ArabDigest.org: Aramco IPO: milestone or millstone?

 

Aramco IPO: milestone or millstone? Summary: On 5 December 2019, Saudi Aramco’s initial public offering on the Saudi stock exchange Tadawul immediately made it the world’s largest publicly traded company but the IPO has come with a cost that is still to be reckoned with. We are again grateful to Alastair Newton for the article below. He worked as a professional political analyst in the City of London from 2005 to 2015. Before that he spent 20 years as a career diplomat with the British Diplomatic Service. Aramco’s guaranteed dividend to shareholders is proving to be a major millstone around the company’s neck. A year ago, as the Aramco IPO was under way, a great deal was being written about the hurdles it faced. Arab Digest (naturally) contributed its share, notably in the 7 November and 11 November newsletters. The latter focused on in the particular, i.e. yield on investment, noting the importance of the guaranteed minimum dividend of US$75bn annually for the first five years to attract non-domestic investors. This was coupled with a belief among some experts that this already impressive sum would be topped up with at least US$10bn in bonus payments — seemingly realistic at a time when Brent crude had pretty consistently topped US$60 per barrel since January 2019.

On Monday Houthi forces fired a missile that struck Saudi Aramco’s North Jeddah Bulk Plant. Saudi authorities said domestic fuel supplies were not affected by the attack, with operations resuming three hours after the event.

To be fair to the optimists, even the most cautious Cassandras did not factor in Covid-19 (even though we now know it was already ‘out there ’ a year ago) and its devastating impact on the global economy. Given this additional burden, which has pushed Brent down to no more than US$46 pb since early March (and, at times, as low as US$20 pb), Aramco deserves credit for sticking to its promised dividend payments, as set out in the press release on the company’s 2020 Q3 results.

On the face of it, this has not really helped Aramco’s share valuation, up just 0.7% on the year (i.e. about 13% above the IPO price). But compare this to the 40% fall in the value of the shares of BP and Shell, both of which have cut dividends to preserve cash, and the benefit is much clearer. (The corollary of this is, of course, that, outside of the dividend, Aramco’s share valuation, which underpins the company’s US$1.9tr valuation, looks to be far too generous.)

Furthermore, the Kingdom itself, struggling to plug a double-digit budget deficit , would be in an even deeper hole were it not for Aramco’s dividend pay outs, of which it receives the lion’s share.

But there is a non-negligible price to pay.

Most immediately — and in addition to ongoing job-shedding and other cost-cutting measures — for the first time since its successful April 2019 issuance, Aramco was forced to return to the debt market earlier this month to raise US$8bn to help pay the Q3 dividend of US$18.75bn. This was necessitated by the whopping 45% fall in profits in the quarter.

Aramco is fortunate in that the quest for yield in the current monetary climate is such that quality emerging market debt is always going to be highly sought — and interest rates on such debt commensurately affordable (in this case only slightly higher than Saudi government bonds). Nevertheless, debt is still debt and this latest issuance, coupled with the loans taken out to acquire the petrochemicals manufacturing giant SABIC, has taken Aramco’s gearing (i.e. the measure of debt relative to equity) to 21.8%, well above its 5-15% target range.

This, in turn, has longer-term consequences.

Press reporting points to a major reassessment of plans to get into refining in both China (a joint venture announced during Crown Prince Mohammed bin Salman’s visit to the country last year) and India, in partnership with Reliance. Furthermore, according to the Wall Street Journal (subscriber access only), a US$6.6bn expansion of the Motiva refinery in Texas is, at best, on hold; and a proposed natural gas collaboration with Sempra Energy in the US may fall through. Other deals, also being subjected to an internal review process launched in September, may be scaled back or scrapped despite the negative implications not only for Aramco’s long-term profits but also for the Kingdom’s standing geopolitically.

However, as always with Aramco its prospects hinge overwhelmingly on the oil price. Even a ppb for Brent of US$46 suggests that investors, buoyed by recent announcements on vaccines, believe that the end may now be in sight as far as the worst economic consequences of Covid-19 are concerned. Nevertheless, having skimmed through a range of forecasts for oil prices through 2021 (and putting to one side outliers like Goldman Sachs) things still do not look too great for Aramco on this count. Notably, the authoritative International Energy Agency currently has Brent averaging just US$46.59 in 2021, which is about par.

Personally, I am firmly in the more conservative camp. For sure, the recent news on vaccine development is very encouraging. But there is still a long way to go on production and distribution, not least determining who is going to pay for mass vaccination in developing countries, as German Chancellor Angela Merkel remarked at the recent G20 summit.

As for the world’s biggest economy and oil consumer, the United States, job losses are already surging again and it is patently clear that nothing is going to change policy-wise this side of 20 January — with the possible exception of Congress passing a (too?) modest fiscal stimulus bill. And when Joe Biden is sworn into office, he will face major hurdles getting Covid-19 under control and the economy back on track, even putting to one side the non-negligible probability that a critical mass of Americans will refuse to be vaccinated. Furthermore, although the roll-out of Mr Biden’s climate agenda will also face domestic challenges and will not by any means be a rapid game-changer, the mere fact of the world’s four largest economies - China, the EU, Japan and the US - being politically aligned on this issue does highlight the relevance of the peak oil demand question explored (again) in the 28 September newsletter.

All this being said — and for all its perceived flaws at the time — the Aramco IPO was undoubtedly a milestone, both for the company and for Saudi Arabia at large. However, the guaranteed dividend incentive looks, if anything, to be even more of a millstone around the company’s neck than was the case at the IPO launch a year ago. And one which is not going away any time soon.

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