Sasol flourishes, capex booms – timely contrast with former State stablemate Eskom

Sasol's financial results matter. Not just to its direct shareholders, but with a market cap of R420bn, it is owned indirectly through the retirement funds of most South Africans.  Like Eskom, it was created by the State. Unlike Eskom, the oil-from-coal producer has been a roaring success. It was listed on the JSE more than three decades back and has been forced to live with the disciplines of being a member of the private sector. Last year Sasol invested almost R40bn in capex, 57% of that in South Africa. Its share price, profits and dividend payments are at record highs and it is expanding into other geographies, especially the USA. CEO David Constable talks of having his ship ready for 2050 and beyond. The contrast with Eskom is stark. A timeous reflection of what to expect from an organisation that has been privatized – and one that has not. – AH 

ALEC HOGG: Well, thanks for being with us here on CNBC Africa's Power Lunch. R420bn is what the market cap is today of Sasol. It reported a 14 percent increase in full-year earnings, boosted by higher chemical prices and a weaker Rand. Joining us on the line to help unpack the numbers is Nic Norman-Smith; he's with Lentus Asset Management. R420bn Nic, it's in the top five-market cap basis in South Africa. Just too maybe put it a little bit in context, I guess that means most pensioners in this country will, in some way be exposed to Sasol.

NIC NORMAN-SMITH: Indeed Alec, especially fund managers who don't want to take too much benchmark risk. Given the heavy weight and certainly it is one to own and we think it's been cheap for quite a while and still, in a market, that is looking more and more expensive and this is one of the few stocks that still look, reasonably attractive from a valuation perspective.

ALEC HOGG: So what would you valuation be for Sasol, after these numbers?

NIC NORMAN-SMITH: It wouldn't change too much. We think the time shared of earnings is broadly in line, with what the sustainable earnings are. Maybe there is some downside risk, given the, we think the Rand is maybe too weak and there is some potential downside risk, with the oil price, but not too much compared to some of the other commodities. We think it is tradable just below fair value and certainly, if you want to look at it from a relative perspective, a lot cheaper than a large portion of our local markets.

ALEC HOGG: And I suppose that tells you where the market is at the moment, but you talk about risk. What about last week, Rob Davies saying to Sasol and to ArcelorMittal, he wants to see them cutting their prices for the South African market, no longer being, tied to import price parity. Is that not a big risk?

NIC NORMAN-SMITH: It is always going to be a risk but look; Mr. Davies is hardly one to make decisions, on the interest of business, unfortunately, but if you look at how much tax revenue Sasol generates, I think it was something like R35bn or R36bn directly and indirectly this year, for the South African fiscus. Government needs to be quite clear about slaying the golden goose, for the goose that lays the golden eggs, so one would hope that he would sensible in terms of messing with the market, as you were talking about earlier.

ALEC HOGG: That's an important point, 'so much tax revenue being generated by this South African champion'. I guess if you start changing the underlying rules someone on the Sasol Board, or maybe more than someone on the Sasol Board, will say 'well, why do we invest more in a territory or a geography where it is uncertain, why not go as they have done to the United States where there's a lot more certainty'.

NIC NORMAN-SMITH: Yes, exactly and one would argue that potentially some of the strike decisions already have forced them to look elsewhere. Look, I think over the half of their CapEx this year was, spent in South Africa, and clearly, it is still their major profit generator, so I don't think they're going in there soon but certainly, we want an environment that is conducive for business investment. It is very dangerous to start changing the rules of the game, especially in an industry that there's a long lead-time and you're putting a lot of capital on the ground. It's not like you can move around very quickly, so you really do need stability, with these long-term projects.   What's interesting is if we have a look at the Louisiana project, that Sasol are looking at and we see how they have all of the various approvals from environmental and various other aspects.

Now, compare that to a Kumba in the Congo or to the Anglo American with their Rio project, where so many of these domains are hurting you, so you just see the benefits of working in a developed country that does have these sort of aspects in place.

ALEC HOGG: And the problem for developing countries as well is that the developed nations are also giving incentives, if you go to the underdeveloped parts of their own society, as Louisiana is but, Nic, just looking at that CapEx, 57 percent in South Africa, currently, or that was in the past financial year. That percentage or that proportion, presumably, will decline as the other projects elsewhere start kicking in.

NIC NORMAN-SMITH: Correct, so there's two things. One is there's been a massive sort of renewal process on the Secunda-Sentinel's part of business, which is the major profit generator, so that's a large portion of the local CapEx. Then secondly, as you mentioned the U.S. expansion and if it does, all go ahead, especially well it will substantially increase, so yes, that shift is already moving. We've certainly seen, if we look at some of the more mature projects, some of the RX Gas Liquid project. That's earning, I think around R4bn a year now for Sasol, so you can certainly see the potential is there, obviously, at the moment but the cash is being ploughed into the States and obviously no profits are getting generated just yet. But one can see that the opportunity is certainly there.

ALEC HOGG: Just to close off with, the stock does trade at a PE of below 11, so relative to the market overall, as you said in the outset, it is not expensive. Are you expecting though, the double-digit growth in headline earnings and dividends, as we've seen in this past financial year, are likely to continue?

NIC NORMAN-SMITH: I think we wouldn't be looking for too much more so, as I said, there's a couple of things. One, is the oil price and the Rand and those we think that provide a massive benefit to Sasol, whether we can expect that going forward, it is not something that we would look for, given the fundamental valuation, so no. We expect things to level out. I think a normalised level is probably slightly lower from an earnings perspective. The headline PE ratio is maybe a little bit too favourable, but not by too much, so it is still an attraction, obviously the major risk, and you mentioned Rob Davies, and the other major risk is the reinvestment risk. These projects always take longer and take a lot more capital than what we expect, and certainly, we would be assuming that the returns they are expecting in the States wouldn't turn out to be quite as good as, what they expect now.

However, the beauty of investing in Sasol, at these levels is they are not paying for that retail potential. If it does come through – fantastic. If it doesn't, your capital should be, relatively intact from these levels.

ALEC HOGG: Fascinating insights there from Nic Norman-Smith, of Lentus Asset Management. The Sasol share price about three-quarters of a percent higher today, so it was anticipated. There are lots of shareholders though that have had a wonderful run on this one. Three years ago or in fact just a year ago, it was R480.00 a share. Today it is trading at R640.00 a share and there are hundreds of thousands of BEE shareholders, black shareholders, many of them, their first ever investment has been in Sasol, and good luck to them.