Can Sasol pass the acid test?


To understand Sasol’s recent travails, it is important to consider the company’s 70-year history. With the industrial behemoth’s results due in August, Jaco Visser takes a deep dive into the company from its birth as a parastatal and considers the outlook for the share as the group tries to move beyond the Lake Charles fiasco.

Back in the infancy of chemistry, chain reactions were unstable and sometimes deadly. For chemical producers today, the stakes are still high, and they need to focus not only on the stability of their operations on the ground, but also on the stability of their finances to ensure shareholders are rewarded for placing trust in them. And, as with any listed company, management must clearly demonstrate this duty and commitment to its shareholders. 

The severe consequences of a disconnect between company management and shareholders couldn’t be more clearly illustrated than by the sorry saga of Sasol over the past decade. In embarking on new ventures, such as the much-analysed and criticised Lake Charles Chemicals Project (LCCP) in the US state of Louisiana, the energy and chemical company management’s aspirations lacked due regard for shareholders. And Sasol shareholders can attest to the resulting monetary losses and subsequent near-complete erosion of trust in one of South Africa’s industrial behemoths.

Fortunately, the outlook for this legacy company (remember that it was started with taxpayer money in 1950) seems brighter with Fleetwood Grobler having taken up the reins as CEO in November last year.

Sasol has had to endure harsh criticism in the past. When the company was created as a parastatal – to industrialise the pioneering technology whereby coal was turned into fuel – critics questioned why taxpayers should foot the bill of constructing the Sasol One plant in Sasolburg in the 1950s.

At present, shareholders want to know whether the Louisiana-based mega-project, which comes at a cost of $12.8bn (or R216bn, which is just a couple of billion lower than the construction cost of Eskom’s R230bn Medupi coal-fired power station, although confirming the latter figure is more onerous than splitting carbon compounds by hand in the dark) is worth losing out on dividend payments and capital appreciation.

The LCCP was borne from former CEO David Constable’s tenure. The Canadian took over the helm of the company in 2011 and stepped down after only five years at the group, during which, as reported by Business Day in 2016, “he performed radical surgery on Sasol, restructuring its operations and making deep cuts in its cost base at the same time as he streamlined its growth strategy to focus on the ambitious Lake Charles project in Louisiana, US”.

Constable was succeeded by joint CEOs Bongani Nqwababa and Stephen Cornell, who were then forced to resign in 2019 after an independent review into the disastrous LCCP venture.

It’s perhaps important to place the travails of Sasol in the context of its myriad moving parts. As fund manager Mike Lawrenson from Tantalum Capital puts it: When Constable took over, the company was viewed as cumbersome and in dire need of organisational change. Sasol was privatised and listed on the JSE by a cash-strapped apartheid government in 1979 and its history, former size and structure as a parastatal are important to consider when analysing the issues the company has grappled with in recent times.

The route from parastatal to the present

The birth of Sasol in 1950, by ramping up the conversion of coal to oil (a German technology employed by the Nazis to support their war effort), was South African industry’s second attempt to capitalise on the nation’s abundance of cheap coal. That is in addition to how cheap the labour was to get it out of the ground.

The Anglo-Transvaal Consolidated Investment Company (Anglovaal) discovered torbanite (bitumen shales) near Ermelo and in 1934 set up the South African Torbanite Mining and Refining Company (SATMAR), writes Stephen Sparks from the department of historical studies at the University of Johannesburg, in a 2016 article titled “Between Artificial Economics and the Discipline of the Market: Sasol from Parastatal to Privatisation” in the Journal of Southern African Studies. Sparks scoured government and Sasol archives in the research for his article.

Anglovaal then appointed Dr Hendrik van Eck (later the head of the Industrial Development Corporation) to probe the establishment of an oil-from-coal plant in SA, writes Sparks. Van Eck, together with another engineer at Anglovaal, took the then-minister of commerce and industries, Adriaan Fourie, in October 1936 to Nazi Germany to visit one of the Fischer-Tropsch factories – the latter name refers to the process of turning coal to oil, according to Sparks. Anglovaal’s torbanite operation “depended on subsidy through elevated customs duty and rail tariffs on imported petrol”.

By the mid-1940s Anglovaal had acquired a more advanced version of the Fischer-Tropsch process from the Americans, and government officials seemed more enthusiastic about the technology and the prospect of utilising SA’s abundant coal reserves. Anglovaal, however, diverted its capital and attention to the Free State gold fields around the same time, writes Sparks.

And so, in April 1950, an industrial adviser to the state convinced Van Eck, who was then heading the IDC, to fund the coal-to-oil project which should be controlled by the state, according to Sparks’ research. Taken by Sparks from the National Assembly’s Hansard on 10 April 1951, MPs were jubilant about Sasol’s start as it wouldn’t be “controlled from abroad or by international monopolies and cartels but by the South African state”. Thus, no outside monopoly capital would be employed. But the taxpayer, in post- war SA, had to pay up.

In this context, the words of Etienne Rousseau, first managing director of Sasol, (taken from Sparks’ article) ring rather ominously today: “When we think of oil from coal we must think in terms of artificial economics and government protection.”

As the price of oil remained low during the 1950s and 1960s, Sasol started to diversify its activities energetically, writes Sparks. “Sasol moved aggressively into chemical production and the provision of gas.”

And then the oil shocks of the 1970s came about. When SA’s oil supply from Persia was cut off following the Iranian revolution in 1978, Sasol’s existence and transformation of coal to oil became a necessity. Plans were approved to construct Sasol 2 and Sasol 3 at Secunda, but the public purse couldn’t afford it, writes Sparks. This led to Sasol’s privatisation in 1979 – the first parastatal that went this route, according to him.

Lake of tears or of joy?

Thus, the LCCP, which was announced in October 2014 at an initial cost of $8.9bn, might sound familiar to long-time watchers of this company. It signalled another huge undertaking for the company. However, this time it would be the shareholders’ and not SA taxpayers’ problem.

In the market announcement, Constable, then still CEO, promised: “In spite of a largely volatile macroeconomic outlook, we are confident that we will deliver this project successfully, by drawing on our experience of executing world-scale fuel and chemical facilities, and enlisting the best employees and industry partners.” The announcement also stated: “Site preparation is underway, and the company expects that the facility will achieve beneficial operation in 2018.”

Almost $12.8bn, six years and three CEOs later, and the plant is still not fully operational.

And this time around, Sasol must bear the backlash of shareholders and banks, rather than the grunts of taxpayers and a benevolent government, in explaining why the company should be trusted.

The loss of confidence can be seen in Sasol’s share price: ten years ago, on 30 July 2010, the share price closed at R289; six years ago – just before the Lake Charles announcement – the stock traded above R600. From there, the value destruction started. It reached an intra-day low of R20.77 at the height of the oil price plunge at the end of March this year. Add to this banks’ uneasiness with Sasol’s covenants (or terms at which they are willing to lend money to it), which existed prior to the oil price crash. The stock had risen back to R139 at the time of writing.

“The higher share price is reflective of the improved outlook for the company’s solvency rather than its expected earnings,” Richard Cheesman, a senior investment analyst at Protea Capital Management, tells finweek.

The stock is trading at a forward price-to-earnings (P/E) multiple of 56.14 and a historic one of 10.86 – meaning that analysts expect lower earnings in future. At this forward multiple, the company is priced dearly.

These multiples, however, may seem a bit disjointed as the LCCP – although beset by overruns – may just as well (as back in the day when SA’s foreign oil supply dried up) be its saving grace. And here we need to crack open the workings and off take markets of this multibillion-rand plant.

The Lake Charles plant firstly consists of an ethane cracker. The word “cracking” refers to the chemical process of breaking down the hydrocarbon compounds of the feedlot stocks (in this case ethane). The ethane cracker is designed to produce just over 1.5m tonnes of ethylene per year.

In addition to the cracker, the plant also consists of a low-density polyethylene (LDPE) plant, a linear low- density polyethylene (LLDPE) plant, and an ethylene oxide (EO)/ethylene glycol plant, which together will use two-thirds of the ethylene produced by the cracker, according to Sasol.

There are also three smaller plants that will produce higher-value chemicals: a Ziegler alcohol unit, an Alumina unit and a Guerbet alcohols unit.

Sasol is banking on the sales of the polyethylene and specialised chemicals (called performance chemicals by the company) to justify its investment in Lake Charles. The plant’s construction didn’t go unnoticed by some other global chemical companies.

It was reported in the financial media on 28 July that Hanwha Solutions (which formed after a merger of Hanwha Chemicals, Hanhwa Q SELLS and Hanwha Advanced Materials) of South Korea is interested in a 50% stake in the Lake Charles ethane cracker – not the whole chemicals project. Hanwha Chemicals produces polyethylene, polyvinyl chloride (PVC) and chlor-alkali. Hanwha is reportedly offering between $1.7bn and $3bn for this stake.

According to Lawrenson, on the assumption that Sasol only intends selling a 50% stake in the base chemicals component of Lake Charles, this rumoured sale would imply that Sasol is effectively disposing 30% of the economic interest in the whole Lake Charles project. Using the reported bid range, this would imply the value of Lake Charles at between $5.7bn and $10bn – less than the anticipated $12.8bn construction cost. “It is unlikely that others will pay for your inefficiencies,” says Lawrenson, referring to the almost 50% cost overrun on the original $8.9bn budget for Lake Charles.

Read more
This is an extract of the cover story that appeared in the 13 August edition of finweek. To read the full story, you can buy and download the magazine here.

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