(Bloomberg Opinion) -- Congratulations Saudi Aramco investors: You bought a country.
Saudi Arabian Oil Co. hosted its first ever earnings call as a public company on an even tougher-than-usual Monday morning (New York time). The results themselves weren’t bad; with $88 billion of net income, it is perhaps no wonder the great-quarter-guys statements from some analysts were more elaborate than usual.
But 2019 is, of course, so last year at this point.
Aramco, as it likes to point out, is different from other oil companies. Chiefly, it is much bigger, which is helpful in this industry. But the other key difference is that it happens to be roughly 98% owned by the government of Saudi Arabia. This salient point defined the company’s listing, with it (the big shareholder I mean) choosing to maximize headline valuation rather than capital markets access by keeping the float in Riyadh. Early on Monday’s call, there was the obligatory shout out for “the largest [IPO] the world has ever seen” and I was reminded of that line from “This is Spinal Tap” where the titular group is hailed as “Britain’s loudest band.”
Where Aramco’s difference really comes out, though, is in its plans for 2020. Acknowledging the crash in oil prices — Brent is flirting with $30 for the first time in four years — Aramco slashed its budget for capital expenditures by roughly a quarter, or $10 billion-ish. This is what any oil major should be doing (one wonders if anyone at Exxon Mobil Corp. dialed in).
At the same time, though, Aramco is ramping up its crude oil production to 12 million barrels a day and throwing in an extra 300,000 barrels a day from liquidating inventory. This is less intuitive if you happen to view Aramco as a strictly commercial entity: Boosting output into a market where consumption is evaporating isn’t standard procedure.
There was an air of unreality on the call whenever this topic came up. Discussing the decline in profits last year, Aramco said four-fifths of that could be traced to “macro factors” beyond its direct control; which rather raised the question of whether Aramco views its latest effort at opening the taps a macro or corporate factor. My favorite bit was when, in response to a question, the company said the Saudi government had “waived” its right to determine the company’s production level. So, naturally, the company, you understand, has moved to maximize output and throw in some stored barrels for good measure amid a historic demand shock. Makes sense.
The serious point here is that, just as Aramco hosts its first annual earnings call, its actions reiterate its critical role in Saudi economic and foreign policy. Flooding the market with oil in the face of what may turn out to be an unprecedented drop in global demand is just a weird move on strictly commercial grounds.
Sure, you can argue Aramco is preventing even further declines in consumption by crashing prices and also inflicting damage on competitors. But the nature of this fear-flavored demand shock suggests prices, which weren’t notably high to begin with, would be down substantially anyway. In terms of market share, Aramco is making up some losses on volume and clearing the decks of higher-cost rivals. But it could also be argued that its timing has exacerbated the financial panic gripping world markets, which carries its own costs, as expressed in Saudi Arabia’s own sovereign debt yields:
Ordinary investors are shielded from the company’s decision in the immediate future by the dividend guarantee through 2024 (another ‘different’ IPO feature). With Aramco’s market capitalization having now dipped below $1.5 trillion, the yield has crept above the 5% level.
But that number needs context, since the $75 billion of minimum dividends isn’t likely to be anywhere near being covered by free cash flow this year. On my numbers, but adjusting for lower prices, capex and downstream margins along with higher production, Aramco might generate roughly $40 billion of free cash flow this year. As I wrote here a week ago, that means less cash overall for the government from its national champion; roughly $115 billion compared with my assumption in December of about $200 billion.
This is where, if Aramco were listed internationally, its differentiation would count against it. My estimates imply a free cash flow yield of less than 3%, lower than when the IPO happened despite the drop in the stock price. If anything, the current turmoil and the reminder that Aramco is beholden to a government that is both running deficits and appears increasingly unpredictable, suggest the discount rate should rise rather than fall. The world’s biggest company has provided a timely reminder of why it is different — and why its valuation remains untethered to reality.
See this for the main assumptions. I tweak those by assuming an average Brent crude oil price of $35 a barrel, cutting capex to $27.5 billionand raising crude oil output to an averae of 11.73 million barrels a day for the year, along with natural gas to 10 billion cubic feet a day. I also include 70% of Saudi Basic Industries Corp.'s consensus estimate for free cash flow, adjusted to two-thirds of the year assuming that acquisition closes next quarter. I also cut net refining margins to $1 a barrel (Aramco's downstream business, including chemicals, made losses at the operating level last year according to the notes to the company's annual accounts).
To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net
This column does not necessarily reflect the opinion of 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.
©2020 Bloomberg L.P.