November 14, 2019

Saudi Aramco: IPO Ahead

by Tajinder Dhillon.

Two trillion dollars is larger than the annual GDP of Canada – and the market valuation Saudi Aramco is hoping to achieve when it lists a portion of its state-owned company on the Saudi stock exchange (Tadawul).

Saudi Aramco is the world’s largest integrated oil and gas company and that market valuation would also be larger than the market capitalization of the 15 biggest oil and gas companies globally.

While complete details have yet to be announced, it will go down as the largest flotation in history. The success of the IPO will be a critical component in achieving “Saudi Vision 2030,” a plan steered by the crown prince of Saudi Arabia, Mohammad bin Salman, to diversify the country’s economy and reduce its dependency on oil revenues.

Saudi Aramco boasts itself as a juggernaut: it produces one in every eight barrels of crude oil globally in addition to having proven liquid reserves five times larger than Exxon Mobil, Chevron, BP, Total, and Royal Dutch Shell combined. In 2018, it produced 13.6 million barrels per day of oil equivalent, including 10.3 million barrels per day of crude oil. It is also the fourth largest integrated refiner in the world, having a gross refining capacity of 4.9 million barrels per day in 2018.

Saudi Aramco reported 2018 revenues of $355 billion and net income of $111 billion, making it the world’s most profitable company as seen in Exhibit 1. It also demonstrated best-in-class margins, reporting an earnings before interest and tax (EBIT) margin of 59.8% and a net profit margin of 31.2%. This compares to an average EBIT and net profit margin of 12.4% and 8.3% for the S&P 500 Integrated Oil & Gas sub-industry according to I/B/E/S data from Refinitiv. It can produce best in-class margins given its position as the lowest cost producer globally, as of 2018. According to Saudi Aramco’s prospectus, the cost of producing a barrel of oil is approximately $7.50 (including capital expenditures per barrel), providing a foundation for strong cash flow generation.

Exhibit 1: Saudi Aramco Revenue & Net Income

Reliance on oil prices

Despite strong fundamentals, there are key risks to consider: outlook for global GDP growth, political and social unrest in the Middle East, and most importantly, oil prices. Sales of crude oil accounted for 56.4% of Saudi Aramco’s consolidated revenue in 2018.

The price of oil dramatically influences the company’s revenues and profit. For example, the prospectus highlights this remarkably when 2016 revenues were $134.5 billion, which increased to $263.0 billion in 2017. A 95% increase in year-over-year revenue was primarily attributable to higher average realized oil prices ($40.7 per barrel in 2016 vs. $52.7 per barrel in 2017).

Saudi Aramco indicates the results of operations and cash flows are significantly impacted by international crude oil supply and demand and the price at which it can sell oil. Regarding supply and demand, the prospectus highlights the growth in shale oil production as having an impact on oil prices. Any developments and technological improvements in how shale can be produced will likely lower oil prices as this will increase the supply of oil. OPEC has intervened in oil markets since 2017 by curtailing oil production in hopes of removing excess supply of crude oil.

As a result, the future path of oil prices will influence the valuation Saudi Aramco will be able to achieve upon listing. Exhibit 2 highlights the strong correlation between oil prices and market capitalization of oil companies globally.

Exhibit 2: Correlation between Market Cap vs. Brent Oil

Saudi Aramco aligned to institutional investor preferences?

The listing of Saudi Aramco will cause shifts in how much money is allocated to the “Big Five” oil and gas companies owned by institutional investors. Using the StarMine Smart Holdings Model, we can assess how the company characteristics of Exxon Mobil, Chevron, BP, Total, and Royal Dutch Shell are aligned with current institutional investor preferences.

StarMine Smart Holdings Model predicts forward changes in institutional buying and selling by determining which factors are currently favored by institutional investors and which stocks are becoming more or less desirable in the current environment. Twenty-five fixed factors across volume, price momentum, profitability, value, growth, analyst revisions and leverage are utilized and ranked from most popular to least.

At the moment, volume is ranked most popular, which is often typical for institutional investors who buy and sell in large quantities. Price momentum also remains valued by institutional investors in addition to profitability and value, while leverage is not a major concern.

The Big Five are highly liquid securities which score well in the model. However, the Big Five have traded sideways during the last year, which results in poor price momentum.  Growth has also been poor among the group, with EPS trailing 5-year CAGR values of: Exxon Mobil (-8.2%), Chevron (-7.0%), BP (-17.6%), Total (-3.0%), and Royal Dutch Shell (1.6%).

As a result, they are rated from “not in favor” to “neutral” among institutional investors. The current StarMine Smart Holdings Model score are as follows (1-100 percentile regional ranking): Exxon Mobil (18), Chevron (40), BP (14), Total (48), and Royal Dutch Shell (58).

Exhibit 3 is an example of how the model is presented in Eikon, using Exxon Mobil as an example.

Exhibit 3: StarMine Smart Holding Model for Exxon Mobil


Source: Eikon by Refinitiv

In comparison, Saudi Aramco indicates that it has higher profitability and cash flow than each of the Big Five in addition to having the lowest gearing ratio of the group (target gearing ratio of 5% to 15%). Saudi Aramco has indicated it will pay $75 billion in cash dividends in 2020. Based on this figure, the dividend yield could be as low as 3.75% (assuming a $2 trillion valuation) or as high as 7.0% ($1 trillion valuation). Chevron has the lowest dividend yield out of the group at 3.9% while BP and Royal Dutch Shell offer the highest yield at 6.3% and 6.1% respectively.

As a result, Saudi Aramco appears to be well-aligned to institutional buying preferences. The question will be whether a large enough amount of the offering will be available to purchase by asset managers upon its listing. One possible concern for asset managers will be around voting rights and if they will have a large enough voice to influence company decisions.

Win for Tadawul Exchange

The listing of Saudi Aramco will be a significant landmark for the Saudi stock exchange, who can catapult into one of the largest exchanges globally. Depending on the valuation of Saudi Aramco, the Saudi Tadawul All Share Index could surpass the FTSE 100 in size and join the group of largest exchanges globally as seen in Exhibit 4.

Exhibit 4: Market Capitalization of Stock Exchanges

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