Sasol Limited (SSL) is an international integrated chemicals and energy company that leverages technologies and the expertise of their 31 270 people working in 32 countries. Moreover, SSL develop and commercialize technologies, and build and operate world-scale facilities to produce a range of high-value product stream, including liquid fuels, chemicals, and low-carbon electricity.
SSL Value Investing Approach
The Investment in Enterprise Value on SSL
The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value EV) is the present value of the entire company. Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash.
Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)
The market value of Sasol was stable at $26 billion average and moving at a rate of 11 percent. While the total debt of SSL represents a 52 percent average while the cash and cash equivalent represent a 50 percent average of the enterprise value, therefore, enterprise value was greater by 2 percent against market value. Purchasing the entire business of SSL is paying 98 percent of equity and 2 percent debt.
The cost of buying the entire business of SSL to date, November 7, 2012, will be $27546 at $44.57. The market price to date is 42.86.
Net Current Asset Value (NCAV) Method
The net current asset value approach tells us that the stock of SSL was trading at an overvalued price from 2007 to 2012. Because the market value was greater than the 66 percent of NCAVPS. The price of the stock of SSL was expensive because the stock was trading above the liquidation value of SSL.
Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation
Another stock test by Graham is by using market capitalization and dividing it to net current asset value (NCAV). The idea is, if the result does not exceed the ratio of 1.2, then the stock passes the test for buying.
The stock price of SSL was undervalued for 2007 to 2012 because the ratio was lesser than the 1.2 ratios. Furthermore,
The margin of Safety (MOS)
The margin of safety is used to identify the difference between company value and price. Value investing is based on the assumption that two values are attached to all companies, the market price and the company’s business value or true value. Graham called it the intrinsic value. According to Graham, the investor should invest only if the market price is trading at a discount to its intrinsic value. Value investing is buying with a sufficient margin of safety. Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. The enterprise value is used because I think it is a much more accurate measure of the company’s true market value than market capitalization.
The margin of safety tells us that there was a margin of safety for 2007 to 2012 at a rate of 95 percent average. The margin of safety was stable at 95 percent all throughout its 5 years. Moreover, the stock price was cheap and it is over the requirement of Graham at 40-50 percent MOS.
Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate)
The table above shows the historical intrinsic value for Sasol. The intrinsic value was increasing and this represents the true value of the stock. It factors the earnings per share (EPS) and the sustainable growth rate (SGR). While EPS is the portion of the earnings which is attributable to the ordinary shareholders. It is the earning power of the company. While the SGR shows how fast a company can grow using internally generated assets without issuing additional debt or equity or in other words it shows how much growth a company can potentially generate internally given its level of profitability.
Furthermore, to arrive at the intrinsic value, the annual growth rate must be calculated first by multiplying SGR to (9+2). Then the result which is the annual growth rate is multiplied to EPS to get the intrinsic value. The table below will show us the historically sustainable growth rate and how it is calculated.
Sustainable Growth Rate (SGR)
The return on equity (ROE) and the payout ratio factors SGR.
Return on Equity clearly shows how many dollars of earnings result from each dollar of equity.
The average ROE was $19 and the average payout ratio was $40, while SGR was $11 average.
There are two approaches to calculating the sustainable growth rate and that is by using the relative ratio for return on equity and the average return on equity. I summarized the results of these two approaches in the table shown below.
Using the average ratio for SSL, it produces a higher result and it is more favorable for the company. As we can see, it affected the results of the intrinsic value and the margin of safety. The graph below will make us understand it better.
The graph shows that the intrinsic value (IV) line is far above the enterprise value (EV) line. This means, that there was a margin of safety for SSL. The space between the two lines is the margin of safety.
Price to Earnings/Earning Per Share (P/E*EPS)
This method will determine whether the stocks are undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS). And comparing it to the enterprise value per share, we can determine the status of the stock price.
The P/E*EPS valuation shows that the stock price was undervalued. Because the P/E*EPS result was higher than the market value. The market value represents 11 percent of the P/E*EPS ratio, therefore the stock was trading at the cheap price.
The Relative and Average Approaches
There are actually two ways of calculating P/E*EPS valuation, one is by using the relative price to earnings ratio and the other one is by using the average P/E ratio. The summary of the results was in the table below.
Enterprise Value (EV)/Earning Per Share (EPS) or (EV/EPS)
We use this ratio to separate price and earnings in the enterprise value. By dividing the enterprise value of projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).
In the EV/EPS valuation, the price (P/E) represents 3 percent and the earnings (EPS) represents 97 percent. It indicates that the price was undervalued and cheap in 2007 to ttm6 2012.
Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA).
It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses. This metric is useful for analyzing and comparing profitability between companies and industries.
The average EV/EBITDA was 1 time. This means it will take only one year of the cash earnings to cover the costs of buying the business.
This valuation also shows the profitability of the company, for SSL, its net earnings were 14 percent average. The company’s free cash flow was negative for 2010, 2012 and the trailing twelve months.
The market value of Sasol was stable at $26 billion average and was moving at a rate of 11 percent. On the other hand the total debt was 52 percent and the cash and cash equivalent was a 50 percent average. Buying the entire business of SSL will be paying 98 percent of equity and 2 percent of total debt. The costs of buying SSL to date would be $27546 at $44.57 per share. The market price to date is $42.86 per share.
The margin of safety
On the other hand, the margin of safety was averaging 95 percent. While the intrinsic value was $1041 average. The sustainable growth rate was $11 average moreover, the annual growth rate was $32 average. In addition, the return on equity was $19 average while the price of earnings was $13 average.
Furthermore, the price was undervalued from 2007 to 2012. While the EV/EPS valuation shows that the price (P/E) was 3 percent and the earnings (EPS) was 97 percent. It will take one year of the earnings to cover the costs of buying the entire business of SSL.
The margin of safety was 95 percent and the stock was trading at an undervalued price. Therefore I recommend a BUY in the stocks of Sasol Limited (ADR).
Researched and Written by Cris