• Earnings conundrum:   Sasol reported that it expects 1HFY21 basic earnings and headline earnings will increase by more than 100% while core HEPS will decline by 5% to 25%.  These distortions in earnings are problematic for valuation purposes, setting a consensus as well as peer group comparisons based on multiples.
  • Reported earnings distorted:  Basic earnings are important to forecast equity in the balance sheet but are distorted by remeasurement items and period end adjustments.  HEPS exclude remeasurement items but remain distorted by currency translations and unrealised hedge gains and losses during times of extreme currency and oil price volatility.
  • Core earnings also a problem:  Sasol’s reported core HEPS is an important measure as it will determine future dividends.  Management compensation was also impacted by core earnings in previous years.  We show, however, that Sasol has changed the definition of core earnings often and the application of the definition remains subjective.  This impacts the utility of the measure.  In our view core earnings also do not reflect the real profits attributable to shareholders.
  • Adjusted EBITDA:  Sasol reports adjusted EBITDA which reflects operating cash flow.  The definition and its application have also been more consistent.  Using adjusted EBITDA to estimate earnings provides a truer measure of earnings, generally lower than reported core HEPS.
  • Derating expected:  While Sasol has traded close to a 10x forward PE for many years, recent volatility in earnings have impacted this multiple significantly.  Declining return ratios and concerns over emissions should also see a future derating in the multiple.
  • All about cash flow:  Ultimately cash flows remain the most reliable measure to value the business.  Due to the difficulty in forecast oil and currencies, the price to rolling free cash flow in the current year appears to be the most consistent ratio over a long period.

Share price: At a long run oil price of $60/bbl we value Sasol at R175/share using an economic profit approach and adjusting for a number of future risks.  Our rating remains at Outperform.