Santos shares hit new lows in October. What next?

There's an interesting risk/reward calculus at play.

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Santos Ltd (ASX: STO) shares hit fresh lows in October, sparking curiosity about the road ahead for one of Australia's largest energy producers.

Shares in the oil and gas giant plunged to 52-week lows of $6.78 apiece on the last day of October, well off August highs of more than $8.00.

The stock currently trades at $6.82, down nearly 7% in the past month.

What's next for Santos shareholders? Let's see what the experts think.

Created with Highcharts 11.4.3Santos PriceZoom1M3M6MYTD1Y5Y10YALL1 Nov 20236 Nov 2024Zoom ▾Nov '23Jan '24Mar '24May '24Jul '24Sep '24Nov '24Jan '24Jan '24Apr '24Apr '24Jul '24Jul '24Oct '24Oct '24www.fool.com.au

Santos shares hit new lows

Santos shares have been under pressure throughout 2024, affected by fluctuating oil prices and investor concerns around the energy sector.

The stock's performance also reflects the broader rotation away from ASX resources stocks, with energy shares bearing the brunt as oil prices remain volatile.

According to Trading Economics, economic factors, including weak demand from China, have hit oil prices this year. Supply factors are also currently in play:

Meanwhile API data showed that US crude oil inventories rose by 3.1 million barrels last week, exceeding the expected 1.8 million-barrel build. 

Santos is a price taker on oil and gas. It doesn't set prices for the products it sells. The market does this, and in commodities, supply and demand principally determine prices.

And just about anything can influence supply and demand. Weather. Interest rates. Geopolitics. You name it.

So when oil (and natural gas, for that matter) is down, you can reasonably expect Santos shares to follow suit.

Potential upside for Santos shares

Despite the downsides, brokers see potential in Santos' strategic projects that could unlock shareholder value in the coming years.

The team at Ord Minnett remains optimistic about Santos, attributing this to its robust free cash flow (FCF) outlook supported by key LNG projects.

It has set an $8.40 price target on Santos shares, reflecting a potential upside from current levels.

The broker's optimism stems from Santos' recent mid-term LNG deal with TotalEnergies, which includes the supply of 20 LNG cargoes beginning in late 2025.

This contract reinforces Santos' long-term revenue base, with approximately 80% of its sales volumes linked to oil prices.

Santos' Pikka and Barossa LNG operations are also expected to generate cash once production ramps up.

Ord Minnett says this gives the company options to return excess capital to shareholders through dividends or share buybacks. The broker projects a 20% FCF yield post-launch.

Valuation multiples: Room to grow

At its current price-to-earnings (P/E) ratio of around 12 times, Santos shares have room to climb if the company meets its earnings targets.

CommSec forecasts an earnings per share (EPS) of 75 cents for FY25.

Applying the current 12x multiple, Santos could potentially reach $9 per share (12 x $0.75), assuming favourable market conditions.

But remember – this valuation hinges on steady oil prices and consistent production from its LNG projects.

It is also what investors expect from the company. Should these expectations change, there's good reason to see the multiple change, too, which could impact Santos shares.

Foolish takeaway

While Santos shares have recently experienced lows, brokers see potential for growth backed by strategic projects and strong free cash flow projections.

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Motley Fool contributor Zach Bristow has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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