Even With a Price Cut, Aramco Isn't Cheap

Liam Denning
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Even With a Price Cut, Aramco Isn't Cheap

(Bloomberg Opinion) -- Saudi Arabians now have the chance to go super-long.

The latest inducement to buy into the IPO of their national oil company is apparently being able to borrow money on a two-for-one basis to buy the shares, as reported by Bloomberg News. Having ditched earlier plans for a big global offering (see this), Saudi Arabia’s biggest earner will now sell stakes mainly to Saudi Arabians using money lent to them by Saudi Arabian banks. Given Saudi Aramco’s central role in the economy, this is somewhat akin to borrowing money to fill your 401K with your employer’s stock.

Still, an overwhelmingly domestic IPO means that stock competes mostly with domestic benchmarks. And with dividends guaranteed for several years and bonus shares on offer for loyal investors, Aramco screens well on that basis. The mooted price range implies a dividend yield of about 4.4% to 4.7%, higher than the Tadawul All-Share’s 3.8%, and more than the sub-4% yields of bonds issued by the company and the state.

Aramco’s prospective yield also implies relatively flat oil prices: roughly $60 Brent crude oil, long term, on my numbers (see this for assumptions)(2).

That flat oil price embedded in the valuation range is reassuring in one sense. If oil prices jump for some reason (other than attacks on Aramco’s facilities), then that, combined with the floor provided by the dividend guarantee, could fuel gains.

That $60 oil price, however, is also the flip side of a sanguine view on Aramco’s risks — the lower the discount rate on the cash flows, the lower the oil price required for a given valuation. This is the benefit to Aramco’s current state shareholder of keeping the IPO mostly at home, where the risk profile and range of competing investment options look very different compared to the view in such places as New York, London and Tokyo.

A test of this looms almost immediately, in the form of an uncertain outlook for oil balances and prices in 2020. Aramco’s stock is due to price the day of the next OPEC meeting, with speculation rife the group may announce even deeper cuts to offset an expected surge in non-OPEC supply.

As it is, assuming 11 million barrels a day of crude oil production and $65 oil implies Aramco’s valuation range puts it on a 2020 price/earnings multiple of about 15 to 16 times, toward the top end of its peer group and well above other emerging-market national oil companies. Assume production of 9.5 million a day and $60 oil, and that multiple jumps to 19 to 20 times.

The inducements not to sell may mute the impact of weaker macro conditions next year — which otherwise could be exacerbated by the small float in a small stock market. In avoiding a global IPO, Saudi Arabia obtained the dubious benefit of a higher headline price. That doesn’t mean its citizens are getting Aramco on the cheap, especially if they’re borrowing for the privilege.

(1) Quick recap of assumptions here.Crude oil production of 11million barrels a day, net refining margins of $3 a barrel and chemicals net margins of $100 a tonne. Upstream production costs (including SG&A, exploration and R&D) of $3.50 per barrel of oil equivalent (BOE). Depreciation of $2.50 per BOE. Corporate tax rate of 50% and interest rate on debt of 3.85%. Capex of $35 billion. Dividend from Saudi Basic Industries Corp. equivalent to 70% of estimated mid-cycle free cash flow of $7.5 billion. Natural gas and ethane production of 9 and 1 billion cubic feet priced at $8.50 and $10 per BOE, respectively. Natural gas liquids production of 1.3 million barrels a day, priced at 50% of Brent crude. Refining utilization of 95% on projected net capacity of 3.9 million barrels a day. Chemicals utilization of 90% on projected net capacity of 20.8 million tonnes per year.

To contact the author of this story: Liam Denning at ldenning1@bloomberg.net

To contact the editor responsible for this story: Mark Gongloff at mgongloff1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

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