Better exercise caution with Sasol
An investment in Sasol demands views on two notoriously volatile variables: the dollar oil price and the rand-dollar exchange rate
Underpinned by a resurgent crude oil price, Sasol’s share price has rebounded by a third over the past 12 months. Signalling that it expects more of the same to come, the market is rating Sasol on a 17 p:e.
This speaks of optimism for a company that traded on an average p:e of just 12 over the past five years and that is set to report a 1%-11% fall in core headline earnings in its year to June.
But it would not be the first time investor optimism towards Sasol has been misplaced.
An investment in Sasol demands views on two notoriously volatile variables: the dollar oil price and the rand-dollar exchange rate. Adding to the challenge is the need to take a view on the potential of Sasol’s $11.13bn debt-funded Lake Charles Chemicals Project (LCCP), now nearing completion.
The oil price has led forecasters on a bewildering quest over the past four years, the price of Brent crude having peaked amid widespread optimism at $115 a barrel in June 2014 before diving to $27/bbl just 18 months later.
Sasol has made major moves to diversify into the production of chemicals. In its half-year to December, these accounted for 47% (R6.38bn) of group operating profit, against R5.53bn (40%) from its synthetic liquid fuels operations. Despite this, the oil price remains critical for the company, which emphasises the strong correlation between the crude oil price and chemical prices.
The crude oil price has been going Sasol’s way, with a rebound since early 2016 taking it to its current $74/bbl. But the going may not be as positive from here on out.
The world’s biggest oil producer grouping, Opec, does not put a figure on its oil price outlook, but notes in its latest market review: "Considerable uncertainty as to world oil demand and non-Opec supply prevails."
The US Energy Information Administration (EIA) does put figures to its outlook — though these are not entirely what oil price bulls would like to hear. In its July market outlook, the EIA predicts that the Brent spot price will average $73/bbl in the second half of 2018.
The oil price is supported by a well-balanced supply and demand situation. But the EIA predicts that world oil production in 2019 will exceed demand for the first time since late 2016. This will depress the annual average price to just below $69/bbl.
The primary cause of the oversupply, notes the EIA, is rising US shale oil production, which will lift the country’s total daily production from 10.8 million barrels in 2018 to 11.8 million barrels in 2019.
For Sasol, the oil price in rand counts as much as the dollar oil price. The rand did not play ball entirely for the company in its year to June. While Brent crude averaged $63.62/bbl — a rise of 28% on the previous year — the rand strengthened 6% against the dollar, from R13.61 to R12.85.
In a positive for Sasol, the exchange rate is now about R13.20. But predicting what it will average in the company’s year to June 2019 amounts, at best, to informed guesswork.
The third wild card to consider is Sasol’s LCCP, located near the city of Lake Charles in the US state of Louisiana. In October 2014 the project was budgeted to cost $8.9bn. But poor execution — by Sasol’s own admission — has added $2.2bn to the cost.
The LCCP complex is centred on an ethane cracker that will pump out ethylene at a rate of 1.5Mt a year. Six downstream ethylene-based chemical production facilities are also included in the project. Now 88% complete, LCCP has entered its start-up phase. Its first production is due before year-end, with the balance to be phased in during 2019.
LCCP has the potential to be a "huge contributor" to Sasol, says Andrew Lapping of Allan Gray, one of Sasol’s biggest shareholders.
But it won’t happen overnight. Says Denker Capital’s Ricco Friedrich: "I believe it will take up to four years to fully ramp up LCCP."
What will kick in as soon as LCCP goes into production is interest on a mountain of debt. Until now interest has been capitalised — R1.63bn of it in the first half of the past financial year alone. With start-up, depreciation on a grand scale will also kick in.
The timing of LCCP’s start-up also leaves much to be desired. Also in start-up phase are ExxonMobil’s 1.5Mt a year ethane cracker complex near Houston, Texas, and Thai group Indorama Ventures’ 440,000t a year ethane cracker complex near Lake Charles.
It will be a lot of new ethane for the market to absorb, with total supply set to rise 35% by the end of 2019. This is putting pressure on the US ethane cracker margin, which fell to US2.65c/lb in July, according to S&P Global Platts — the lowest level since 2011. Just 12 months ago the margin was US12.68c/lb.
Sasol may, as the market suggests, be a great buy. But investors should continue to be wary.