Sasol Limited

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 3/5

Sasol Limited is a South African integrated energy and chemical company, focused on producing liquid fuels, chemicals, and electricity from coal, gas, and crude oil, and is currently transitioning to renewable energy.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

Sasol is a global integrated chemicals and energy company, with South Africa being its primary market. Its operations can be broadly divided into two segments:

  1. Energy Business: This segment encompasses the exploration, development, and production of oil and gas, coal mining, and production of synthetic fuels from coal. The notable aspect of this segment is its Secunda facility in South Africa which is the world’s largest coal-to-liquids plant. However, they are also investing into gas production in Mozambique and have operations in the US and Europe.
  2. Chemical Business: This segment is involved in the manufacture of chemicals, including polymers, surfactants, and solvents. These chemicals are used in a variety of applications, such as plastics, paints, and detergents. They sell their chemical products in both African and international markets, with the highest sales in Asia and the US, followed by the EU.

Revenue Distribution: Sasol’s revenue distribution is diversified across geographical segments, as illustrated below for the 2023 financial year:

  • South Africa: 47%
  • North America: 24%
  • Asia: 16%
  • Europe: 10%
  • Other regions: 3%

While this distribution provides geographic diversity, a large part of earnings are tied to a South African economy, hence geopolitical risks in the African continent are important. In terms of business segments, roughly half of the revenues are from chemicals, while the other half is from energy, with an emphasis on its synfuels operation.

Industry Trends: Several key trends are shaping the industries in which Sasol operates:

  • Transition to Renewable Energy: The global push for cleaner energy is creating a challenge for companies with a significant fossil-fuel presence. Sasol is responding by investing in sustainable energy and moving away from coal as a feedstock.
  • Geopolitical Influence: The volatility in commodity prices due to geopolitical risks have made supply difficult.
  • Demand for Chemicals: The demand for chemicals is increasing worldwide, fueled by increased population and urbanization. For chemical companies, success lies in innovation and customer centricity.
  • Cyclicality: The industries in which Sasol operates, especially oil and petrochemicals, have a cyclic nature. These cycles can lead to fluctuations in financial performance.
  • Pricing Pressure: The industry may be subject to price pressures, as commodity prices might drop or competition increase, especially in the refining space.
  • ESG Considerations: Investors are increasingly demanding that companies prioritize their environmental, social, and governance performance. This trend affects the cost of capital, as those not compliant with global and regional regulations are likely to pay more.

Competitive Landscape: Sasol’s main competitors include large, global integrated energy and chemical companies, which typically are more diverse. Also, the company competes with smaller local players, depending on the specific products and geographical area. Here are some specific competitors:

  • Energy: Anheuser-Busch InBev (AB InBev), Shell, BP, ExxonMobil, and TotalEnergies.
  • Chemicals: Dow, BASF, LyondellBasell, and Ineos.

Key differentiating factors for Sasol include:

  • Technology and Expertise: Its Fischer-Tropsch technology and the know-how on the production of synfuel is a key differentiator.
  • Integration: Its vertically integrated business model, from coal mining to chemical production, provides greater operational efficiency, and more control over supply.
  • Strategic Positioning: Sasol aims to leverage its operational assets, distribution systems, and global presence to target niche and more profitable markets.

Margins: Sasol’s margins are determined by the price of its products, as well as the cost to produce them. Their 2023 report states that the energy business had a gross profit margin of 27%, while the chemicals businesses had a 20% gross profit. The net operating margin in 2023 was a healthy 12%. However, these figures are significantly impacted by the economic conditions and market conditions of each period. For example, the earnings for their chemicals business suffered as a result of weak global demand and increased market competitiveness. As a commodity-based company, the volatile nature of commodity prices influences their profitability.

Financials:

Sasol’s financial performance is heavily influenced by commodity prices and global economic conditions. Here’s an in-depth look at their financials:

Revenue:

  • In the 2023 fiscal year, revenue increased to R273.7 billion ($16.5 billion), driven by an increase in energy sales prices
  • In the previous years, 2022, total revenue was R240 billion.
  • The majority of revenue comes from the chemical and energy business segments.
  • In recent years, revenue from energy has fluctuated depending on oil prices.

Profitability:

  • In 2023, the company had an earnings before interest and taxes (EBIT) of R32.9 billion ($2.0 billion), for a 12% margin. * In 2022 the operating profit was R23 billion ($1.4 billion), with a margin of 9.6%. * The margins have been volatile with prices and macroeconomic conditions changing rapidly, affecting margins of different business segments differently. * Although a commodity company, Sasol’s higher levels of vertical integration and unique products have provided a buffer to their profits as compared to competitors, that may be highly dependent on oil prices.

Cash Flows:

  • In 2023, the free cash flow was R13 billion (almost $800 million), after investing R16 billion in total CAPEX. * In 2022, the company generated an operating cash flow of R46 billion and had R29 billion in capital expenditure, creating a free cash flow of 17 billion. * The trend for cashflows has been positive in the previous few years due to higher commodity prices, which had also increased the debt repayment capabilities of the company.

Debt:

  • Sasol has brought their debt down from R103 billion in 2021 to R60 billion in 2023, which should also lower their interest payments. * They have stated that they plan to deleverage further with their strong cash flows. * Even with the reduced debt, their interest payments in 2023 were approximately R6.6 billion ($400 million), which is a drag to the overall profitability. * They have stated that the intention is to continue deleveraging and target long-term debt to have a ratio of two times debt to EBITDA.

Moat Rating: 2/5 Sasol has a narrow moat, stemming primarily from:

  1. Technological Expertise: The unique and hard-to-replicate Fischer-Tropsch technology gives Sasol some level of competitive advantage in producing synfuels from coal, creating a barrier to entry.
  2. Integration: The integration of the business from mining of resources up to chemical manufacturing provides a degree of efficiency and supply chain management.

However, the moat is not strong due to a few reasons:

  • Commodity Nature: The company’s major products are commodities, which are easy to be replicated. The prices of these products are set by the market and have limited pricing power. They can also be easily substituted.
  • Technological Advancements: The company’s synfuels process might be outdated by other cleaner alternative fuel sources.
  • Industry Cyclicality: Cyclicality makes its revenues and profits volatile, making it difficult to earn consistent outsized profits over time.
  • Competitive pressure: There is increased competitive pressure from local and international players that can easily eat away profitability.

Risks to Moat and Business Resilience: Sasol faces several risks that could erode its moat and business:

  1. Technological Disruption: The rise of renewable energy sources is a major threat to Sasol’s core energy business, which is mainly based on fossil fuels. As the world is shifting towards cleaner energy, the company could face challenges sustaining its business model.
  2. Environmental Regulations: Stricter environmental regulations regarding carbon emissions could increase compliance costs or negatively impact sales. The company has a significant amount of carbon emissions, due to its operations, which can create additional pressure on prices and future returns.
  3. Commodity Price Volatility: Sasol’s revenue and profitability are closely tied to commodity prices. The high volatility in oil, gas, and chemical prices creates uncertainty and can affect its ability to maintain profitability.
  4. Political and Economic Risks: As a large proportion of operations are in South Africa, any geopolitical and economic instability could pose risks to operations. 5. Financial Risks: The current interest payments, as well as a highly leveraged capital structure, limit the financial flexibility of the company to adapt to changes and invest in new avenues. They have had issues previously that they need to deleverage. 6. Operational Problems: The company has faced operational challenges due to its reliance on old equipment, which may make its operations unreliable and cause stoppages. 7. Competition: They face increasing competition on chemical side from newer and well-integrated companies, mostly from Asia.
  5. Integration issues: The company has bought numerous companies but has not been successfully integrating them all.

Business Resilience:

  • Although there are multiple risks to the company, its vertical integration may provide some resilience to volatility.
  • The company still has significant expertise in synfuels and chemicals and can leverage these skills for the future.
  • The company is working to shift to lower-carbon alternatives, and can benefit from these in the long run.

Understandability: 4/5 Sasol’s operations are complex because of its integrated nature across different business segments. However, the basic elements of the business-mining, producing chemicals and fuels, trading energy-can be understood. The primary challenge in understanding the company arises from the complex financial statements, diverse geographic spread, and its high exposure to global market and geopolitical factors. However, it is not a “simple” company that is easy to follow and understand. The company’s future may be highly influenced by external factors.

Balance Sheet Health: 3/5 Sasol’s balance sheet shows signs of improvement, however significant risks remain:

  • Although the company has had high levels of debt in the past, due to significant levels of capex, the debt is reducing as the operating cash flow from energy side has surged.
    • As noted, long-term debt has come down to R60 billion ($4 billion). This implies that a major concern is now being addressed by the management.
  • They have also indicated they wish to pay off more debt in the coming years.
  • Although net equity has more than doubled since 2021, it can easily come down if any major changes in earnings, or if assets are revalued.
  • As compared to its competitors, the company still has higher debt to EBITDA ratios.
  • On the balance sheet, goodwill and other intangible assets represent 34% of all assets, which may present future risks if these assets have to be impaired.
    • A significant proportion of the company’s assets are linked to the highly volatile fossil fuel and chemicals industry.
    • The company’s cash on hand has improved in recent years.

Overall, there are some improvements in balance sheet strength, but a closer inspection reveals that they are not as strong as needed. It is still far from the strongest balance sheets in the market.

Recent Concerns and Management Commentary:

  • Sasol had a weak FY23, due to operational challenges (power supply, raw materials), and high input costs. However, the management expects improvements in earnings going forward due to more stable supply chains and higher prices of its products, especially gas.
  • They also acknowledge the transition risks and opportunities, as the company transitions to sustainable energy, and they have planned major investments for green hydrogen, green ammonia, renewable energy, and carbon capture.
  • They intend to use proceeds from divestments of some parts of the business towards deleveraging.
    • Management has also confirmed that they plan to keep debt-to-EBITDA at 2x.
  • They stated that market conditions and margins are expected to improve for the chemical side of the business in coming periods.
  • Management has also mentioned that their focus on improving production and reducing costs will yield positive results.
  • The company noted that their management incentives are aligned with shareholder value creation.
  • Also they expect global economic growth, coupled with higher demand for chemicals to drive profitability in the future.

In Summary, Sasol faces an uncertain future in the energy space, and a changing global economy. While they have key differentiators, they also have problems with high debt and potential for competition, along with an ever changing regulatory landscape. The management is taking steps to focus on profitability and reducing debt, while simultaneously investing in sustainable solutions for the future. However, a lot more needs to be done for the company to be classified as “strong” and “safe”.