The Santos Ltd (ASX: STO) share price is trading near its 12 month high after the company delivered a drastically improved half year result yesterday. However, it’s not enough to change my skeptical view.
Santos is one of Australia’s largest oil and gas companies. Founded in the 1950’s, Santos owns and operates one of Australia’s largest portfolios of oil and gas fields, connected by extensive pipelines and complementary facilities.
What Did Santos Report?
Santos recorded a large improvement in most key financial metrics. Total product sales for the period was up 18% to US$1.97 billion, supported by a 32% increase in production and lower production costs.
Net profit after tax (NPAT) jumped an astronomical 273% to US$388 million for the first half. The company said underlying profit was up 89% to US$411 million. This gives a more meaningful comparison as it strips out one-off or non-recurring items from the results.
The company reported a 74% uplift in free cash flow to US$638 million which helped to support an interim dividend of US$0.06 per share, a 71% increase on the previous corresponding period.
Balance Sheet Concerns
The Santos balance sheet has often given me cause for concern and this was exasperated with net debt increasing by 38% during the half to reach US$3.4 billion as of 30 June.
The capital intensive nature of the business operations means that the company is always susceptible to racking up large amounts of debt. In lean years when the oil price is low, this can lead to ballooning debt right at a time when profits are falling.
If I were a shareholder in Santos, I would have much preferred that management not pay a dividend at all, instead using the cash to pay down debt. Long term shareholders will remember the all too painful implosion of the share price in 2015 when a heavily indebted Santos was forced to sell assets, lay off workers and raise capital in order to stay afloat as the oil price went into free fall.
Whilst I am not predicting a repeat of this scenario anytime soon, the risk of such a calamity occurring again intensifies as the debt burden grows.
Management Comments
Commenting on the financial results, CEO Kevin Gallagher said: “Our forecast free cash flow breakeven oil price for 2019 is now reduced to ~US$31 per barrel, in-line with 2018 notwithstanding higher capex (capital expenditure) this year. Every US$10 per barrel increment in average oil price above our free cash flow breakeven increases annual free cash flow by between US$300 million to US$350 million.”
Gallagher went on to say that current growth initiatives were on track and supported management’s goal of reaching more than 100 million barrels of oil equivalent production by 2025.
Would I Buy Santos Shares?
Santos is a company that can do very well during periods where the oil price is high. The problem is, I never know when these periods will be. Like most companies that make money from selling commodities, Santos will inevitably go through periods of boom and bust.
I’d rather invest in a high quality company signified by a durable competitive advantage with the ability to generate high returns on equity in all economic conditions.
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At the time of publishing, Luke has no financial interest in any companies mentioned.
