What now for Woodside and Santos?
Our view after Woodside and Santos walk away from merger talks.
Over two months since first confirming merger discussions were underway, Woodside (ASX: WDS) and Santos (ASX: STO) are walking away with no agreement. The no-moat Australian oil and gas producers have provided little color, save for Woodside reiterating it only pursues transactions when value-accretive for shareholders. Excellent news.
No slouch, we can hazard a guess Santos’ Kevin Gallagher was demanding his pound of flesh. And with a lack of blockbuster cost or infrastructure synergies in the offing, the parties have called time. Santos somewhat cryptically assures shareholders that it continues to review options to unlock value. Also positive, if nonspecific.
Santos was the most under pressure in the lead-up to merger talks announced on Dec. 5, 2023. Shares had fallen 16% to $6.75 from October highs. Declining commodity prices were the chief cause, Brent falling to below $75 US per barrel from nearly $100 US. But as the perceived quarry in the potential merger, Santos gained the most, the shares retaking most of the lost ground to $7.90 by early this month. The market was betting Gallagher would exact a premium.
News of the talks ending, however, has precipitated an 8% intraday plunge for Santos. Woodside shares, on the other hand, rose less post-December 2023 lows, up 10% to $32.75 highs, and have logically suffered a lesser 2% decline since the merger’s demise.
The washup is that we are largely back to where we started. Woodside and Santos both currently trade around 7% above levels prevailing immediately prior to the announcement of merger talks. Both remain materially undervalued in relation to our respective $45 and $12.30 unchanged fair value estimates.
And at $7.30, Santos remains at the steeper 40% share price discount to Woodside’s about 30% at $32.00. Both hover near the cusp of 4- to 5-star territory, given Santos’ harsher High fair value uncertainty against our Medium rating for Woodside.
Comparing uncertainty ratings of Woodside and Santos
Our Morningstar Uncertainty Rating for Santos is High, with moderate debt levels in support of an 11.0% cost of equity. High enterprise risk reflects commodity price volatility.
To put the rating in perspective, we rate all Australian resource and energy exposures as being at least high-risk, including BHP Billiton, despite its greater commodity and geographical diversification, along with its increased scale advantages.
Santos faces environmental and operational risks, which are a given with the oil and gas industry, as well as country-specific risks associated with some of its non-Australian assets. It is also a comparatively small player in a world of oil and gas supermajors.
Our Morningstar Uncertainty Rating for Woodside is Medium. Commodity price volatility is a key risk in Woodside with a high proportion of fair value deriving from projects that are yet to be built.
To put this in perspective, all Australian resource and energy exposures have this risk. Relative to Australian peers, Woodside is a comparatively lower-risk Australian upstream energy exposure because of its low operating costs and moderate gearing within what is an above-average-risk industry.
Woodside faces environmental and operational risks, a given with the oil and gas industry, as well as community-specific risks associated with some of its assets. It is also a comparatively small player in a world of oil and gas super majors.