Stop paying for these mistakes | Fin24
 
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Stop paying for these mistakes

May 30 2019 09:13
Simon Brown

Woe is Sasol*. 

Its Lake Charles jaunt was initially supposed to cost some $8.9bn, but it kept on creeping higher and earlier this year Sasol said the costs could be as much as $11.8bn. 

That was absolutely and finally the maximum it would cost, the company said. 

But then came the latest announcement, in which Sasol now admits it’ll be costing somewhere between $12.6bn and $12.9bn. 

That’s a cost overrun of almost 50% and is completely insane.

Now sure, when building something cost overruns are part of the deal. 

If you’ve ever built a house (or even just done an extension or some remodeling) you’ll know all about cost overruns. 

In fact, when costing a build, the person pricing it generally adds between 10% and 15% extra for this exact reason, and it always seems to get used. 

But 50%?

The problem is that when the project was being conceived, the long-term profits would have been based on the $8.9bn figure. 

With an extra $4bn being spent, the profitability (return on capital) is significantly less. 

Taking it a step further, we can surely assume that if the initial costing had projected the $12.9bn amount, the project would never have been undertaken?

So now Sasol sits with an asset that it massively overpaid for and that will deliver returns well below what was expected. 

The question of course is who gets fired? Does it even matter? 

Shareholders carry the cost – and the markedly reduced returns – while the executives take their salaries home (perhaps with reduced bonuses) and they are free to ride off into the sunset.

There is also a bigger issue here that I have written about before. 

The desire to always be growing. 

What was wrong with Sasol that it needed to pivot towards a chemical company, as opposed to just an oil and gas company? 

Sure, changing dynamics in its core markets may have reduced long-term profitability. 

But notice that the attempt to solve that problem has now led the company straight towards reduced long-term profitability.

Aside from Sasol, the JSE (and, in fact, all global markets) is littered with large projects, and merger and acquisition (M&E) activity. 

These are meant to boost profits, but instead they often severely dent them. 

Most research on large projects and M&E activity shows that large deals fail to deliver on promises about two-thirds of the time.

So why do companies keep trying? Is this because shareholders demand continued go-go growth? 

Or are the executives blinded by the idea of being bigger, better, faster and richer? 

What is wrong with being a stable company offering decent enough growth (single digits that beat inflation) and solid, chunky dividends?

Personally, I have a number of stocks in my portfolio that have undertaken these kinds of large deals and every single one has failed. 

So now I have a new rule that I am adding to my investment strategy. 

Any large project, merger or acquisition will trigger me to put the stock on the sale table. 

I won’t sell immediately because the market usually gets excited about these deals and drives the share price higher. 

I will take that extra profit. 

But then when the hard, and seemingly certain, reality of failure starts to weaken the share price, I will take my money and run.

Sure, Sasol will survive and offer profits again one day and executives won’t be taking on any large projects anytime soon. 

But the damage is being caused in the long term, and it’s the shareholders that are paying for it. 

I, for one, will no longer be paying for these blunders. 

I may re-enter a share again, but they’ll have to convince me of the merits – as does any other stock I buy.

*The writer owns shares in Sasol.

This article originally appeared in the 6 June edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.

jse  |  sasol  |  global markets
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