The Investment Case – Sasol Ltd

A global leader in synthetic fuels.

Investment Insights

ORAPA – Assuming an exchange rate of R7 to the dollar, an increase of just US$1 in the average annual crude oil price translates into an additional R550m of operating profit for petrochemicals giant Sasol. It is, therefore, not hard to understand why Sasol’s share price has climbed 21% in the past year as oil prices have once again shot above US$100 a barrel.

Sasol’s primary appeal is its position as an innovator in synthetic fuels. The Fischer-Tropsch process that it uses to produce liquid fuel from coal and gas is its core capability.

“The group’s most significant strength is its technology, which it strives to keep current through continued investment in research and development,” says Frost & Sullivan chemicals business unit leader Mani James. “There is increasing global demand for their gas-to- liquids and coal-to-liquid technologies, driven by the growing need for energy.”

It is however easy to forget that Sasol is also a leading manufacturer of a number of chemicals, from mining explosives to polymers. In addition, the group has interests in producing gas in Mozambique and Canada, and crude oil in Gabon. It also refines oil in South Africa and supplies pipeline gas to industrial and commercial customers.

It is a more diversified business than it is often given credit for, probably because its synthetic fuels operations are so compelling. In an increasingly energy-hungry world, this is where its primary growth potential lies.

History

The South African Coal, Oil and Gas Corporation Ltd was established with government support in September 1950. The company’s first MD, Etienne Rousseau, wanted to name the company South African Synthetic Oil Limited (Sasol). The name wasn’t adopted, but the acronym stuck.

The company’s aim was to commercialise coal-to-liquids technology. As South Africa had no large oil reserves of its own, the state saw the potential in using its rich coal reserves to produce fuel.

The Sasol One plant was set up on a new site, named Sasolburg, just south of the Vaal River, where it could take advantage of the low grade coal in the area. Its first coal-to-liquids venture came on stream in 1955.

Sasol was listed on the JSE in 1979, shortly before production began at its new Secunda plants. Sasol Two came on stream in 1980, followed shortly by Sasol Three.

The group’s international expansion began in 1990 with the setting up of a marketing office in the UK. Its first foray into running operations outside of South Africa was initiated with the signing of a deal to develop the Oryx gas-to-liquids plant in Qatar in 2001. Production at the site began in 2007.

Dividends

Despite lowering its dividend in the 2009 financial year as a means to conserve cash, Sasol has stated its intention to return to a policy of growing its dividend pay outs. Its total dividend (interim plus final dividend) rose from R7.10 per share in 2006, to R9 per share in 2007 to R13 per share in 2008. The lower dividend of R8.50 per share in 2009 was corrected with an announced dividend of R10.50 per share for 2010.

The interim dividend declared for the six months to 31 December 2010 was R3.10 per share. That places the dividend yield around 3.1%.

Which funds hold this stock?

Sasol is viewed favourably by South African fund managers across the spectrum. It is one of the five biggest holdings in every one of the leading general equity funds over the last three to five years. It is the number one holding in the Allan Gray Equity Fund at 11.73%, makes up 9.1% of the Kagiso Equity Alpha Fund, 9.0% of the Coronation Equity Fund, 6.48% of the Prudential Equity Fund and 4.14% of the Absa Select Equity Fund.

The two leading large cap funds, both of which feature in the top five performing unit trusts over the last five years, are also keen on the stock. Sasol is the second largest holding in the Coronation Top 20 Fund at a weighting of 9.5%, while the Absa Rand Protector Fund holds 8.1% of its funds in the counter.

In addition, every one of the top five mining and resources funds gives Sasol a weighting of at least 10% in their portfolios.

Why would an individual consider investing in this company?

Some analysts believe that the world has already reached “Peak Oil” – the point from which natural oil production will steadily decline as reserves run out. Whether that is true or not, there is little argument that the supply of oil is stagnant at best. Yet global demand is increasing.

That being the case, coal-to-liquid and gas-to-liquid technologies are increasingly in vogue. Not only do they realise a product that is cheaper than oil, but they make use of commodities with much healthier global lifespans.

Sasol is one of the most established and experienced synthetic fuels businesses in the world. Its proprietary technologies are increasingly in demand, and it is constantly innovating to refine them further.

Similar to producers of copper and iron-ore, much of the outlook for Sasol’s synthetic fuel business could hinge on China. Not only is there direct interest from the Chinese in Sasol’s technologies, but oil prices may increasingly be influenced by demand from what is now the world’s second largest economy. The country already imports around half of its fuel requirements.

“Sasol is our preferred resource share because of relative commodity prices and the impact of Chinese demand on these commodities,” Allan Gray Portfolio Manager Andrew Lapping wrote in a 2010 commentary. “As the Chinese consumer becomes

wealthier, more people will drive cars and oil consumption will increase. The government is spending enough money on infrastructure to ensure there are sufficient roads available for the rapidly growing fleet of cars.”

In addition, Sasol also acts as a double hedge – both against a higher oil price and a weaker rand. Both scenarios translate into higher earnings for the company.

From a financial perspective, the group’s ability to generate cash is a strong positive for the group. By conserving cash during the market turmoil of the last couple of years, the group has maintained a strong balance sheet from which it is able to pursue expansion. From capital expenditure of R16bn in 2010, Sasol expects to spend R23bn in the current period and 31bn in the 2012 financial year.

What risks does this company face?

Sasol’s long-term performance remains highly sensitive to movements in the rand. The strong local currency has a dampening effect on financial performance and the group does not anticipate much weakening in the currency in the short term.

“The oil price in rands is the most important driver of Sasol’s earnings,” Allan Gray’s Lapping explains. “Going forward, Sasol should be a good investment if the rand oil price remains close to, or exceeds, R600 per barrel.”

As more and more emphasis is placed on clean energy, Sasol has also been forced to take note of its significant carbon footprint. To its credit, the group has set targets to reduce its carbon intensity through driving energy efficiency and exploring the potential or low or no carbon electricity, particularly through using gas. However, it may increasingly find itself under pressure to spend greater amounts of money cleaning up its act.

The group also recently announced that Canadian David Constable will take over as CEO when Pat Davies retires at the end of June. Constable is the first person to be appointed to this position from outside of Sasol and, as a foreign appointment, will certainly draw closer scrutiny from shareholders and government alike.

Where does this company’s growth potential lie?

The number of projects Sasol has on the table is notable. From building a purified aluminium production unit in Germany, to a partnership with Tata in India to produce motor fuel from coal, to plans to double its hard wax production in South Africa, it is heavily committed to growing its operations around the world. It also has plans to build a new coal-to-liquids plant in Limpopo.

Perhaps most significantly, it is exploring the feasibility of building a coal-to-liquids plant in China, with an anticipated production of 80 000 barrels a day. This could be the biggest foreign investment by any company into that country and, if it receives government approval, might be the first of as many as 20 such plants. Sasol wouldn’t necessarily be involved in all of them, but it could certainly expect to take a large share.

On top of this Sasol is continuing to look at projects in India, Uzbekistan and the Middle East. The acquisition of two shale gas assets in Canada could also lead to the development of gas-to-liquids projects in that country.

“Sasol’s continued global expansion provides a positive outlook for sustainable profitability in the long term,” says Frost & Sullivan’s James. “However, the company will also continue to invest in its South African operations, which will remain a key contributor to its revenues.”

With Sasol’s track record of technological innovation, a number of analysts are also backing the group’s ability to develop successful green technologies. It already has a memorandum of understanding in place with a Norwegian state-owned enterprise to become involved in exploring carbon capture technologies. With the world’s eagerness for reducing carbon emissions, Sasol’s ability to move into this arena could be a telling factor in its long-term future.

For more, visit Moneyweb’s click-a-company profile on Sasol Ltd.

See article here.