Santos Ltd (ASX: STO) shares could be worthless, despite trading at $4.50 currently and valuing the company at around $8 billion.
In early 2015, investment bank Credit Suisse posed the same question using hypothetical oil prices at US$55.20 a barrel and an Australian dollar buying US 80.6 cents. That essentially means an Australian dollar oil price of $68.49 a barrel. The analysts found that each Santos share was actually worth minus 13 cents.
The current oil price is US$49.37 a barrel and the Aussie dollar is buying 75.7 US cents – equating to an Australian dollar price for oil of $65.22 a barrel – below the assumptions used by Credit Suisse in early 2015.
What the analysts also pointed out was that should oil prices stay this low for a number of years, then credit rating agencies could be forced to slash the credit ratings on Santos' debt – which stood at US$4.7 billion (net debt) at the end of June 2016.
Santos recently reported an underlying loss of US$5 million – despite sales of US$1.2 billion – in the first half of 2016. The oil and gas producer also announced a US$1.5 billion pre-tax writedown on their Gladstone LNG plant.
Santos wasn't the only one writing down its assets with AGL Energy Limited (ASX: AGL), AWE Ltd (ASX: AWE) and Origin Energy Limited (ASX: ORG) all writing down the value of their oil and gas assets.
Santos also reported US$291 million of operating cash flow, but then spent US$58 million on exploration and evaluation assets and a further US$314 million on oil and gas assets. That was only offset by the US$411 million of proceeds from asset sales – without which Santos would have needed to raise capital or borrow – clearly something no company can keep doing if it wants to stay in business.
The problem Santos faces is that it expects to spend a total of US$750 million this financial year on capital expenditure. The company expects to be free cash flow breakeven with oil prices at US$43.50 a barrel – but that doesn't mean it will be profitable – and the company could be forced to take further writedowns on its oil and gas assets if oil prices slide further.
The company also appears to be taking a wildly optimistic view of crude oil prices in the year ahead – as the table below shows.
| Year | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 |
| Oil price (US$/bbl) | 40 | 60 | 70 | 80.77 | 82.79 | 84.86 |
| Exchange rate | 0.7 | 0.7 | 0.75 | 0.75 | 0.75 | 0.75 |
Source: Santos half year report
Foolish takeaway
Ok, it's probably unlikely that Santos' shares are worthless, but it also seems highly likely that the company is not worth $8 billion. Buyer beware.
