Cheap as they are, Sasol’s shares are still a gamble
There is “well-worn buy when there investment is advice that one should blood on the trading floor”. But does this apply to Sasol?
Whether now is the time to pile into the synthetic fuels and chemicals producer remains a question on the lips of many investors.
At about R46 a share on Monday, Sasol had lost almost 90% of its market value since January, but it was already looking cheap to many market observers when it dipped below R400 a share because of the mismanagement of its Lake Charles Chemicals Project in the US, which led to enormous cost overruns and delays.
The company’s joint CEOs stepped down over the debacle, and as Lake Charles neared completion 2020 at first looked like it was shaping up to be a better year for Sasol.
Enter Covid-19. The pandemic sweeping the globe has seen governments implement drastic measures to contain the spread of the coronavirus.
Demand for oil, like many other goods, has fallen off a cliff. On top of that the Saudi-Russian stand-off has seen the Middle Eastern nation flooding the market, causing crude prices to plummet to lows not seen since the oil price crisis of 1998.
The Sasol share price plummeted to well below R30 in recent weeks, and credit ratings agencies have downgraded it to junk status. To pay down its enormous debt, Sasol is now looking to raise $6bn (R112bn) through cost-cutting, asset sales and possibly a rights issue.
Grim as Sasol’s situation might be on platforms such as Bloomberg, 50% of analysts rate the stock as a buy.
Investment guru Warren Buffett advises being afraid when others are greedy and greedy when others are afraid.
“Broadly, it’s a good heuristic to follow,” says Richard Cheesman, senior investment analyst at Protea Capital Management. But it is missing a caveat. “In a market like this, companies with a lot of debt can find themselves in a lot of trouble,” he says.
Adrian Saville, CEO of Cannon Asset Managers, says that at R130bn Sasol’s debt is greater than its equity. “So it’s loss-making, doesn’t have strong cash flow, and the balance sheet is under strain, it’s wrestling with operational issues and now it’s going to sell assets off.”
Terence Craig, chief investment officer of Element Investment Managers, says Sasol’s debt means it is no longer in control of its own destiny, and banks can dictate what they do and how much equity they raise. “You fall into a situation where effectively the lenders determine the company’s capital structure and not shareholders”, he says.
When it comes to Sasol’s fortunes, a lot depends on the oil price, Cheesman says. “If it continues where it is for the rest of the year, they are going to be in a lot of trouble. Not so if it bounces back.”
Craig notes that Sasol is also a chemical play now, though the margin between the ethane price and polythene price is also not as good as it once was.
Many analysts who rate the share as a buy believe oil and chemicals prices are unsustainably low, even with the current headwinds. As shale producers in the US fold, they see market forces as another driver of a price revival.
Indeed, in recent days Sasol’s share has shot up on the oil rally. But Craig says one cannot assume this is the end of the rout. “While there’s been a supply shock on the oil price, there might be demand shock still to come,” he says.
Analysts who rate the share as a buy say that even if commodity prices don’t bounce back immediately, Sasol says it can maintain about $1bn in liquidity headroom, meaning it should be able to weather the storm for the next 12 months or so. There is also concern that Sasol’s unsustainable debt levels might see it breach its debt covenants with lenders, which require that its net debt does not exceed 3.5 times Ebitda (earnings before interest, taxes, depreciation and amortisation). But in this unprecedented environment, bullish buyers think it’s likely that Sasol’s lenders will adjust the threshold should Sasol come close to breaching it.
As Sasol moves to dispose of assets, observers are sceptical that Sasol can sell assets for fair value in the current market. “And if that’s the case the lenders may force Sasol to raise equity via a deeply discounted rights issue, which could cause huge dilution for existing shareholders if they did not want to follow all their rights,” says Craig.
By one analyst’s calculation, however, a reduction of $4bn could be enough to get the debt down to sustainable levels and potentially avoid a rights issue, which is not ideal at current share prices. Even so, a rights issue remains a real possibility.
But is it ever savvy to invest in a company ahead of a probable equity raise?
Cheesman says that, theoretically, if you are able to follow your rights and the shares are being issued at the fair value, you should be indifferent if there is a capital raise. But “in practice those criteria are often not met — not all shareholders are necessarily able to contribute more capital, and the rights issue price might be at a steep discount to fair value, causing significant dilution in value”.
Saville says it’s quite different to issue equity to fund a compelling expansion as compared with Sasol’s case where it is to “pay down a balance sheet that’s run away from it”.
Though many might bet that Sasol is more likely to recover than to tumble further, Cheesman says there are a lot of fallen companies on the JSE which may not be as speculative as Sasol or companies not as exposed to commodity prices, which are difficult to predict.
Paul Theron, CEO of Vestact, agrees. “Sasol is a strategically vital asset in SA, so it will never be allowed to fail, but that doesn’t mean that its equity shareholders can’t get wiped out,” he says.