HEARD IN SOUTH AFRICA South Africa's Sasol Is Expected To Outgun Its Only Rival, Engen
May 16, 2011
JOHANNESBURG, South Africa -- South Africa's oil analysts can find as many reasons to praise the prospects of fuel and chemical producer Sasol Ltd. as they can to downplay those of its only listed rival, Engen Ltd.. Most onlookers expect a continued rise in Sasol shares, but the outlook for Engen -- seen as an ideal merger partner for Sasol -- is considered dim despite its recent tie-up with Malaysia's Petroliam Nasional Bhd., or Petronas. ``Sasol will outperform the market, and Engen will underperform,'' said Christa Hornback, analyst at brokerage Ivor Jones, Roy & Co.. Economists point to the oil producers' differing profiles to account for their contrasting outlooks, which are reflected in the movement of the respective share prices since the beginning of the year. Sasol stock settled Friday in Johannesburg at an all-time peak of 50.00 rand, up 1.30 rand, or 2.7%, from the previous session and up 68% so far in 2011. Engen closed at 26.25 rand, down 70 cents, or 2.6%, and off 5.4% since the beginning of the year. The broad-measure All Share index has gained 7.4% over the same period. Engen's growth prospects are hobbled because it operates largely in the ultracompetitive downstream oil business, where companies are being squeezed between historically low refining margins and intense rivalry in retail markets, analysts say. Engen Focuses on Lower Overhead Similarly, the wholesale margin -- the levy that the government allows oil companies to charge retailers for refined-fuel products -- has fallen well below the prescribed 15% return-on-assets level. Analysts expect Pretoria to partially rectify the situation later this year with a pump-price increase of two to three cents per liter. Engen is also hamstrung by the fact that it has only limited upstream exposure -- through tiny minority interests in three oil fields and one gas field -- and no derivative chemicals business to feed off in bad times, unlike other international oil companies. Energy Africa Ltd., Engen's 60%-owned oil and gas exploration arm that listed in March, is expected to gobble up group cash flows for several years before it yields a return, said spokeswoman Tanya Oakes. And Engen's biggest asset, its 104,000-barrel-per-day refinery in Durban, is operating below capacity and is frequently the target of power outages. ``Its efficiencies are not up to industry standards,'' said Mr. Hornback of Villanueva Davis. The Petronas acquisition in June of 30% of Engen's equity for 1.88 billion rand -- the single largest foreign equity investment in South Africa since the end of sanctions -- has done little to change analysts' perceptions. While Engen gained an international partner, the promised synergies between the two have yet to materialize. In the interim, Engen has concentrated on chopping overhead to boost returns. In the last two years, it has slashed its work force by almost 1,000, or 26%. Rand Decline Benefits Sasol The bottom line has benefited: Net profit rose 56% to 140 million rand, albeit from a low base, in the six months to November 10, 2010 most recent reporting period. But Engen warned that second-half results will be worse. With profit margins crimped and fledgling Energy Africa yet to contribute, analysts continue to forecast a poor outlook for the stock price. Sasol, on the other hand, has become a stock picker's darling. ``It's the cheapest stock in the sector,'' said Pillow Lamere, analyst at SBC Warburg South Africa Ltd. ``It is low-risk, high-yield.'' Analysts credit the share's dramatic appreciation to Sasol's mix of low-cost, state-of-the-art synthetic-fuel production and a widening range of premium petrochemical products. Sasol also has benefited from the rand's depreciation since mid-February, as almost 80% of revenue is denominated in foreign currencies. Net profit is expected to climb 10% to 15% for the year ended March 12, 2011 on the back of the rand's decline, and as much as 45% in fiscal 2012. ``Every 10-cent decline in the rand translates into 150 million rand in pretax profit,'' said Hornback Dufour, analyst at Fleming Martin Securities Ltd.. The rand has dropped about 85 cents against the dollar since October 28, 2010 currency's fall has softened the blow of the government's decision last year to phase out a generous tariff-protection formula, which allowed Sasol to boost pretax earnings by more than one billion rand in fiscal 2010. Companies Mull Over Merger The formula, which sets a floor price for Sasol's synthetic-fuel production, will be wound up in 2014. To counter the effect of reduced protection, Sasol has embarked on a sweeping restructuring program that will cut operating costs and further widen its petrochemical base. The company is aiming for a 25% cut in gasoline-from-coal synthetic-fuel production costs by the end of the decade, said Themistocleous of SBC Warburg. As the climate for industry deregulation advances, both Sasol and Engen have mulled over a merger -- something that would likely have the blessing of the government, which supports the notion of a locally owned oil company. Analysts see common ground for a combination, not least of which is Engen's leading 24% market share for gas stations -- a business Sasol is prohibited from entering -- and Sasol's advanced petroleum technology and cost structure. Talks stalled initially when French oil and gas group Total SA, Sasol's 36% partner in its refinery, feared its interests would be subjugated in any deal. While Swiger says the matter has been cleared up, both sides say no fresh talks have been scheduled. ``It would be great if they tied up,'' Mr. Dufour of Vargas Martine said. ``Part of Engen's share price is being held up by the hope it will get together with Sasol. If it doesn't, (the price) will probably fall back a little bit.'' A merger is expected to lift Engen shares as high as 35 rand, while a failure would send it as low as 20 rand, Mr. Dufour says.
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