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Santos Ltd (ASX: STO), a leading independent oil and gas producer in the Asia Pacific region, is gaining attention as a potential opportunity for investors, according to fund manager L1 Capital. L1 Capital's assessment of the energy market and Santos shares highlights factors that suggest the company's shares may be significantly undervalued.
Positive Energy Market Outlook
L1 Capital's portfolio is centered on businesses with lower price-to-earnings (P/E) ratios, strong earnings growth potential, and substantial cash flow generation. The fund manager's analysis indicates that the ASX oil and gas stocks outlook is more promising than market expectations.
Key factors driving this positive outlook include growing energy demand, underinvestment in new sources of supply, and increased merger and acquisition activity within the energy sector. L1 Capital believes these factors bode well for Santos shares.
The fund manager points out that Chinese aviation activity is on the rise, driven by Asian demand, and notes the strategic petroleum reserve (SPR) has been depleted and is now being replenished.
Bearish Sentiment in the Energy Sector
L1 Capital highlights that investor positioning and sentiment toward the energy sector are currently bearish, reaching a level of negativity comparable to mid-2020. During that period, extreme COVID-related fears led to reduced travel and oil price volatility, including briefly negative oil prices.
The fund manager points out that US hedge funds are notably underinvested in the energy sector despite the West Texas Intermediate (WTI) oil price exceeding US$80 per barrel. Factors such as Middle East conflicts, a favorable supply-demand outlook, and historically low oil inventories contribute to the opportunity for growth in the energy sector.
Why Santos Shares Are Attractive
L1 Capital identifies Santos shares as "extremely undervalued" despite their strong growth prospects and significant capital investments. The fund manager recently proposed a demerger of Santos' domestic oil and gas assets, focusing on leaving the company as a pure-play LNG enterprise.
L1 Capital's analysis suggests that the Santos share price could potentially see at least a 40% upside based on a conservative sum-of-the-parts valuation. Furthermore, the fund manager anticipates additional upside driven by the tightening energy market.
L1 Capital notes that Santos could be an attractive acquisition target due to its strategically valuable assets, with 80% of its asset value comprising low-cost, long-life LNG assets.
Santos Share Price Valuation
Santos shares were trading at an enterprise value-to-earnings before interest, tax, depreciation, and amortization (EBITDA) ratio of 4.2 times in October, as per L1 Capital's analysis. This valuation is notably lower than other energy businesses with less favorable growth outlooks. While Santos is projected to witness a 22% EBITDA growth between 2024 and 2027, other energy companies like Woodside Energy Group Ltd, Exxon Mobil, and Chevron are expected to experience EBITDA declines during the same period.
Conclusion
L1 Capital's assessment of Santos shares as an undervalued opportunity in the energy sector highlights the potential for significant upside and acquisition attractiveness. As the energy market evolves, Santos appears to be well-positioned for growth and offers an appealing investment option for those who recognize its potential value.
