Sasol’s share price is still stuck at its lowest levels in nearly 13 years. This follows the sharp drop when it warned shareholders in a January 31 trading update that earnings for the six months to December 2019 might be as much as 78% lower than in the first half of the previous financial year.
The warning, the latest in a string of bad news over the past few months, saw the share price fall to a low of R229 within minutes of its release.
This, together with the fact that nearly R1 billion worth of shares changed hands that day, indicates that the news probably came as a shock to shareholders.
The current price of R234 per share values the whole of the international chemical group at only R150 billion, compared with its asset value of R226 billion according to the balance sheet at the end of the June 2019 financial year.
Interestingly, the listed Sasol BEE share, trading as Solbe1 on the JSE, has been trading at a premium to the ordinary Sasol share since the middle of last year.
Sasol issued a warning towards the end of November that earnings and earnings per share (EPS) for the six months under review would be at least 20% lower than in the corresponding period, and this might have created the impression that earnings would be around 20% lower. However, the 20% mentioned then referred solely to the JSE rule that requires a company to issue a trading statement as soon as it has fair indication that earnings will be at least 20% lower (or higher).
Sasol then promised to publish an update later, which warned that earnings would decline to between R5.37 and R7.76 per share in the first six months of the 2020 financial year. The first half of 2019 produced EPS of R23.92.
This is bound to disappoint investors. A poll of 11 analysts on the CNN Business database forecast earnings of around $2 for the full financial year and international financial network MarketScreener shows a consensus earnings forecast of more than R27 per share for the full year. It seems improbable that earnings will come close.
For investors, the major problem is still the huge Lake Charles Chemical Project (LCCP) in the US. The project was introduced as a game-changer for Sasol, positioning it as a huge player in the chemical markets with an earnings stream of several billion dollars per annum.
However, the project took much longer to complete and cost much more than planned.
News of an explosion at LCCP a few weeks ago added to Sasol’s and shareholders’ woes.
Dramatic changes to fix Sasol
Behind the latest cost blowout at Sasol’s ‘too big to fail’ Lake Charles project
Explosion at Sasol’s Lake Charles
Sasol’s trading statement stated that shareholders can expect a satisfactory set of operational results for the six months to December 2019. Management said it would report good figures regarding production volumes, costs and the level of working capital.
Unfortunately, financial results have been impacted by a weak economy which resulted in lower margins and operating profit.
Sasol management also indicated earlier that the company would have to start accounting for all costs and interest related to LCCP as it starts production.
Companies usually capitalise operating costs and interest during the construction phase of large projects.
The accounting of operational costs of LCCP start now, as the units are entering what Sasol terms beneficial operations. In addition, income lags behind costs as production increases slowly and Sasol aims to build up inventories.
“As the LCCP units progress through the beneficial operation schedule, the costs associated with the relevant units are expensed while the gross margin contribution follows the planned ramp-up profile and inventory build,” says the statement.
“Earnings are impacted by approximately R1.7 billion in additional charges and approximately R2 billion in finance charges in the half year to December as the LCCP units reach beneficial operation.”
Sasol also warned that the contribution to earnings before interest, tax and depreciation from the Lake Charles project will be lower in 2020 than expected, mostly due to the damage caused by the explosion and fire at the low-density polyethylene (LDPE) plant, one of the six downstream units using the products from the project’s main chemical cracker.
The explosion at the new plant came at a very unfortunate time – just when it looked like Sasol was on the brink of winning back investor confidence with the final completion of LCCP. Sasol announced that the project was basically complete at the end of 2019.
“At the end of December 2019, engineering and procurement activities were substantially complete and construction progress was at 98%,” according to the announcement issued subsequent to an initial investigation of the accident. The initial findings indicated that damage was limited to a small portion of one of the project’s units.
“Importantly, major equipment such as the compressors, were unaffected. Parallel commissioning activities on the remainder of the LDPE unit will continue,” Sasol advised.
The ethylene cracker at the LCCP is expected to produce 1.5 million tons of ethylene per annum with the six downstream units utilising the ethylene to manufacture different chemicals and plastics, one of which is LDPE (a low density plastic used to manufacture all kinds of bottles, plastic bags, and plastic parts and components for use in various products).
Meanwhile, Sasol will sell the ethylene produced by the upstream processes destined for the LDPE plant to external customers. It says the impact on earnings from the whole of the LCCP complex will be limited to the loss of the margin of converting ethylene to LDPE, reflecting the profit to be earned from manufacturing LDPE from ethylene.
Shareholders are bound to hope and pray that the accident at one of the LDPE units is the last hurdle before the LCCP unit begins producing serious money, which will eventually answer the question of whether the project will deliver the returns envisaged in 2014 when the decision was taken to invest the billions to propel Sasol into a higher league.
The big question
Moneyweb put the obvious questions that investors are concerned about to Sasol, first questioning the investment decision in 2014 – given the perfect vision of hindsight.
“Despite the revised cost and schedule, Sasol still considers the LCCP to be a sound strategic investment that is of significant importance to Sasol’s future growth and will generate value for our shareholders for many years in the future,” says Matebello Motloung, group media relations manager.
Sasol still believes the LCCP will further strengthen its position as a global player in the chemicals market, as it will produce both base and performance chemicals.
Despite taking on huge debt and the risk of embarking on such a big project, Sasol maintains that it will reduce the company’s risk profile by diversifying income streams. The LCCP represents more than a third of Sasol’s assets and is set to triple its chemical production capacity in the US.
A bigger footprint in the growing chemicals market will have profound financial benefits for the group, according to Motloung.
Shareholders will be eager to see if these benefits are starting to appear now that the project is basically up and running, except for the latest setback that is said to affect only a small part of the project.
Sasol also said that expensive parts of the unit, such as compressors, were not damaged. Motloung added that Sasol is insured against such accidents.
Over the medium term, Sasol still believes the LCCP will contribute between $1 billion and $1,3 billion to earnings before interest tax and depreciation within the next few years and will be able to reduce the debt burden to more manageable levels.
The difference in Sasol’s share price of R234 and BEE Sasol – trading at R250 per share – is bound to attract attention. The Sasol ordinary share usually trades at a premium to the Solbe1, mostly due to what brokers refer to as a liquidity discount.
The biggest difference between the ordinary share and the ordinary BEE share is that Solbe1 trades on the empowerment sector of the JSE and only black people as defined by the black economic empowerment codes can buy the shares. With fewer buyers, the share price lagged Sasol when shareholders pushed the price higher on high demand.
The opposite proved to be true as well. When the share price declined sharply, the lack of liquidity did not reflect the general sentiment in the market.
The same happens in the case of smaller companies or companies with a relatively small free float available to the investing public outside of large majority shareholders.
Nevertheless, BEE shareholders also shared in the pain of a share price falling by 50% over the last few years, and are surely as eager as other shareholders to see recovery.