, Santos didn’t disappoint, announcing an underlying loss of US$5m. Even that flattered the true outcome.
If we accept that US$1.5bn of impairments, mostly to the troubled GLNG project, are one-offs, surely the near US$500m tax benefit recognised over the period is too. Making those adjustments, the pre-tax loss widened to almost US$90m.
Even for a business under siege from operating issues (low oil prices), balance sheet issues (crippling debt) and management issues (new chief executive), this was a poor outcome and demonstrates the lack of flexibility available to energy firms compared with, say, Fortescue, which has greater opportunities to cut costs.
Losses from GLNG and Cooper Basin
Debt remains a problem
GLNG ramping up
The first processing facility at GLNG is now running and resulted in a 37% lift in LNG output. All up, Santos produced 31m barrels of oil equivalent (mmboe). For the full year, this should grow to over 60mmboe as GLNG ramps up.
GLNG’s start should be marked by hurrahs but, with oil prices so low, it has passed in sombre silence. The project generated an operating loss of US$49m – and that excludes finance costs and the impact of a US$1bn writedown.
|Six months to June (US$m)||2016||2015|| /(–)
In contrast, the stake in PNG LNG, a lower-cost project, appeared to generate operating profits of about US$150m. Admittedly, GLNG is still in ramp-up phase so hasn’t hit full profitability but it is also clear that this high-cost project will struggle in a low oil price environment.
LNG wasn’t the only problem. The Cooper Basin, long a source of stable profits, generated an operating loss of US$65m as lower contributions from oil and higher costs cut operating margins.
The sole highlight came from gas sales in WA, where profits rose 28% to US$97m although last year’s number was low because of scheduled maintenance.
This result is awful. It illustrates how high commodity prices can mask fragile economics and how lower prices savage profits. The Cooper Basin, once considered a defensive source of cash, is failing and there are few obvious solutions.
Expenditures cannot be cut any further. Santos already appears to be underspending on capital expenditure. Depreciation of US$400m was matched by just US$283m of spending. With limited room to cut costs, more painful options may be needed to restore Santos to health.
Operating cash flow isn’t close to making a dent in a US$4.5bn debt pile. Another dilutive capital raising or asset sale is likely unless oil prices stage a remarkable recovery.
It’s easy to come up with a $9 valuation on the business and just as easy to imagine it bust. For the conservative, this is a candidate for sale. For oil bulls – we are among them – the leverage from higher oil prices and the potential sale of assets is hard to ignore. Santos's stake in PNG LNG alone should be worth $6bn and an asset sale isn't completely off the cards yet, especially with a new chief executive in place. HOLD.