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1、 Disclosures with legacy moats, the historical asset base generated high returns but opportunities to drive the same returns on incremental investment will be limited; while companies that can continue to reinvest at high rates, will, in turn get capitalized at higher multiples. In the commodity che
2、mical space, with widely diffused technology, moats are driven primarily by cost advantages, and cost advantages accrue largely from advantaged feedstock positions. Now, by definition, advantaged feedstock is scarce (if it were widely available, it wouldnt be advantaged); so the commodity chemical u
3、niverse largely falls into the legacy moat bucket, with the one caveat that the size of the moat isnt structural, but cyclical given that it depends on the competitiveness of the advantaged feedstock which in turn depends on comparative energy prices. The primary challenge that these commodity chemi
4、cal businesses then face is reinvestment and capital allocation. You have a core business that throws out great cash flows, and by definition a limited opportunity within that core, and that is hard to replicate. Incremental investment often tends to dilute the moat and if you dont reinvest, then yo
5、u have a cash utilization problem. The reinvestment challenge is the same, whether the company is based in developed or in emerging markets. In this note, we compare and contrast four companies within our coverage universe that have had strong legacy competitive positions and their responses to thei
6、r reinvestment challenges. These responses range from geographic diversification (Sasol, SABIC), greenfield reinvestment (Sasol, DWDP) to debottlenecking and buybacks (LYB). Moats and growth(s) Moats in commodity chemicals are driven by advantaged feedstock positions .which by definition are scarce,
7、 leading to a reinvestment and capital allocation challenge Theres a wide spectrum of responses to this challenge, from SABIC to LYB to Sasol; and a fine line between overinvestment and stasis 3 EQUITIES CHEMICALS 12 February 2018 Sasol Sasols growth strategy is a product of the domestic environment
8、 in South Africa. That domestic South African business is a classic example of a business with a legacy moat, with the size of the moat being a function of energy prices, but one with limited to no reinvestment potential. We view that business, over time, as a declining annuity. Its a business that
9、effectively should be thought of as an integrated coal-based refiner. The company through the Fischer-Tropsch Coal to Liquids process, basically transforms, domestic coal into refined fuel products and into chemicals. At its core, this business captures the arbitrage between coal prices and oil and
10、layers an element of refining margins and chemical spreads on top of that. In energy price environments of over USD40/b, the business has strong core earnings power and high cash generation. However, given concerns around capital costs and carbon emissions, this is not a business that has any meanin
11、gful growth prospects in South Africa, in our view. Over the long term, we view this business as being effectively capped from a volume perspective, with some room for downside volume surprises as facilities age and maintenance capex rises over time. Over the long term, we would also view prices, on
12、 a normalized basis, as being fixed (and equivalent to our long term oil price and rand assumptions) and more importantly, not in the companys control. And, in the long run, costs will rise broadly in line with inflation in South Africa. So, Sasol has a domestic core business, that while being highl
13、y profitable and cash generative, has capped volumes, fixed prices on a normalized basis and rising costs as we mentioned earlier, a declining annuity, that investors tend not to capitalize at particularly high multiples. The natural response to this domestic situation is to use strong domestic cash
14、 flows to develop another earnings growth stream, preferably outside of South Africa and thats been the companys strategy all the way through the last decade or so. We wrote about Sasol being ex easy growth in our initiation way back in Dec 2011 in Sasol: The growth conundrum. Even at that point, th
15、e company had struggled to deliver on its 10 year growth targets, set in 2003 of 450/500kbpd of international volume, having only managed to deliver 34kbpd of volume (through the Oryx Gas to Liquids (GTL) project in Qatar). Execution on growth has not materially improved in the last seven years, wit
16、h the company first deciding on, and later abandoning GTL projects in Canada and the US, before finally deciding to bet heavily on a US ethane cracker project, which went from being USD5-7bn, coming on- stream in 2016, to now being USD11bn in capex, coming on by end 2018. Sasol energy volumes (mn bbl) Sasol chemical volumes (ktpa) Source: Corporate reports Source: Corporate reports 0.010.020.030.040.050.060
