Can you think of who is the largest company in the world? Most investors have a general understanding of who they are. As of this writing, the most valuable companies by public market capitalization are Apple (1,137 B), Microsoft (1,097 B), Amazon (887 B), and Alphabet (886 B). The combined net income earned from these companies in 2018 was 116.91 B (Apple 59.53B, Alphabet 30.74B, Microsoft 16.57B, Amazon 10.07B). What these companies have offered the world in the form of goods and services is amazing. These are incredible companies that have made all of our lives easier (some of us richer), either directly or indirectly. There is one company that has been in talks about going public for a couple of years now that generates almost as much cash as all four of these companies combined, around 111B in 2018. Who is this behemoth that generates as much cash as Apple, Alphabet, Microsoft, and Amazon combined? Saudi Aramco, the oil giant of Saudi Arabia.
The company is a larger cash cow than first stated because Saudi Aramco has a large tax burden to help support the large welfare system and military of Saudi Arabia. Saudi Aramco funds about 80% of the Saudi government. Income before taxes was an astounding 212B in 2018. This is incredible when you think about the Arabian desert was almost worthless in the early 1900s. The story of Saudi Aramco is very interesting and I encourage you to look into it.
Aramco has kept its financials secret for decades. In recent years they have released financial information to issue bonds for the first time in decades and showing interest in an IPO. Aramco originally targeted going public in 2018, but because of delays is now targeting 2021.(1)
The proposed idea was for Saudi Aramco to issue 5% of its current shares to raise $100B, giving Aramco a $2T valuation.
Is Saudi Aramco worth $2T?
Almost anything energy-related is out of my circle of competence. Also, owning a business whose intrinsic value is heavily dependent on the price of a commodity as volatile as oil is not attractive to me. That being said, it’s a fascination company to study.
What helps make Saudi Aramco such a profitable company is how cheap their production cost is. Some experts say the Ghawar oilfield has an average cost of $10-$20 a barrel.(3) Saudi Aramco’s recent bond prospectus revealed that Ghawar produces about 4 million barrels per day (a third of Aramco’s entire production). However, experts in the past always assumed Ghawar could produce 5 million barrels a day. (4) “A surprisingly low production capacity figure from Ghawar is the standout of the report,” said Virendra Chauhan, a consultant at Energy Aspects Ltd. in Singapore. The U.S.’s Energy Information Administration listed Ghawar’s production capacity at 5.8 million barrels a day. An investor in Saudi Aramco must take this information seriously and determine if Ghawar’s oil field is depleting, which not only decreases the potential oil production but inevitably decreases margins since the oil from Ghawar is probably cheaper than most of the other oil fields.
There is a negative trend of moving away from oil and moving towards cleaner energy options. I think Amin Nasser (CEO) has been on top of this trend considering their investment in petrochemicals. They recently started the process of acquiring SABIC, and have plans of investing up to $100B in petrochemicals the next decade. (2) He even notes only about 20% of global oil is for passenger vehicles, “the remaining 80% is used by sectors like planes, ships, trucks, petrochemicals and lubes for which there is no alternative yet and where demand for oil is expected to increase substantially.”(2) This is great capital allocation for the company in my opinion. As the demand for chemical products increases due to emerging markets being lifted out of poverty, the demand for oil in those areas will increase. Even if the need for oil in vehicles and energy decline, so many industries rely on oil as a raw material that doesn’t have a substitute as of today. The question I have is will those end products they plan to produce be cheaper than the current oil products they are producing today? Meaning, how will margins be affected? I have read both positive and negative, and honestly, I have no conclusion (part of why it’s out of my circle of competence.)
Although the cost of drilling for oil is cheap, what is the kingdom cost per barrel of oil? In other words, what does the price of oil need to be to keep the fiscal budget of Saudi Arabia balanced?(3) Saudi Aramco doesn’t have to be a successful company on its own, it has to be successful enough to operate and sustain the government of Saudi Arabia. Quartz estimated in 2014 the necessary oil price to balance the fiscal budget of each OPEC nation. Saudi Arabia’s was $86.1 per barrel.(3) Saudi Arabia is fine for now because of the large stockpiles of oil from previous years. At some point, the average price of oil will need to be above $86 per barrel. Otherwise, the benefit’s Saudi Arabia provides to its citizens will need to decrease, or other sources of revenue will need to occur. Saudi Arabia has started to focus on generating new revenue sources beyond Aramco, which is why purposing an IPO and raising debt is in discussion.
Capital Allocation Focus
Although I think the general idea of Aramco allocating capital to streamline petrochemical production is good, the question is what returns will that produce? Abdulla Bager, an engineering manager at the Ras Tanura Refinery, is quoted saying, “The pace that the company is moving is too fast, even for us. We sometimes get surprised with things in the media that we were not aware about.”(2) Is Aramco moving so fast or have to many objectives being executed at once that they are not focusing on the returns of capital they will earn? When I think of the great capital allocators of big businesses (Apple, Berkshire Hathaway, Amazon, etc.), they are normally focused and patient. Could you image one of the VP’s at GEICO saying, “Berkshire Hathaway is moving so fast we can’t keep up?” Currently, Saudi Aramco has 190 large scale projects listed between 2019- 2021.
The returns on future invested capital could be very high for Aramco, but I’m not sure. Their core oil business has been such a cash cow that in the past it didn’t matter if other investments failed, they were overshadowed by the success of cheap oil. I think we are now at a point, and I believe Saudi Arabia has already figured it out, that they need some of their investments to work out to keep a healthy economy in the future.
If Saudi Aramco was worth $2T, that would equate to about an 18 P/E. Today talks are coming that Saudi Aramco may issue around $1.5T, which would equate to 13.5 P/E. $500B is a huge difference, and I chuckle because that’s about the size of behemoth companies like Berkshire Hathaway and Facebook. Aramco has a decent cash pile and very little (if any) debt. The ROIC is north of 30%, stellar! As a new investor, I need to have a high conviction on what future ROIC will be. If I participate in the IPO, I’m interested in what new capital will generate. Can Saudi Aramco invest the money received from the IPO and over 10 years produce 30% ROIC? I have low certainty on that.
The company is in a great position to profit should oil ever bounce back above $100 a barrel. That’s a big IF though. I don’t like investing based on “if’s”. I have low certainty on the future landscape of oil production.
Innovation in alternative energy and battery capabilities has been slow so far, but that could change quickly. I believe the greatest safe haven for Saudi Aramco is focusing on products that have no raw material substitute for oil. Could new products come out that are better? I think not likely, but I still have a low certainty on that.
Like any investment I make I have to determine a reasonable valuation range of a business and compare it to its current price. When I have a large margin of safety with high conviction, I invest. It’s unusual having a company around for so long but have only a couple years of financial history to analyze. I have read reports (not formally reported by the company) that in 2014, after the oil price collapse, Saudi Aramco made around $14B as oppose to $111B in 2018. What were they making when Oil was $110 a barrel? I don’t know. I can only reasonably estimate that the future earnings of Saudi Aramco can be around $25B to $200B depending on oil price and production efficiency. With $80B to $120B in the normal range. Will that range be the same 10 or 20 years from now after all the new investments, projects, and energy landscape changes?
Saudi Aramco has a fascinating history of almost 100 years. It’s a dominant player in the oil industry and is the golden goose for the entire country of Saudi Arabia. The thought of a $2T IPO sounds crazy, and crazier thinking about an IPO that becomes the largest market-cap-weighted public company in the world.
In general, investing in an IPO is not a good idea for the sole reason of not being able to choose my buying price. Saudi Aramco, although receiving push back, wants to IPO at $2T. Let’s say they agree to a $1.7T IPO. The company picks what price to sell me shares, as oppose to allowing me to purchase shares whenever I believe the disconnect between price and value is attractive enough. It’s possible to have a company IPO for less than the intrinsic value, but unlikely. Think about if you wanted to take your company public, would you IPO your shares for less than what you thought it was worth?
As I think you can gather based on my writing, this company is in my too hard pile. I know what the company does, have a decent understanding of its product line and business history, but I have a very low degree of certainty to determine the intrinsic value of Saudi Aramco.
Not only is there nothing wrong for an investor to conclude they can’t come up with a good intrinsic value, but an honest investor must conclude that most of the time. I see too often analysts who put together a stock valuation that shows a large disconnect between price and value and never purchase a share. If someone is confident enough to put together a conclusion that a stock is worth $100 but is selling for $50, why wouldn’t they buy it? This shows me they are not confident at all with their target price. If an investor doesn’t have a high degree of confidence in knowing what a company is worth, they should put it in their too hard pile.
Blas, Javier, and Dan Murtaugh. “Aramco Is World’s Most Profitable Firm But Cash Flow Lags Rivals.” NDTV.com, 1 Apr. 2019, www.ndtv.com/world-news/aramco-is-worlds-most-profitable-firm-but-cash-flow-lags-rivals-2016248.
Sertin, Carla. “Inside Saudi Aramco: How the Oil Titan Is Transforming to Thrive in an Economically Diverse Saudi Arabia.” Oil & Gas Middle East, Oil and Gas Middle East, 8 May 2019, www.oilandgasmiddleeast.com/drilling-production/33882-inside-saudi-aramco.
LeVine, Steve. “Saudi Arabia’s Oil Production Costs Are Higher than US Shale.” Quartz, Quartz, 12 Dec. 2014, qz.com/311179/the-real-reason-why-saudi-arabia-can-afford-a-price-war-against-us-shale/.
Blas, Javier. “The Biggest Saudi Oil Field Is Fading Faster Than Anyone Guessed.” Bloomberg.com, Bloomberg, 2 Apr. 2019, www.bloomberg.com/news/articles/2019-04-02/saudi-aramco-reveals-sharp-output-drop-at-super-giant-oil-field.
Hecht, Andrew. “What’s the Status of the Saudi Aramco IPO?” ETF Daily News, 12 Aug. 2019, etfdailynews.com/2019/08/12/whats-the-status-of-a-saudi-aramco-ipo/.
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