Recent changes to the Blackmore Capital Australian Equity Portfolios - Buying Santos Ltd (STO)
We have added Santos to the portfolios as the sole exploration and production (E&P) energy exposure, after a period of some 10 months without a major direct energy holding. The addition is based on a medium- term view of energy prices, and as an inflation hedge. An improvement in the oil price outlook requires a gradual reduction in oil inventories and broad economic recoveries in the major oil consuming countries, albeit with the airline industry lagging the economic recovery, potentially significantly. Also, the effect of monetary policy to date has been to suppress real interest rates, which has increased the appeal of gold and supported asset prices. As the recovery takes hold there is a risk of inflation rising, which is already being factored into inflation adjusted bond pricing. Energy has a significant effect on CPI baskets, so it also serves as a hedge against this potential inflation. From a bottom up perspective, Santos is well positioned in its sector with a break-even cost of US$25/bbl, a development programme (Dorado, Barossa) that works at current oil prices and, judging by the last quarter, better LNG contract pricing (US$8.27/MMBtu realised) than its peers. Its balance sheet gearing (34%) shows the impact of the recent acquisitions from Conoco, but we expect this will reduce with a recovery in cash flow and asset sales. Energy companies have proven to be poor allocators of capital for an extended period as evidenced by the industry-wide asset impairments of the past quarter, however under current management, Santos has made sensible acquisitions while managing its cost base and balance sheet in a responsible manner relative to its peers.
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