Sasol Limited Stock: A Potential Value Trap (NYSE:SSL)

I by no means take pleasure in writing bearish stories on high-quality corporations for just a few causes. The primary is that they possess a touch of unfairness to the agency’s administration group, and second, it’s not straightforward to elucidate to traders that an organization’s current operational efficiency and its inventory’s prospects will not be all the time intertwined. Nonetheless, any individual has to do it, so right here we’re.

For these unaware, Sasol Restricted (SSL) is a South African multinational power agency with an emphasis on fossil gasoline and chemical actions resembling coal mining, oil manufacturing, gasoline retail, and chemical provide. Sasol is extremely well-managed, and SSL inventory at the moment trades at a price-to-book low cost of roughly 1.51x. Nonetheless, a potential vantage level means that its inventory possesses a possible worth entice amid a structural break within the financial system that has added strain to the agency’s prime line. Furthermore, the corporate has regional value issues, and its inventory’s market-based traits will not be aligned to profit from the present monetary market atmosphere.

Allow us to delve right into a extra detailed dialogue about just a few of Pearl Grey Fairness and Analysis’s newest findings on Sasol Restricted’s American Depositary Receipts.

Operational Replace

Overview

Sasol’s major segments are chemical substances and power. The latter of the 2 is closely reliant on gasoline, which spans roughly 76% of the division’s income. As for the prior, Sasol’s chemical substances enterprise providers industrial wants on a world foundation and spans roughly 60% of the corporate’s broad-based income combine.

Though the corporate hosts a various set of income streams, its framework is extraordinarily reliant on industrial output, which is inextricably linked to the financial cycle.

H1 Report Assessed

Sasol launched its half-year earnings report final month, revealing 26.6% year-over-year income progress and a primary earnings-pr-share lower of three%. The corporate guided its traders decrease previous to the earnings launch, citing components resembling rising enter prices, the Eskom disaster in South Africa, and weaker commodity costs as essential issues.

As revealed earlier than, throughout the first half of its 2023 monetary 12 months, Sasol skilled top-line progress. Nonetheless, the agency succumbed to prices. In our view, and as defined later within the article, Sasol will quickly really feel the burden of decrease top-line progress and sustained value pressures.

Mining

The corporate’s mining section’s EBIT fell by 5% year-over-year amid points with South Africa’s nationwide railway firm, Transnet. Civil unrest is rising by the day in South Africa, and railways are deteriorating with each transit. Furthermore, as a result of ongoing South African electrical energy disaster, Sasol will possible must ramp up its exterior coal purchases amid decrease throughput from its personal mines, consequently diminishing its revenue margins.

Gasoline

Moreover, Sasol’s fuel unit has prolonged its EBIT by 26% year-over-year. Nonetheless, just a few options should be saved in thoughts. Firstly, Sasol’s EBIT included roughly $270 million in sale proceeds by way of the sale of its Canadian shale holdings, which is taken into account a non-recurring occasion. On prime of that, oil, coal, and fuel costs have capitulated because the begin of Sasol’s H1, and they’re unlikely to get well, on condition that there was a structural break within the financial system, which incorporates smoother provide routes and decrease core demand.

On a optimistic notice, Sasol says its Mozambique drilling plan is “progressing forward of plan and continued with a very good security efficiency”. For these unaware, a regional conflict has developed in Mozambique throughout the previous few years, and the nation’s energy grid points are rife. Subsequently, Sasol’s mere 2% regional decline in year-over-year manufacturing illustrates the enterprise’s robustness.

Nonetheless, sadly, we anticipate the agency’s regional operations to endure within the coming quarters for a similar causes as talked about earlier than. Additionally, Mozambique’s at runaway inflation (10.3% as of February), that means Sasol’s regional upkeep and growth CapEx may be larger than common.

Fuels

Sasol’s fuels section noticed an 11% year-over-year decline in H1 attributable to a struggling client base. For instance, the corporate’s downstream actions in South Africa have been severely impacted by a regional financial decline in South Africa, which prompted each particular person shoppers and enterprises to taper on their spending. Sasol may battle with the identical points within the years forward, as little is being completed to recommend South Africa’s financial system will abate a major drawdown induced by the capitulation of its nationwide power supplier, Eskom.

Chemical compounds

As per its H1 launch, Sasol’s chemical substances enterprise skilled year-over-year EBIT declines of 86% and 87% in Euroasia and America, respectively, whereas its African EBIT retreated by 15%.

Most of those losses have been attributable to impairment checks, which remeasured the agency’s chemical substances asset base. Though the impairment losses can theoretically be backed out of core earnings, the scale of the impairments is a tangible concern as they replicate the antagonistic nature of the agency’s commodity worth basket trajectory. Extra importantly, though these impairments will be recovered in the end, they convey Sasol’s decrease cash-generating potential in at the moment’s financial local weather.

Valuation and Dividends

At face worth, most would argue {that a} inventory with a ahead dividend yield of 6.28% and a price-to-book ratio of merely 0.66 is undervalued, proper? Properly, no, as a result of tail danger should be thought of.

As beforehand talked about, Sasol’s commodity basket is beneath immense strain. In our opinion, a lot of the worth danger was attributable to an easing in provide chains, which prompted commodity costs to stage after a sustained interval past their transferring averages. Nonetheless, we anticipate additional declines stemming from demand-side components.

Utilizing the U.S. as a benchmark, other than most sturdy items costs, proof means that core inflation stays resilient, indicating that client spending energy is in verify. Non-core has dipped considerably, which aligns with our argument that commodities have tapered as a consequence of free provide chains. Nonetheless, by going with the inverted yield curve for one purpose, we expect a structural break is pending, which might result in weaker core spending energy, a possible recession, or, even worse, an financial disaster.

Moreover, the beforehand said details about South Africa’s struggling infrastructure and Sasol’s impairment losses should be thought of when taking a look at Sasol’s ebook worth.

Lastly, Sasol’s dividend protection ratio of two.73 is stable. Nonetheless, the asset’s payout ratio of 107.42% indicators an unsustainable dividend, particularly given the chance that larger regional CapEx in Mozambique, decrease web earnings, and decrease chemical substances section depreciation may trigger its free money move to fairness to taper.

Last Phrase

Though Sasol Restricted is an extremely well-managed firm with a inventory that is buying and selling at a price-to-book low cost, we expect traders should keep away from throwing warning to the wind as numerous systemic and uncovered dangers persist.

Sasol suffered vital impairment losses inside its chemical substances section throughout its newest working half-year. Furthermore, a capitulation in oil, fuel, coal, and chemical costs coupled with macroeconomic tail danger poses vital headwinds. Lastly, Sasol Restricted is combating persistent systemic points in South Africa and Mozambique, which could taper its forward-looking earnings.

With all components thought of, we assign a cautionary maintain ranking to Sasol Restricted with an indefinite outlook.

Editor’s Notice: This text discusses a number of securities that don’t commerce on a serious U.S. change. Please concentrate on the dangers related to these shares.