Picture: ISTOCK
Picture: ISTOCK

Getting a grip on Sasol’s investment case seems to require a balancing act worthy of Solomon. You have to weigh up the US dollar oil price and the rand/dollar exchange rate, and then make a call on its controversial US$11bn Lake Charles Chemicals Project in the US.

Sasol’s results for the year to June are a perfect example. In dollars, the oil price moved in Sasol’s favour, with the average Brent crude oil price rising 15% to $49.77/bbl. But the strengthening rand meant the rand oil price fell 15%, from R707/bbl in 2016 to R598/bbl by July 2017.

This means Sasol’s headline earnings will fall between 11% and 22%. Even at the bottom of this range, it would mean earnings have tumbled nearly 40% over the past three years.

It’s a grim trajectory, especially as it comes while Sasol is building its hugely ambitious Lake Charles development in the US state of Louisiana.

By any standards, the project is immense: it is centred on an ethane cracker that will pump out ethylene at a rate of 1.5Mt/year. Also included in the project are six downstream ethylene-based chemical production facilities.

But views on the project vary wildly, from it being an expensive white elephant to a move of strategic genius on the part of Sasol’s board.

Overall, Sasol has six "buys", five "holds" and two "sells" from analysts. On average, they expect the share price to rise to about
R412 over the next year — nearly 5% above its current level.

"From a risk-reward perspective, we like the project from here," says Allan Gray analyst Rory Kutisker-Jacobson.

Momentum SP Reid Securities’ Percy Takunda also believes "the current valuation of Sasol does not attribute accretive earnings from Lake Charles and the improved efficiencies from the SA business".

JPMorgan analysts say the trading update was exactly as the market expected. "The Lake Charles Project was also bang in line with expectations, [with] $7.4bn spent [and the project] 74% completed," they say.

JPMorgan is one of the more ambivalent brokerages. It says: "While we believe there is meaningful long-term upside potential, we also believe there are near-term risks" — such as the oil price.

But there are perhaps far more cynics out there right now. Liston Meintjes of NVest Securities says: "You can’t quantify the project’s risks. I would definitely not be a buyer of Sasol."

Meintjes, like many other market experts, will have been rattled by the series of disasters at Lake Charles since its start in October 2014.

For starters, there’s a $2.1bn (26%) cost overrun on the budgeted $8.9bn. Then there’s the fact that the project’s start date has been pushed back from mid-2017 to the second half of 2018. Final completion, initially expected in 2018, is now likely towards the end of 2019.

And debt keeps mounting. Next year, it is expected to peak at 44% of equity. For now interest is being capitalised — R1.3bn of it in the first half of the past financial year alone.

That capitalisation will end when Lake Charles is commissioned, when depreciation on a grand scale will also kick in.

"The project will not be earnings accretive any time soon," says Evan Walker of 36One Asset Management. "I can see no real investment case to own Sasol."

The consensus view seems to be that Sasol’s earnings will continue to drop over the next two years. Over that time, anything could happen.

At least Sasol has acted to reduce its risk. It has put in place a currency hedging programme to provide cover on $4bn (70%) of its exposure to rand/dollar movements between R13.46/$ and R15.51/$. The consensus of 35 currency analysts polled by Reuters in July calls for the rand to end 2017 in Sasol’s range at R13.60/$.

But Sasol has not hedged the dollar oil price. It’s a big risk, considering a $1 change in the oil price per barrel translates into a R730m (about 2.5%) change in its pretax earnings.

Right now the position of oil bulls is looking decidedly uncomfortable. In its July market review, the International Energy Agency says that "few [oil] investors expect a recovery any time soon".

The situation is very different to that at the start of the year, when hopes were high that the excess oil supply situation would soon be over. This was because the Organisation of the Petroleum Exporting Countries, Russia and Oman had signed a deal to slash their combined production by 1.8mbarrels/day.

Things didn’t work out as planned, and compliance with that agreement is on the skids.

The situation is aggravated by sharply rising oil output in the US, the world’s largest oil producer. In July, for the fifth consecutive month, shale oil output rose by more than 100,000b/d, while total US oil production increased by 900,000b/d (11.5%) in the 10 months to July.

That’s a lot of extra oil for an oversupplied market to absorb — which is why Goldman Sachs warns that the oil price could tumble below $40/bbl if US output continues to rise.

thomass@fm.co.za

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