Opinion / 29 April 2019, 4:00pm / amelia.morgenroodt
JOHANNESBURG – In general, South African companies did not have much success outside of the country in recent years and therefore investors adopted a wait-and-see attitude regarding Sasol.
The share price has been moving sideways in a broad band between R360 and R500, coming nowhere near its historic high above R600 in 2014.
The very ambitious Lake Charles Chemicals Project (LCCP) was tackled in 2014, at an expected cost of $8.9bn to be in operation by 2018.
LCCP consists of a world-scale 1.5 million ton per year ethane cracker and six downstream chemical units adjacent to Sasol’s existing chemical operations near Lake Charles, Louisiana.
Cost overruns and delays have, however, plagued the project. In February Sasol announced the first production unit was starting up and once again revised total expected cost upwards to between $11.6 billion (R166.37bn) and $11.8bn.
The cracker is expected to achieve profitable operations by July 2019, with 80 percent of LCCP capacity being operational by August 2019. This is expected to add $700 million to their earnings in 2020, and after that, it is likely to add between $1.2bn and $1.3bn per annum to Sasol’s earnings.
Due to LCCP, the current gearing is 48 percent and management is actively managing debt to ensure Sasol maintains an investment grade rating.
If the full LCCP cash flow for the 2019 financial year (R30bn) is allocated to debt, the net debt to equity ratio will decrease to 32 percent, and this would indicate the balance sheet could quickly deleverage, once LCCP is complete.
The group’s historically strong return on equity (ROE) has come under pressure. However, this balance sheet strain is expected to be alleviated within two years. This should aid a recovery of the ROE, which would align it to historical levels. A stronger balance sheet should also provide confidence that dividends can be sustained.
Sasol’s results remain influenced by several external factors (not under management’s control), which have a significant impact on its profitability, such as oil price and exchange rate movements. However, management has been able to influence costs and improve efficiencies during periods where operating conditions were unfavourable.
The investment proposition remains mostly hinged on the success of the LCCP project. Oil prices are expected to stay between $62 and $71 per barrel over the next year, which will aid Sasol’s profit and cash flow generation while the company has hedged the downside risk.
Sasol’s share price is closely aligned to the rand/$ exchange rate and the Brent crude oil price. Management has guided that a 10c change in the $/rand currency price would impact earnings by approximately R790m while a $1 per barrel change in the Brent crude price would impact earnings by about R860m. Both of these metrics exclude the effect of hedging programmes.
Due to these sensitivities, Sasol has entered into hedging arrangements; these provide downside protection against the depreciation of the currency pair or a decrease in the oil price.
The US is expected to become a more dominant player in the supply of oil and could contribute up to half of the industry growth, driven by shale oil production. The US can take China’s market share from Iran, pending a resolution in the tariff dispute between the two countries.
Amelia Morgenrood is a PSG Wealth financial adviser based in Pretoria. Views are of the author and not necessarily the general view of the entire PSG entity. Sasol shares are held on behalf of clients.