Santos hits ~12-year high after paying out all its free cash flow in a show of board confidence

Santos' (STO) delivered a largely uneventful 1H26 result after pre-warning the market in July about problems at its Barossa and Pikka projects that delayed the ramp-up to higher production and weighed on first-half cash flow. 

However, with Barossa now near full rates and Pikka ramping towards plateau, the board declared an interim dividend, in line with expectations, that paid out effectively all of Santos's first-half operating free cash flow. 

"With the major development build and peak major project capex for Barossa and Pikka behind us, second-half production is expected to be around 20 to 30% higher than the first half, supporting stronger free cash flow and returns for shareholders," said Santos CEO Kevin Gallagher. 

The stock is currently up 2.7% to $8.34, the highest since October 2014.  

Santos 1H26 financials in focus

Santos delivered a result in line with the figures it flagged in July:

• Interim dividend: US11.6 cps, down 13.4% vs US13.4 cps a year ago — in line with US11.6 cps consensus, slightly ahead of MS's own US11.4 cps forecast. Total payout US$377m

• First-half production: 45.6 mmboe, up 3% year-on-year

• Sales revenue: US$2.6bn (US$2,620m), up 1.6% year-on-year

• EBITDAX: US$1.6bn (US$1,555m), down 11.5% year-on-year

• Reported NPAT: US$355m, down 19.1% year-on-year

• Underlying profit: US$397m, down 21.9% year-on-year

• Free cash flow from operations: US$378m, down 65% year-on-year

• Gearing: 28.1% (23.2% excluding operating leases)

Santos reported a first-half net profit of US$355 million, down 19% year on year, with underlying profit down 22% to US$397 million, partly on a change to how it calculates depletion. Sales revenue edged up 1.6% to US$2.62 billion on stronger oil and condensate pricing, while EBITDAX fell 12% to US$1.56 billion as Barossa and Darwin LNG started up and Santos bought in third-party cargoes during commissioning.

Free cash flow from operations dropped 65% to US$378 million. On an all-in basis, after growth spending, it swung to negative US$119 million from a positive US$256 million a year earlier. Santos put that down to commissioning costs at Barossa and Pikka, the timing of cargoes shipped either side of 30 June, and a Papua New Guinea under-lift, all of which it expects to reverse in the second half. Gearing stood at 28.1%, or 23.2% excluding leases.

Second half to be better

After Santos's second-quarter update in July, analysts were largely willing to look through the soft half, reading the commissioning setbacks as timing rather than damage to the assets. Jarden saw the problems as largely resolved heading into the second half, while RBC Capital Markets and CLSA both characterised the quarterly miss as timing related rather than structural. UBS went further, calling the update a material de-risking of the business ahead of the result. 

Alongside the ramp up in production, the second half will see stronger LNG pricing feed through to earnings. Most of Santos's LNG is sold on a three-month lag, with management noting: “the benefit of that stronger pricing will flow into realised pricing in the second half", with JCC (Japan Crude Cocktail) now trading above US$100 a barrel.

"For every $10 Brent trades above our breakeven, free cash flow increases from around $400 million today to between $550 million to $600 million once Barossa and Pikka reach plateau, an increase of around 50%," noted CFO Lachlan Harris. 

The bottom line: By paying out effectively all of its first-half operating cash as a dividend, in a half where all-in free cash flow was negative, the board backed its own view that the heavy spend on Barossa and Pikka is done and the company is now entering what analysts like to call the ‘harvesting’ phase. The market appears willing to take the same view, with Santos breaking out trading stubbornly below the $8 mark for the past six months. The test now is delivery, with Pikka reaching plateau late in the third quarter, Barossa holding steady, and the stronger second-quarter oil pricing arriving in LNG revenue as the lag unwinds.