CHIEF FINANCIAL OFFICER’S REVIEW
|Steering through volatile external markets|
|Sustainably reducing our cost base
through continuous improvement
|Allocating capital to enable value-based growth|
|Protecting and strengthening the balance sheet|
|Making digital a part of our DNA|
2017 marked the start of an exciting era for Sasol, as we focused on driving value-based growth to enable us to deliver superior returns to our shareholders.
Steering through volatile external markets
Volatility in economic, political and social factors continued to add pressure to Sasol’s results. Oil prices traded at an average of US$50/bbl on the back of geopolitical factors and the rand/US dollar exchange rate strengthened as global macro-economic dynamics overshadowed increased domestic political and economic risks. Both of these factors had a significant impact on our earnings. To mitigate the impact of financial risks on our business, we entered into various hedging contracts to protect the Group against volatility in commodity prices, currencies and interest rates.
Against this backdrop, we showed great resilience and character: we delivered record production volumes at Secunda Synfuels of 7,83mt, and increased our production from our Eurasian Operations by 6%, due largely to management turnaround programmes to increase the efficiency of our operations. Earnings attributable to shareholders for the year ended 30 June increased by 54% to R20,4 billion from R13,2 billion in the prior year. Headline earnings per share (HEPS) decreased by 15% to R35,15 and earnings per share (EPS) increased by 54% to R33,36 compared to the prior year. The prior year EPS was negatively impacted by the R9,9 billion impairment of our Canadian shale gas assets. Core headline earnings, which reflects the sustainable operating performance of the Group, increased by 6% (R2,29 per share) compared to the prior year. We continued to deliver a strong cost performance and managed to contain our cash fixed costs to below inflation in nominal terms, despite the additional once-off costs incurred due to the Mining strike. Through our continued focus on cost control and the commitment of our people, we achieved our Business Performance Enhancement Programme (BPEP) sustainable savings exit run-rate target of R5,4 billion per annum in 2017, a year earlier than planned. We have now closed out our BPEP programme, having achieved the targeted sustainable savings. Going forward we are committed to further drive continuous improvement to identify opportunities to sustainably drive down costs and deliver improved returns to our shareholders and stakeholders.
Sustainably reducing our cost base through continuous improvement
Our significant cash and cost change programmes, implemented since 2014, have placed Sasol in the strongest possible position to respond to the volatile macro-economic environment and staying profitable in a low oil price environment. We are among very few oil and chemical companies globally who are able to generate positive free cash flows from our core operations at oil prices of $40/bbl. We are focused and committed to ensuring that we protect our competitive advantage by being innovative and continuously delivering on our effectiveness and efficiency initiatives, while mitigating our financial risks to create headroom on the balance sheet.
Our current operations, which form the foundation of our business, are robust, and we are focused on enhancing their performance by:
- optimising margins by improving our customer experience and reducing variable costs;
- containing costs below inflation; and
- improving the effectiveness and efficiency of our assets by targeting higher volumes and greater reliability and availability of our plant operations.
In addition, we are continuing with the diversification of our asset base into value-accretive, higher-margin businesses that place us in the best possible position to deliver sustainable value to our shareholders and stakeholders.
The cash flows generated from our robust foundation businesses will enable us to realise our growth aspirations in Southern Africa and North America. Our Lake Charles Chemicals Project (LCCP) in the US is of strategic importance to Sasol and will diversify our earnings base both from a geographic and product-slate perspective. The first units of the LCCP are on track to reach beneficial operation in the second half of calendar year 2018. The funding of the LCCP has been secured by using cash generated from our own operations and various borrowing facilities. The Production Sharing Agreement (PSA) project in Mozambique is progressing according to plan, with six of the 13 wells already drilled. We plan to use the gas from this project both in Mozambique and for our South African operations as we explore opportunities to operate in a lower-carbon economy and extend our gas-fed value chain operations to beyond 2034.
We expect Sasol’s balance sheet to deleverage two years post the completion of the LCCP. Hence we are refining our capital allocation principles to guide how we allocate capital in a disciplined and transparent manner.
To ensure that we remain competitive and cost agile, we adopted a continuous improvement culture that aims to enhance our systems, capital allocation process and further achieve efficiency in our operations to reduce our cost base. This will be achieved by challenging ourselves to work smarter and more efficiently. The use of digital technologies and systems will be a key driver in achieving these efficiencies. We adopted a formal and focused digital initiative to align and guide the organisation forward. To ensure we can unlock maximum value, we engaged with partners who know the digital industry best. Digital technologies are transforming how we work and we aspire to deliver even more superior returns using these.
Global growth remained weak, with International Monetary Fund (IMF) estimates showing that world GDP growth slowed to 3,1% in the 2016 calendar year from 3,4% in the 2015 calendar year. Economic growth in the Eurozone and US was moderate, but broadly better than expected. While China’s economic growth stabilised, large emerging market economies such as Brazil and Russia experienced recessionary conditions. South Africa’s economy grew by only 0,3% in the 2016 calendar year, the slowest growth rate since 2009, mainly due to severe drought conditions, weak business and consumer confidence and policy uncertainty. Commodity and financial market volatility persisted throughout the financial year.
Key risks impacting our financial performance
In order to assess the impact of the operating environment on our business, it is important to understand those factors that affect the delivery of our results.
Sasol’s integrated risk management process has enabled us to remain resilient in the volatile macro-economic environment. We closely monitor the progress of our strategic objectives by considering and planning for various likely financial scenarios in determining whether the risk is within the limits of our risk tolerance and risk appetite as well as testing the robustness of our mitigation actions.
Overall in 2017, Sasol has delivered a strong business performance across most of the value chain, with our Secunda Synfuels Operations (SSO) reporting record volumes and our Eurasian Operations delivering their highest production volumes since 2015. Continued volatility in the macro-economic environment, particularly the stronger rand and low oil price, adversely impacted our financial performance.
Earnings attributable to shareholders for the year ended 30 June increased by 54% to R20,4 billion from R13,2 billion in the prior year.
Headline earnings per share (HEPS) decreased by 15% to R35,15 and earnings per share (EPS) increased by 54% to R33,36 compared to the prior year. The prior year EPS was negatively impacted by the R9,9 billion impairment of our Canadian shale gas assets.
Core HEPS, adjusted for remeasurement and once-off items and the impact of the currency re-evaluation amounted to R39,06 per share which is 6% (R2,29 per share) higher compared to the prior year.
The Sasol Limited Board (“the Board”) considers core headline earnings as an appropriate indicator of the sustainable operating performance of the Group, as it adjusts for period close and once-off items as noted below.
|Translation losses/(gains) (including foreign exchange contracts) arising from a stronger closing rand/US dollar market exchange rate at 30 June 2017||R2,70||(R0,86)|
|Mark-to-market valuation of oil and foreign exchange derivatives using forward curves and other market factors at 30 June 2017||(R1,73)||–|
|Provision/(reversal of provision) for tax litigation||R1,49||(R3,77)|
|Impact of prolonged labour actions at Mining in the first half of the year||R1,45||–|
|Core headline earnings||R39,06||R36,77|
Included in remeasurement items is a partial impairment of our US Gas-to-Liquids (GTL) project amounting to R1,7 billion (US$130 million) due to the uncertainty around the probability and timing of project execution and the reversal of a partial impairment of the Lake Charles Chemicals Project (LCCP) amounting to R0,8 billion (US$65 million), which resulted from lower spot discount rates and the extension of the useful life of the project to 50 years.
The highlights of our operational performance can be summarised as follows:
- SSO increased production volumes by 1% to a record 7,83 million tons;
- Natref production volumes decreased by 5%. Plant shutdowns during the first half of the year contributed to a 3% decrease in production volumes and unplanned downtime during May 2017 led to a 2% reduction in production volumes;
- Our Eurasian Operations increased production volumes by 6% due to stronger product demand;
- ORYX GTL achieved a utilisation rate of 95%, compared to 81% in the previous year, which is higher than market guidance;
- Our Performance Chemicals business reported a 2% increase in sales volumes, which is at the upper end of our market guidance, mainly as a result of stronger demand and improved plant stability;
- Our Base Chemicals sales volumes increased by 3%, slightly below market guidance, due to extended shutdowns at our chlor vinyls and polypropylene plants and a fire at a third party warehouse; and
- Liquid fuels sales volumes in our Energy business decreased by 2% due to a greater portion of production volumes from SSO being allocated to our higher-margin yielding chemical businesses and lower Natref production volumes. Excluding the effect of the Natref downtime and lower allocated volumes from SSO, our liquid fuels sales volumes increased by 1%.
The decrease in the effective corporate tax rate from 36,6% to 28,3% was mainly as a result of the R9,9 billion partial impairment of our Canadian shale gas assets in the prior year. The adjusted effective tax rate, excluding equity accounted investments, remeasurements and once-off items, was 26,5% compared to 28,2% in the prior year.
Profit from operations - price volume variance analysis
Our cash flow generation and utilisation
Free cash flow generation is one of the most important drivers of sustaining and increasing shareholder value. We define free cash flow as consisting of both operating components (operating profit, change in operating working capital and capital investment) as well as non-operating components, including financial income and taxes.
We had negative free cash flow of R16 billion in the year (2016 – R23,2 billion) mainly due to the significant capital expenditure in the year of R60,3 billion. We apply cash generated from operating activities to repay our debt and tax commitments and then provide a return to our shareholders in the form of dividends.
Free cash flow
Cash generated by operating activities
Cash generated by operating activities decreased by 19% to R44,1 billion compared with R54,7 billion in the prior year. Our net cash position decreased significantly by 44%, from R52,2 billion in June 2016 to R29,3 billion as at 30 June 2017, mainly due to the funding of the LCCP and the effect of a stronger closing rand/US dollar exchange rate.
Over the past three years, we have made capital investments of R179 billion, of which R60,3 billion was invested in 2017. We focused our investment mainly in projects in South Africa, Mozambique and the United States, with some investments in Canada, Germany and Qatar. This relates primarily to the LCCP in the US and the Mozambican PSA project.
Our capital investment in South Africa was R17 billion in 2017, which is approximately 28% of the total capital investment for the year. Further details of additions to our non-current assets is provided in notes 16 and 17 to our Annual Financial Statements.
In 2017, the cash outflow of our capital investment programme exceeded the cash retained from operating activities by R28 billion.
Managing our funding plan, debt profile and credit rating
We have prioritised our growth aspirations as we steadily advance our growth strategy, particularly in Southern Africa and North America. Capital investments in these regions will constitute a significant portion of our total capital expenditure over the next 10 years. Following the completion of the LCCP, we expect our gearing to reduce and we have sufficient headroom in our balance sheet to fund these opportunities, and provide a buffer against volatilities.
Solvency and liquidity
Currently the Group is maintaining a positive cash position, conserving the Group’s cash resources through a renewed focus on working capital improvement and capital reprioritisation. The Group meets its financing requirements through a mixture of cash generated from its operations and short- and long-term borrowings. We maintain adequate banking facilities and reserve borrowing capacities. Sasol is in compliance with all of the financial covenants of its loan agreements, none of which is expected to present a material restriction on funding or its investment policy in the near future.
We believe that cash on hand and funds from operations, together with our existing borrowing facilities, will be sufficient to cover our working capital and debt service requirements in the year ahead.
Our long-term capital expansion projects are financed by a combination of floating and fixed-rate long-term debt, as well as internally generated funds. We endeavour to match debt to the currency of the underlying revenue generation.
Net debt increased by R26 344 million in 2017, from R30 166 million at the end of 2016. This was mainly due to the funding of the LCCP. Our debt was made up as follows:
|Long-term debt||81 405||79 877||42 066|
|Short-term debt||2 625||138||534|
|Total debt||84 153||80 151||42 919|
|Less cash (excluding cash restricted for use)||27 643||49 985||48 329|
|Net debt/(cash)||56 510||30 166||(5 410)|
|Increase in funding (proceeds minus repayments of debt)||9 536||30 420||13 286|
The average tenure of our debt portfolio is eight years. Our debt comprises different instruments, which bear interest at a floating or a fixed rate. To mitigate our interest rate risk, we use interest rate swaps, where appropriate, to convert some of our debt into either floating or fixed-rate debt to manage the composition of our portfolio. In July 2015, we entered into an interest rate swap to convert 50% of the US$4 billion term loan facility incurred by Sasol Chemicals (USA) LLC (to part fund the capital expenditure of the LCCP) from a variable to a fixed rate.
Our debt profile at 30 June analysed by currency was:
|Rand||20 922||25||20 138||25|
|US dollar||59 391||70||58 686||73|
|Total debt||84 153||100||80 151||100|
As we execute our growth initiatives in the US, we expect that our debt exposure will be biased towards the US dollar, matching the currency in which marginal revenues will be earned.
Looking forward, we expect a significant cash contribution from the LCCP and our balance sheet to de-leverage by at least 2021. However, to fund our future growth ambitions, we aim to have a gearing ratio of at least 30%. This will mean having to source the appropriate funding mix at the most attractive rates in the market. We have implemented a dynamic funding plan which is based on our latest assumptions and capital requirements. We review the plan on an on-going basis and report on it to the Audit Committee to ensure that we have sufficient liquidity and headroom on the balance sheet in the foreseeable future.
Our credit rating is influenced by some of our more significant risks. These include crude oil price volatility, movements in the sovereign credit rating of South Africa, our investments in developing countries and their particular associated economic risks, the potential for significant debt increase and the execution challenges associated with a number of our planned growth projects if they materialise simultaneously, as well as the risks arising from potential increases in capital costs associated with these projects.
In April 2017, S&P downgraded South Africa’s sovereign credit rating from BBB- investment grade to BB+ with a negative outlook. Based on Sasol’s exposure to the political and economic risks of South Africa, the company’s long- and short-term foreign currency corporate rating was downgraded from BBB/A-2 to BBB-/A-3 with a stable outlook.
Similarly, Moody’s Investors Service downgraded Sasol’s long-term issuer rating to Baa3 (negative outlook) from Baa2 (negative outlook), and raised the national scale issuer rating to Aaa.za from Aa1.za in June 2017.
Delivering on our growth projects
Our rigorous focus on capital discipline and the implementation of our capital allocation framework in 2017 assisted us to optimise our capital expenditure and ensure that the project pipeline is focused and value accretive for our shareholders. The Capital Investment Committee played a significant role in reviewing the project pipeline and opportunities for growth and expansion against stringent criteria.
Our near-to-medium-term strategy focuses on two regions: Southern Africa and North America. Therefore, our focus remains on the execution of our world-scale ethane cracker and derivatives complex – the LCCP – in the United States (US) as well as further developing our footprint in Mozambique.
Overall construction on the LCCP continues on all fronts, with most engineering and procurement activities nearing completion. At 30 June 2017, capital expenditure amounted to US$7,5 billion, and the overall project completion was 74%. The total forecast capital cost for the project remains within the approved US$11 billion budget and project progress is tracking the approved schedule. This budget includes a contingency which, measured against industry norms for this stage of project completion, is considered sufficient to effectively complete the project to beneficial operation (BO) within the approved budget. Various savings opportunities have been identified and are continuously being implemented to mitigate project risks. Although unplanned event-driven risks may still impact the execution and cost of the project, we are confident that the remaining construction, procurement, execution and business readiness risks can be managed within the budget. We continue to monitor the economics of the project against the backdrop of a challenging macro-economic environment. We rely extensively on the views of independent market consultants in formulating our views on our long-term assumptions. Their views differ significantly, from period to period, which again is indicative of the volatility in the market. For these reasons, the internal rate of return (IRR) for the LCCP, based on these different sets of price assumptions, varies between a range of returns which is both higher and lower than our weighted average cost of capital (WACC). At spot market prices, using the last quarter of 2017 as a reference, the IRR is between 8% to 8,5%. We are of the view that limited structural changes have occurred to market fundamentals since February 2017, when we last published the expected long-term IRR of the project, hence, based on our assessment, we are of the view that the IRR is in a range of 7% to 8% (Sasol WACC at 8% in US$ terms) based on conservative ethane prices. The cracker, however, remains cost competitive and is at the lower end of the cost curve for ethylene producers. We will continue to focus on factors that we can control, which are progressing the cost and schedule of the project according to plan. The updated economics, earnings profile, capital spend and sensitivities are detailed in the Analyst Book available on our website, www.sasol.com.
Construction of our 50% joint venture high-density polyethylene plant with Ineos Olefins and Polymers USA is essentially complete and is on track for start-up during the second half of the 2017 calendar year. Our strategic R14,0 billion mine replacement programme, which will ensure uninterrupted coal supply to SSO in order to support Sasol’s strategy to operate its Southern African facilities until 2050, is nearing completion. The development of the Production Sharing Agreement (PSA) licence area remains on budget and schedule. We have successfully drilled and tested four oil wells and two gas wells, and captured 3D seismic over parts of the PSA area.
Managing cash fixed costs
We continued to drive our cost-containment programme and managed cash fixed costs well below inflation in nominal terms, when compared to the prior year. The strong cost performance was achieved by an accelerated sustainable delivery of our BPEP and RP.
Our BPEP achieved sustainable cost savings of R5,4 billion in 2017, a year earlier than expected. This was enabled through focused management actions and the accelerated delivery on certain key levers. We will close out the BPEP and track the sustainable savings on key elements, such as headcount, to ensure that we do not diminish the savings achieved. We will also apply the same amount of diligence to our low oil price RP. Accordingly, we have increased our sustainable cash cost savings target from R2,5 billion to at least R3,0 billion by 2019.
Going forward, our objective to keep our costs in line with inflation may be negatively impacted by:
- expenditure to ensure continued plant stability and reliability;
- labour and electricity costs which escalate above inflation;
- costs incurred on growth initiatives and new projects; and
- currency effects.
To mitigate these risks, we are focusing on continuous improvement to address the structural shift of the energy prices by sustainably improving our margin contribution and cost base delivery.
Embracing digital technology to drive effectiveness and efficiency
To improve effectiveness and efficiency in how we do business, we are focused on using technology to redefine our customer experiences, improve operational efficiency, and embed digital advantages throughout Sasol’s business. To embrace digital in the company, we are evaluating our resources and capabilities to ensure that we can deliver on the digital roadmap for Sasol. We have started to implement digital solutions in some areas of our business. These include our supply chain function and our Digital Catalyst pilot which is aimed at transforming how our chemicals customers do business with us across the full value chain.
Our objective is to embed digital across our value chain to improve the effectiveness and efficiency of our operations, while ensuring we remain within our risk and governance structures.
Sasol’s shareholder base consists primarily of large institutional shareholders, as well as a significant number of value investors. The top 20 shareholders collectively own more than 60% of Sasol’s outstanding shares. Approximately two-thirds of our shareholder base is in South Africa.
Total shareholder return
We return value to our shareholders by way of both dividends and share price appreciation.
Total shareholder return (TSR) is a measure of the performance of the Group's shares over time, and combines both share price appreciation and dividends paid to indicate the total return to a shareholder over the period. Sasol’s TSR for the five-year period ending 30 June 2017 was 38% in rand terms and a negative 37% in US dollar terms, which is in the mid-range of our peers.
The performance of the share price over this period was influenced by a combination of factors which we could control (directly related to improved operational efficiency and various cost-containment initiatives) as well as factors beyond our control, such as market sentiment and the partial recovery of the global economy following the 2008 economic crisis and continuous macro-economic uncertainties. The volatility of the crude oil price, coupled with the rand/US dollar exchange rate, further contributed to the lower share price performance.
To address this, the Group has put a number of measures in place to:
- improve project execution by implementing lessons learnt from previous projects;
- actively manage the balance sheet to address external volatility;
- focus on continuous improvement to address the structural shift in the energy price by improving the efficiency of our operations; and
- work with the government and other stakeholders to manage the impact of regulations on Sasol’s South African business.
Our dividend policy is to pay dividends within a dividend cover range based on HEPS. Taking into account the current volatile macro-economic environment, capital investment plans, our cash-conservation initiative, the current strength of our balance sheet, and the dividend cover range, the Board has declared a gross dividend of R12,60 per share (15% lower compared to the prior period). The dividend declared is in accordance with our dividend cover policy of 2,2x to 2,8x of annual HEPS.
The dividend demonstrates our commitment to return value to shareholders through dividend payments.
Outlook for 2018
2018 is likely to be a watershed year for Sasol as we prepare for the first units of the LCCP to come on line. Our core focus will be on project execution, to ensure that the cost and schedule milestones are adhered to and that the business processes and systems are ready for this mega project. Once the LCCP is fully operational it will reshape Sasol to be more of a chemicals company, drive our strategy and accelerate growth for our shareholders.
We expect economic conditions to be very similar to 2017, with average oil and commodity prices remaining low, the rand exchange rate remaining volatile and global chemicals demand increasing. While the rand has strengthened in recent months, the currency still faces a number of near-term risks as the potential for a further sovereign credit downgrade has not been eliminated and domestic growth prospects remain challenging. Global political uncertainties will remain high, providing a downside risk to the global economic outlook.
The Group’s strategic positioning, the execution of our hedging strategy and our strong balance sheet will enable us to withstand these uncertainties for the sustained benefit of our shareholders. Through our committed employees, we will continue with our strict discipline in managing factors within our control, including volume growth, cash and cost control, project execution and effective capital allocation.
We expect an overall strong operational performance for 2018, with:
- Base Chemicals US dollar product prices to recover during the year and our South African Base Chemicals sales volumes to be between 3% to 5% higher than the prior year; in addition our US high-density polyethylene plant will contribute an additional 80kt to 110kt during the second half of the year. Normalised operating profit is estimated to be between R3 billion to R5 billion;
- Performance Chemicals sales volumes, excluding merchant ethylene which will now be accounted for in Base Chemicals, to be between 2% to 3% higher, with average margins for the business remaining resilient;
- Liquid fuels sales volumes to be marginally below 60 million barrels due to planned shutdowns at Natref;
- Gas production volumes from the Petroleum Production Agreement to be between 114 bscf to 118 bscf;
- Average utilisation rate at ORYX GTL in Qatar to exceed 90%;
- Normalised cash fixed costs to remain in line with SA PPI;
- Cumulative capital conservation and cash flow contribution from our RP to be close to the upper end of our targeted range of R65 billion to R75 billion by the end of 2018;
- Capital expenditure, including capital accruals, of R59 billion for 2018 and R37 billion for 2019 as we progress with the execution of our growth plan and strategy. Capital estimates may change as a result of exchange rate volatility;
- Our balance sheet gearing up to a level of between 35% and 44%;
- Rand/US dollar exchange rate to range between R13,00 and R14,50; and
- Average Brent crude oil prices to remain between US$45/bbl and US$55/bbl.
Sasol is well positioned to achieve its targets and visions and I would like to thank our employees and stakeholders for their important contributions throughout the year. Through the delivery of our cost-containment programmes, technology improvements, innovation and stability in operations, we will continue to focus on improving our profitability and delivering superior returns to shareholders. We will continue with disciplined capital allocation and prioritising dividends for our shareholders. Our balance sheet remains strong and is again testament to our commitment to deliver value. We will continue to diligently manage each of our value drivers, to create value for our shareholders on a sustainable basis.
Chief Financial Officer