It’s no secret that things have been challenging at Sasol, but no one could have predicted the utter collapse that has happened in the past three weeks, effectively wiping off billions of value and resulting in 15-year plus share price lows.
The question is, what led to the company getting to this point – and is there any chance of recovery?
Sasol is an integrated energy and chemical company that has operations around the globe and is based in Sandton, South Africa.
The company was formed in 1950 in Sasolburg in the Free State. It was built on processes first developed by German chemists and engineers in the early 1900s.
A partially state-owned entity (SOE) for most of the previous century, it was one of the apartheid government’s greatest triumphs. It is listed on the JSE and on the New York Stock Exchange in the US.
Operating business units comprise mining and exploration, and production of oil and gas activities, focused on feedstock supply.
How did we get here?
Several reasons and events have contributed to the collapse of the Sasol share price. Some have been outside the control of management, while others have been fully within its control.
- Macroeconomic factors
Two major global events of the past few weeks have had a direct impact on Sasol and could not have been forecast. Firstly, the Covid-19 pandemic has resulted in a near shutdown of economic activity. Secondly, Saudi Arabia’s decision to flood the market with supply has resulted in a collapse of the price of Brent crude oil under $30 per barrel.
Sasol’s own expectation of the price of Brent crude, as per its latest results announcement, was $50-$70 per barrel, hence the company didn’t enter any hedges to protect it from the impact of a price drop. The downturn in price therefore had an immediate impact on the share price.
- Lake Charles
In 2014, Sasol embarked on a multi-billion dollar project in Louisiana in the US. The Lake Charles Chemical Project (LCCP) was envisioned to lead the company into the future, by diversifying its earnings away from energy and into chemicals.
The rationale was that prices for chemicals are not as volatile as they are for crude oil, and that the cash generation capacity of the facility would enable the company to absorb the initial capital invested quite easily.
Unfortunately, things haven’t turned out as planned. The project was expected to cost $8.9 billion and be online in 2019 at the latest. The cost has now escalated to $13 billion, and the project has been riddled with delays, costs overruns, and mechanical failures. Earlier this year, there was a fire at the facility, and even though there were no fatalities it did raise some questions about it.
Furthermore, the world has changed since the initial project valuation was completed.
The chemicals sector is in a downcycle due to two main structural shifts in the industry: the increased supply of commodity chemicals due to the start up of new Chinese chemical complexes, and the downturn in demand as a result of trade tensions between the US and China.
Sasol management stated in the interim results presentation that the expectation was for the downturn to last for about 18 to 24 months.
Note that this was before Covid-19. The impact of the virus is such that the initial estimates may be extended for a period longer than two years, which further devalues the expected cash flows from the project now that it is finally in the commissioning face.
- Balance sheet
On March 3, Sasol announced that it had received its credit reviews from global rating agencies S&P and Moody’s based on the company’s 2020 interim results.
The outcome: S&P affirmed Sasol’s BBB-/A-3 credit rating, while Moody’s downgraded Sasol’s credit rating to Ba1/NP.
This announcement was concerning to the market, as the company had $1 billion worth of debt due by May 2020 (note there was a provision that enabled the company to roll forward the commitment to May 2021), and a total debt balance exceeding $12 billion. Add to all of this a declining profit and/or earnings base.
In terms of what was noted, and some of the things that weren’t mentioned in the Sens release, investors might want to consider the following additional information:
The Republic of Mozambique Pipeline Investments Company (Rompco) is a joint venture between Sasol, Companhia Mocambiçana de Gasoduto SA, and the South African Gas Development Company (iGas) that was formed in 2004.
If one looks at the past interim results, in December the venture achieved R14 billion worth of earnings before interest and taxes (Ebit), representing 5% of the company’s overall Ebit. Although this seems small in the universe of Sasol, the venture does collectively contribute R150 billion to GDP for SA and Mozambique.
However, in 2019, Sasol announced that it could from 2023 no longer guarantee gas supply to its customers.
Sasol was identified as one of the largest polluters, with its facility in Secunda identified as the world’s biggest single-site emitter. The company committed to comply with legal emissions limits by 2025. In light of its capital expenditure rationalisation and the fact that a plan has not yet been published on how to address the emissions issue, there needs to be consideration in terms of how this will unfold in the coming years and whether Sasol will be able to honour its commitment.
In 2018, when Sasol unwound its broad-based black economic empowerment (B-BBEE) transaction Inzalo and introduced its new scheme, the evergreen Sasol Khanyisa scheme – which include Sasol BEE shares that trade on the empowerment segment of the JSE – the expectation from the broad-based shareholders was for an uplift in value. Based on the past few week’s movements, that is unlikely to happen. Furthermore, considering that there is an upcoming rights issue on the table, the question becomes whether Sasol BEE shareholders will be willing to follow on their rights and, if not, what will happen to their equity holding, which has eroded well over 90% in value.
The way forward
In response to the negative sentiment, and to calm investors and borrowers alike, management issued a range of interventions intended to stabilise the company going forward to ensure its survival.
- Asset disposal
As per its interim results announcement, Sasol announced that it would be looking to dispose of certain non-core assets. Due to the current climate, it was reiterated that the asset disposal process would be accelerated and that the expected proceeds from the corporate action would yield $2 billion, which would be applied to reducing the gearing levels.
The big question on the lips of almost every analyst is which specific assets are on the chopping block, and for what value.
In terms of the business units, there are certain assets that can be deemed non-core, but if one looks at the environment and the sheer desperation in timing to conclude the sales, the assets are more likely not to be sold at fair value, but at a price far lower. The rushed timing would bring out all the vultures, globally.
Management has proposed entering a hedging strategy to manage liquidity, specifically with regards to the price of Brent crude. In its Sens announcement, Sasol stated that the benefits of the hedging would only be felt at a price of $25. The question that eluded analysts and investors alike, was why this wasn’t the case prior to the oil price crash. Furthermore, when would the benefits of hedging be reflective in the revenue earned by Sasol?
- Strategic partner
The company stated that it would consider partnership options for its base chemicals business in the US; the assumption would be that this would include LCCP. In hindsight, this decision should have been taken earlier. Also, from a valuation perspective, the company has incurred costs well over $13 billion, and a partner would need to be substantial. And what would they bring to the table, from a project risk perspective? Barring any more technical delays, the LCCP should be producing and starting to generate positive cash flows soon.
- Rights issue
The company has hinted at a possible rights issue of $2 billion. Some analysts have indicated that if it were to go through it would be the single biggest capital call in JSE history. Notwithstanding that a requirement for the capital raise would be that the asset disposals and certain cost-cutting measures take place.
One needs to ask how willing shareholders must be to support the rights offer at the current moment, considering that the share is trading under R30 and that any offer to shareholders would need to be discounted.
What this effectively means is that the share price might decline even further than these historic lows. Thus shareholders wanting to support the rights offer would need to take a very long-term view.
This is especially true for SOE-related shareholders such as the Public Investment Corporation and Industrial Development Corporation, which together hold 20% of the issued share capital. They would need to ask themselves if there is a better application of capital in other investments in the country.
The road to recovery will be very long, and the current operating model of Sasol needs to change. It is evident that CEO Fleetwood Grobler has a mighty task on his hands.