Sasol: gearing brought under control

Sasol. The one that got away for many. It partially got away for me.

After a massive effort from management to cut costs and sell off assets, aided by a stronger oil price and generally better economic circumstances, Sasol confirmed today that it will not need to tap shareholders for more money in a rights issue.

A rights issue is a process through which companies raise money from shareholders. For the right reasons, like to execute a great acquisition, it can be good for shareholders. For the wrong reasons, like to pay back the bank, it can be catastrophic.

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Make no mistake: Sasol still carries plenty of risk. The debt balance sits at over R126bn, which is more or less equal to Sasol’s market cap. This means that Sasol is still extremely highly geared, but the outlook for Sasol has improved drastically.

Don’t make the mistake of misreading this and thinking that Sasol is therefore owned entirely by the banks.

The market cap is the equity value i.e. net of the debt. The market cap plus the debt balance (and any excess cash) is known as the enterprise value of the group. Enterprise value is used extensively in valuations and private equity deals, as it values the assets without worrying about how they are funded e.g. by debt or equity.

Ignoring cash, this means that Sasol’s assets are worth around R250bn.

A recap on Sasol’s (and my) rollercoaster

When the craziness happened in March 2020 and the stock market suffered a big drawdown, Sasol was one of the hardest-hit companies. In just 20 days, the share price collapsed from R193 to below R22 a share.

That’s a drop of nearly 90% in the space of three weeks.

With some believing that Covid-19 was the death knell for a company that had suffered from poor investment decisions, a lack of cost control and an over-indebted balance sheet, Sasol proved them all wrong.

I was one of the few who believed that the oil price was simply unsustainable. I distinctly remember telling Mrs Ghost that if the oil price stayed below $20 a barrel, we would need to survive by farming potatoes and it wouldn’t be because I had lost all our money in Sasol.

No, it would be because the world as we knew it would cease to exist.

Like many commodities companies, Sasol isn’t just correlated with a specific resource (in this case oil). The share price usually moves to a greater extent than the resource price, due to the leverage effect of fixed costs and debt within Sasol.

To understand more about leverage, read this article that I’ve written previously on operating and financial leverage. It’s one of the most important concepts in finance and investing.

As the world showed some signs of returning to normal, Sasol rallied like crazy to over R172 per share by early June. Many traders took profit, but I stubbornly held on, believing there was more to come.

Oil steadily climbed to $45 a barrel by the beginning of September, but then faltered. At the end of October, it was down at $37 a barrel and had taken the Sasol share price all the way back down to R75.

There have been two “perfect trades” in Sasol over the past year. The trough-to-peak of 23 March 2020 to 8 June 2020 is the first one, returning 7.86x your money in just 77 days. The other great run was from 29 October 2020 to 1 February 2021, returning 2.77x your money in 95 days.

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There are some interesting lessons to be learned from this:

  • In a turnaround strategy, it can be more important to get in early than to buy the dips later on. The real magic happens when the risk is the greatest.
  • Using a strategy of buying shares, rather than trading leveraged instruments like CFDs with margin calls, means that big downswings can be survived by simply not selling the shares vs. having to meet margin calls or be closed out in a CFD trade
  • Technical analysis really can work sometimes. The trough on 29 October of around R75 per share had been tested previously on 14 May and 25 May and corresponded with the peak of the first recovery rally which ended on 9 April.

The details are small in this Sasol chart from but just focus on the horizontal blue line. That’s the technical resistance line that I am talking about. I’m by no means a technical expert, but I do use support and resistance lines.

The mistake I made was to sell all my Sasol shares in December. As a second wave of Covid swept across major countries, I was scared that the oil price would fall over again and we would be back at R75 per share.

What I should have done was listen to experienced traders who suggested that I only sell half my exposure, leaving the other half to benefit from a potential further recovery. Hindsight is always perfect, but I left a further 60% return on the table by making this mistake.

Why did the Sasol share price drop despite the good news about the rights offer?

Markets are forward-looking. When people talk about news being “priced-in”, they mean that the market had a specific expectation. If that expectation is met, even if it is good news, the share price may not react with further upside.

When people refer to an “earnings surprise” they don’t mean that the actual release of earnings came as a shock. Even the worst analysts aren’t so fast asleep. No, they mean that the performance was a surprise compared to the consensus estimates of the analyst community.

Despite the happy news today, Sasol closed 0.77% down. The real story here is that Sasol is nearly a ten-bagger since March 2020 i.e. you would have almost 10x your money if you had timed your entry perfectly.

I’m just grateful that I enjoyed some of that journey.

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