Improvements in petrochemicals company Sasol’s leverage and credit metrics have led to S&P Global Ratings adjusting its outlook on the business profile to “slightly weaker” owing to having underperformed against the agency’s expectations.
While this poorer-than-expected performance is largely owing to advancing climate change risk in the energy segment, S&P indicates that Sasol’s funds from operations (FFO) to debt ratio improved to 36% in the 2021 financial year, compared with 13% in 2020.
That is well ahead of the November 2020 expectations of between 16% and 17% for 2021 and an average of 18% thereafter.
Based on revised forecasts, S&P now expects FFO to debt of between 35% and 40% in 2022, rising gradually in 2023 and 2024. This improvement in Sasol's leverage and credit metrics is owing to a combination of successful asset disposals, a significant recovery in global oil and chemicals prices complemented by a robust hedging strategy, and the implementation of strict cash preservation strategies since March 2020, S&P states.
Nonetheless, both oil and chemicals prices and the rand:dollar exchange rate remain highly volatile and Sasol's earnings before interest, taxes, depreciation and amortisation (Ebitda) will be sensitive to changes in these factors in S&P’s forecast period to 2024.
Consequently, S&P believes a slightly longer record of FFO to debt at or above 2021 levels is required to support an upgrade.
Recovery in credit metrics depends on higher operating cash flow generation and management's measures, including asset disposals.
S&P previously noted that Sasol's high sensitivity to lower oil and chemicals prices and a strong rand translated into persisting cashflow volatility and forecast risk, and considered that lower debt may not, on its own, be sufficient to return credit metrics to levels commensurate with a lower financial risk profile within the forthcoming 12 to 18 months.
However, Sasol's new strategy provides some clarity on the company's future focus, which includes more sustainable feedstocks and a pivot toward specialty chemicals.
Sasol's new strategy (Sasol 2.0) is to be implemented in several phases, with the initial phase to 2025 focused on strengthening the balance sheet, portfolio optimisation, restoring dividend payments and progressing on climate change goals.
Thereafter, the roadmap targets a self-funded 30% reduction in greenhouse-gas emissions by 2030, and the company reaching carbon net zero status by 2050.
From a credit perspective, the strategy clarifies Sasol's financial policy priorities, which include a commitment to a long-term net leverage target of 1.0x-1.5x, a continued focus on cost optimisation, an optimal contribution from chemicals and a pivot toward investments in specialty chemicals and more sustainable feedstocks.
At a high level, the strategy appears well formulated to meet both investors' risk appetites and their financial return objectives, while also addressing Sasol's heavy environmental footprint linked to coal-fired power, coal feedstocks and ageing plants with high levels of carbon dioxide (CO2) and sulphur emissions in its South African operations.
“We expect the path toward higher specialty chemicals contributions and greener feedstocks to be gradual; however, we, therefore, do not expect to factor them into our business risk assessment for some time,” S&P comments.
The agency’s positive outlook reflects that rating upside could materialize over the next 12 months if Sasol maintains its ratio of FFO to debt sustainability above 30%, despite volatility in the global energy and chemicals markets.
The risk of a downgrade is limited, owing to the ratio of FFO to debt after adjustments have made significant headroom above 12% to absorb negative developments, such as an Ebitda reduction owing to lower oil or chemical prices or demand disruptions, operational setbacks, or increased capital expenditure or dividends.
“We could lower the rating if Sasol experiences liquidity stress that constrains its ability to pass our rating-above-the-sovereign stress test that caps the rating at the sovereign level, but we see this outcome as remote, given our strong liquidity assessment,” S&P warns.
Raising the rating, on the other hand, would be dependent on Sasol's adjusted FFO-to-debt ratio remaining sustainably above 20% in mid-cycle conditions, and above 30% in high-cycle conditions, such as what is currently being experienced.