Sasol’s perfect storm

On 4 March, a day before Sasol’s share price nosedived, the board of directors saw fit to approve a further R70-million worth of long-term share incentives (LTI) for the senior management team.

The shares, issued at a price of R192.83, are now worthless given that the share is trading at about R50.00 following the rout in the oil markets, but that is arguably irrelevant. 

The point is that poor capital allocation and poor project execution, coupled with sizeable exogenous shocks have combined to create the company’s biggest crisis yet. 

Yet the board and the remuneration committee have opted to continue with LTI programmes rather than suspend them as a result of Sasol’s poor performance.

Rich rewards to Sasol executives regardless of poor capital allocation decisions are not new. The acquisitions of Condea in Europe 2010 and the Montney Shale fields in Canada in 2011 cost the company and shareholders dearly, yet these decisions did not affect incentives paid to executives at the time.

Similarly, the delays and cost overruns on the Lake Charles Chemical Project have had a limited impact on executives’ short-term incentives and no impact on long-term incentives.

“Long-term incentives for 2018 were calculated on Sasol’s return on invested capital which specifically excludes assets under construction,” says Terence Craig, CIO at Element Investment Managers.

This may also rankle with shareholders who like to think that management interests are aligned with theirs. 

“If you bought shares at the beginning of the 2018 financial year and held on to the end of F2019, you would have lost money. Yet directors scored in F2018 and did not have to pay anything back in F2019, putting them in a better position than shareholders.”

Sasol’s debt has spiralled out of control — debt is now 35 times the company’s market capitalisation — and management has announced a package of measures to both conserve cash (by cutting capex) and raise cash by way of asset sales and a $2-billion rights issue. 

The debt was incurred during the development of Sasol’s ambitious Lake Charles Chemical Project, the brainchild of David Constable, who earned more than R500-million as CEO of Sasol between 2011 and 2016.

When the project was announced in 2012 it was budgeted at $6-billion, however from the outset problems and costs were allowed to balloon. 

“We are… disappointed by… cost and schedule overruns on LCCP…” Sasol co-CEO’s Bongani Nqwababa and Stephen Cornell said in February 2019 at the presentation of Sasol’s interim results. This is “a lesson from which we have gained invaluable insights…”

Three months later, in May, projected costs had escalated from $11.6-billion to $12.6-billion. So much for “invaluable insights”.

Almost 70% of the cost of the project is funded in dollars. This debt, which has spiralled from R140-billion in January to R190-billion currently, was to be funded by cash flows from Lake Charles. But project delays mean that this cash is not yet flowing, placing the burden of maintaining the interest repayments largely on the SA business.

Adding to Sasol’s woes, the lower oil price coupled with the slowdown in production and sales in the wake of the Covid-19 lockdown will reduce earnings, which means that come the June year-end, Sasol’s net debt in relation to earnings (before accounting treatments) will be worse than anticipated.

“Sasol is very likely to breach its debt covenants in June,” says Craig. “This will mean their bankers will have them over a barrel and decisions on the structure of the balance sheet will be out of their hands. This situation benefits the bankers and no one else.”

 

While the macro-conditions do not favour Sasol, analysts believe the CEO is the right man for the job.