Finance Minister Tito Mboweni, delivered his much-anticipated budget speech in February, generally exceeding expectations with limited resources and pressure from all sides. He left taxes largely unchanged, recognising the already high burden on South African (SA) taxpayers and choosing instead to take on the powerful labour unions with a plan to cut R160bn from the state wage bill over the next 3 years. Unfortunately, the budget speech was delivered against the backdrop of global risk aversion related to the economic impact of the new coronavirus (COVID-19) and the global sell-off overwhelmed any positive impact that the budget may have had on local asset prices.
The FTSE/JSE Capped SWIX fell 9.5% in February, taking its YTD loss to 11.9%. The rand also continued to sell off with other emerging market (EM) currencies, ending the month down 4% against the US dollar and 10.6% weaker YTD against the greenback. A slew of top-40 companies reported earnings during February, most of them mining companies. Mining company earnings were generally disappointing, weighed down by either commodity prices or, in the case of iron ore and platinum group metals (PGMs), where commodity prices were strong, volumes generally disappointed. Woolworths and Shoprite also reported results during February and both showed decent results in their SA food businesses with satisfactory food price inflation. However, their offshore businesses continued to disappoint and for Woolworths, its local clothing business was also disappointing.
SA inflation once again surprised on the downside, with January headline inflation coming in at 4.5% – slightly below consensus expectations. That reading was the highest it’s been since June 2019 and it is now back at the mid-point of the SA Reserve Bank’s (SARB’s) target range, but still hardly at a level that should keep the SARB from cutting rates further. The rally in global interest rates and the budget speech weren’t enough to keep SA government bond yields lower, with the benchmark R186 bond ending the month 0.1% higher at 8.1%.
Sasol: Lake Charles woes continue to impact profit
Sasol had a challenging six months ended 31 December 2019 (1H20) as a combination of weak oil and chemicals prices and heavy Lake Charles Chemicals Project (LCCP) capex spending continued to put pressure on the balance sheet. However, capex spending should ease going forward and Sasol has guided it to nearly halve from R56bn in FY19 to R30bn by FY21 (FY20 guidance: R38bn). As a result of weak oil and petrochemical markets and LCCP capex, Sasol is at the upper end of its balance sheet guidance ranges. Gearing is at 65% (vs guidance of 55%–65%), while net debt/EBITDA is at 2.9x (vs guidance of 2.6x–3.0x). LCCP now has 80% of its installed output online and the project is 99% complete (LCCP capex is tracking at $12.8 bn). LCCP had a negative impact of R2.8bn on EBITDA for the half-year. There was also a further R2.0bn in interest expenses (~ R3.20/share) that hit the income statement in 1H20. Sasol is guiding for $600mn-$700mn in FY21 LCCP EBITDA. At the midpoint, that would equate to R10/share in EBIT (~R3/share in EPS) if achieved.
We believe the share is cheap if one assumes a relatively normal environment for oil and chemicals prices. Sasol should be able to generate R30 HEPS in FY21 if oil averages $60/bbl and with a moderate recovery in chemical prices. At a price of R204/share, that is attractive if achieved (6.7x multiple on FY21 earnings under this scenario). The challenge is that between now and then, there is a risk to the balance sheet if oil and chemical prices decline. If oil averages below $55/bbl for an extended period (and chemicals prices are similarly weak) then the company is likely to breach its covenants (which have already been lifted for December 2019 and June 2020 from 3.0x to 3.5x for net debt/EBITDA).
Sasol is a highly leveraged cyclical company at a time where its commodities are under pressure. If the company can get through the next 12–18 months, the share is notably cheap (trading below 7x on earnings that don’t have demanding oil or chemical price assumptions).
Northam Platinum: A volume growth story
Northam is unique to its platinum group metal (PGM) peers in that it has a genuine volume growth story – production volumes grew 20% YoY in the six months ended 31 December 2019. We expect Northam to reach 1mn of 4E oz (that is, platinum, palladium, rhodium and gold) in FY24 or FY25. If achieved, that would be 75% in cumulative volume growth from 591,000 4E oz in FY19 to 1mn 4E oz in FY24 or FY25.
Net debt to EBITDA is 1x. Northam has previously indicated that it is comfortable with that level of leverage and that once it is reached, it would distribute any excess cash generated to shareholders. During this six-month period under review, Northam bought R2.4bn of Zambezi pref shares (c. 20% of all Zambezi prefs in issue) and it now owns 22.9% of all Zambezi prefs in issue. At the current rate of free cash flow generation, we believe that the liability stemming from the Zambezi prefs is manageable. At ~6x spot earnings with an attractive volume growth profile, Northam is attractively positioned.
