Santos Ltd’s (ASX:STO) Turnaround Couldn’t Have Been Timed Better

One of the Australia’s leading producers of oil and natural gas, Santos Ltd (ASX:STO), has taken several strategic initiatives over the past year to survive the epic fall in energy prices, which occurred when its financial health couldn’t have been worse – Santos had huge ongoing capital investments in multiple projects. Although the debt has been reduced from the $7.4 billion figure at the start of the year, it’s still $5.4 billion — a big number in light of the fact that Santos is still losing money, of late primarily due to large non-cash write downs on its natural gas project. But that may change soon, analysts expect the company to turn profitable in 2017 on the back of rising oil prices and its restructuring efforts.

The strategic steps

In 2016, the biggest challenge for the company was to survive the debt-overhang. Santos cut-down capital expenditures substantially, reduced its workforce, sold stakes in key assets, cut dividends and raised equity at a steep discount when shares were trading at multi-year lows. Its efforts, along with a rebound in oil prices, helped it remain free-cash-flow-positive in the past two quarters, while reducing debt to manageable levels. asx-sto-historical-debt-simply-wall-st Santos has been able to reduce its production costs to US$39 per barrel from US$47 per barrel. To create value for shareholders, now the company has made a bold decision to spin-off all non-core assets, leaving it with five key assets to operate. The company indicated that the move would allow it to reduce debt by $2 billion over the next three years. Additionally, Santos expects to generate nearly $400 million incremental operating cash flow based on the assumption that oil prices would trade near US$60-mark in 2017. Is the assumption realistic?

The OPEC and non-OPEC join forces

While crude had been rallying since OPEC announced production-cuts on Nov 30, now their biggest rival Russia has joined the collective effort, pledging to reduce production in 2017. Following a successful meeting with non-OPEC countries such as Russia, Khalid Al-Falih, the energy minister of Saudi Arabia, announced that they will cut production well below the agreed upon reduction on Nov 30. This might be the cost of bringing Russia into the fold. Nevertheless, the news sent crude futures nearly 6% higher to above $54-mark. Well, if this coordinated effort among the largest oil producers materializes, oil prices touching the $60-mark as expected by Santos doesn’t seem to be a far-fetched assumption. Santos shares jumped 5% this Monday to close at $4.52—still more than 10% below the sell-side analysts’ median price target of $5.10. With its Asian exports from the $18.5 billion flagship Gladstone gas-project on the east coast tied to oil prices, shareholders have a lot to feel good about.