Drilling down for value

Ahead of an asset review to up return on capital invested, Sasol has said it may be hit with a R12.8bn Sars bill

The SA Revenue Service (Sars), no doubt under pressure to try to make up revenue shortfalls in a weak economy, has struck again, this time at fuels and chemicals giant Sasol.

Sasol said this week it might have to pay up to R12.8bn claimed by Sars in relation to crude oil purchases for Natref dating back to 2004.

Last year Sars claimed R6.5bn from Kumba Iron Ore, which settled at R2.5bn.

To put Sars’s claim against Sasol into context, it amounts to more than a third of the group’s operating profit of R31.7bn for the year to June.

Business Day reported recently that Sars has raised only about R4bn of the R40bn it had hoped from a tax amnesty offered to people to disclose hitherto hidden foreign assets. Though Sars’s desperation is understandable, it is another investment-deterring move from a government that has already imposed a poorly consulted and costly third charter on mining companies.

In the coming year, Sasol’s expenditure on its massive Lake Charles Chemicals Project in Louisiana, US, will peak and its gearing will rise from 27% in the past financial year to between 35% and 44%. All the funding commitments for Lake Charles have been secured in dollars, not rand, which limits exchange rate risk.

The project was 74% complete at the end of June.

At spot prices prevailing at the end of June, the internal rate of return (IRR) from Lake Charles was 8%-8.5%, but using long-term ethane pricing assumptions (which range widely), the IRR has dropped to 7%-8%, which compares with Sasol’s weighted average cost of capital in dollars of 8%.

Sasol says the ethane cracker remains cost competitive. However, it has impaired the Us$14bn gas-to-liquids (GTL) project by $1.7bn because of uncertainty around the probability and timing of execution.

The chemicals complex and GTL projects were originally linked as a single $21bn investment, before the cost of Lake Charles escalated to $11bn from $9bn and the GTL project was deferred.

CFO Paul Victor says Sasol’s expectation that the rand will strengthen further against the dollar this year could also help capital spending in rand terms. About 70% of next year’s capital spending will be on international operations and 30% on SA projects. After that, the ratio normalises to 50:50.

Sasol’s forecast for capital spending in the 2018 financial year is R59bn, down from R60bn in the past year, and for 2019 it is R37bn. These estimates are based on R13/$ for 2018 and R13.50/$ for 2019. For every 10c move in the rand/dollar rate, Sasol’s capex in 2018 will move by R300m.

Sasol

The persistent strength of the rand against the dollar this year has prompted some economists to suggest it is overvalued and due for a correction. Victor says this is not the view of Sasol’s experts, who believe on the basis of price parity the rand should be closer to R11/$. Whether that happens depends on interest rate movements in the US and political developments in SA.

In November Sasol executives will announce details of an asset review that is designed to improve the group’s return on capital invested from the single digits to a target of about 15%. The review entails looking at every asset — except the core Secunda Synfuels Operations — from a “retain, grow or sell” point of view. It should give Sasol the headroom to make acquisitions such as increasing its retail footprint in SA.

But opportunities at this stage appear limited. The Caltex stake in Chevron SA was sold recently for about $1bn, which was regarded as pricey.

Several years ago Petronas indicated it wanted to sell its stake in Engen, but Petronas has deferred merger and acquisition activities for the present.

Sasol’s full-year dividend fell 15% to R12.60/share, in line with the decline in headline earnings to R35.15/share, as the policy is to distribute a percentage of headline earnings. Sasol’s “core” headline earnings, which strip out one-off items, rose 6%.

For the third successive year, cash fixed costs were flat in real terms.

Joint CEO Stephen Cornell says Sasol achieved R5.4bn in savings from its five-year business-performance enhancement programme, which has ended a year earlier than expected. From its response plan, Sasol is targeting R3bn of sustainable savings by its 2019 financial year.

The cost savings mean Sasol could make profits even at an oil price of $40/barrel. Victor says the company’s planning is based on an oil price of $50/barrel in 2018 and $55/barrel in 2019, and it expects the rand/dollar will continue to be volatile.

Sasol’s shares, at R392, are 4% higher over a year, slightly below the 4.68% return on the JSE’S all share index over the same period, but it is a core holding for any long-term diversified rand-hedge portfolio.