The Santos Ltd (ASX: STO) share price is up 31% for the year and could be considered a buy at current levels, based on earnings and dividends.
Background on Santos
Santos is an oil and gas producer that also conducts exploration. The company has assets in Australia, Indonesia and Vietnam. Santos has a market capitalisation of $14.4 billion, making it the second biggest independent producer of oil and gas in Australia. The company supplies oil and gas to the Australian and Asian markets with exploration activities that focus on reliable existing resources.
The investment case
Based on valuation ratios, Santos is cheap and could make a good addition to a diversified portfolio. Currently sitting on a price-to-earnings (P/E) multiple of 16.4x, the company is valued below the S&P/ASX 200 (INDEXASX: XJO) index, which has a P/E ratio of 18.1x at the time of writing.
Additionally, Santos has a history of paying healthy dividends, with a dividend payout ratio normally above 50% of earnings in profitable years over the last decade. This should mean that we can expect a boost to the current Santos grossed-up dividend yield of 2.8% as the company continues to improve its profitability. Indeed, at the Santos Ltd AGM address in May, management reaffirmed its intention to continue restoring dividends.
Santos was affected by lower energy prices in recent years; however, this appears to be behind it and in 2018 net profit rebounded with the company posting record earnings per share of US30.2 cents (AU43 cents). This came after international bodies reached an agreement to restrict the global supply of oil, leading to a recovery in oil prices.
With a net profit margin of 17% last year, Santos is maintaining earnings well above paying expenses, which management has promised will be reduced in future years. The company also had free cash flow of US48 cents (AU69 cents) per share in 2018, suggesting that the real earnings being generated may be much higher than those indicated by accounting earnings. When we take US$667 million (AU$953 million) of annual depreciation out of the picture, Santos is far more profitable than it appears. This depreciation should not affect new shareholders as the company has several exploration assets coming online that can provide new sources of revenue. Last year its proven and probable reserves increased by 20%, and more recent news has also been positive, with oil and gas assets providing good appraisals. This news has been met with positive reactions from the market and analysts, supporting a higher share price.
Santos made a significant acquisition last year, purchasing Quadrant Energy, which is providing additional growth. The company holds US$4.4 billion (AU$6.3 billion) of debt according to its company update in March. While this debt level was reduced compared to previous reporting periods, it could still pose a risk if energy prices retreat. However, with a price-to-book ratio of 1.40 at the time of writing, the current Santos share price offers great value to compensate for these risks.
Foolish takeaway
Looking at the above valuation metrics provides a strong case for buying at the current Santos Ltd share price. Given the company's history of paying healthy dividends along with solid earnings, cash flow and positive news in recent times, I think investors can benefit from including Santos in their portfolios.
