Saudi Aramco, IOCs and energy
My first-ever article in E-MorningCoffee, which I released on November 19th, 2019 (article here) was about Saudi Arabian Oil Company (“Saudi Aramco”, or simply “Aramco” – website here). I wrote this article just a few weeks before the government-owned company was about to do its IPO in late 2019, saying that the targeted valuation looked very expensive. Aramco’s stock has performed reasonably well since its IPO, even though the stock appeared over-valued at its IPO and still appears richly valued vis-à-vis its peers. This article will look at how Aramco’s shares have performed compared to the shares of other international oil companies (“IOCs”) since the IPO, and how the company compares today from a valuation perspective to its peers. Please note that I am not opining on the transition of Aramco and / or its energy peers away from fossil fuels and towards clean energy because I am neither in a position nor have the knowledge to intelligently comment on the ambitions of Aramco or its global peers in this respect.
The background
The Saudi government started working an IPO of state-owned Aramco in 2016, aiming to sell 5% of the company to global investors for $100 billion. This target, if achieved, would mean that the company would reach the coveted $2 trillion valuation threshold, making it the largest company in the world by market capitalisation, a stated objective of Crown Prince Mohamed Bin-Salman. Ultimately, this proved too ambitious, at least for international investors, who balked at this valuation during several rounds of pre-marketing. As a result, the company decided to abandon the idea of a global offering and instead focus on a purely domestic offering. After years of work, the government finally completed a domestic IPO on December 11th, 2019, which valued the company at $1.7 trillion. Three billion shares of Aramco were sold at the IPO, representing a scant 1.5% of the company, at a price of SAR 32 /share or $8.53 /share. The government raised $25.6 billion from the sale, an amount that was later increased to $29.4 billion after underwriters executed the green shoe. The successful IPO resulted in Saudi Aramco becoming the largest company in the world by market cap, a somewhat hollow statement given the scaled-back offering and the sole listing on the Saudi Stock Exchange (the Tadawul). Even so, this offering was the largest amount ever raised in an IPO, a record that stands to this day.
Although I going to update my readers on the company’s stock performance, I will warn you that the shares are difficult to purchase if you do not have a brokerage account in Saudi Arabia. Should you not have such an account but wish to have exposure to Aramco, you can get indirect exposure to the company as part of a larger portfolio of local companies by investing in a Saudi Arabia ETF like those offered by Blackrock (iShares here) and Franklin Templeton (here).
Turning back the clock – the IPO
As mentioned already, the price of Aramco’s shares at the IPO was SAR 32/share, or with the Saudi riyal fixed to the US Dollar at Sar 3.75/US$1.00, a dollar-equivalent price of $8.53/share[1]. Although the price stayed around the IPO level for several weeks, it slipped below the IPO price in early January 2020, just before the onset of the coronavirus pandemic. On March 16th, 2020, shares of Aramco hit their post-IPO low, closing at SAR 22.98/share, nearly 29% below the IPO price. Of course, keep in mind that global stock markets were plunging too as the onset of COVID-19 led to a flight out of equities and into safety.
By late August 2020, the price of the shares had returned to their IPO level and moved higher as the price of oil was rising and people were “settling into” the pandemic. In the autumn of 2021, the shares took another step up to a new higher range and then went even higher in early 2022 as oil prices spiked when Russia invaded Ukraine. The shares hit an all-time closing high of SAR 42.50 on May 16th, 2022, which also followed the issuance by Aramco of one bonus share for every 10 shares held effective May 15th. Since then, the shares have fallen back to around SAR 38.45/share. Using the post-split-adjusted shares outstanding of 219.8 billion, this translates into a market capitalisation for Aramco of Sar 8.45 trillion, or $2.25 trillion-equivalent, less than Apple ($2.6 trillion) but larger than the next largest company – Microsoft ($2.0 trillion) – in the S&P 500 index.
Performance of Aramco shares and its peers since the IPO
Even at the less ambitious price at which the IPO was ultimately completed, most equity analysts and international investors did not think the company was worth $1.7 trillion, which is why investors outside of Saudi Arabia gave an emphatic “no thanks” to the offering. After years of preparation for the IPO and a lot of fanfare globally in anticipation of the transaction, the IPO turned into a purely domestic affair, a stage on which the Saudi Arabian government could more effectively “lean into” local institutional and retail investors to ensure that the offering was fully subscribed at a price that almost certainly would not have worked in the international capital markets. My comments in this respect are by no means a reflection of the quality of Aramco from an operational perspective, as the company is truly unique. Aramco has more assets and annual revenues, the most attractive operating profit margins, and the highest daily production of oil of any major international oil company (“IOC”) in the world, not to mention access to vast long-lived reserves and a highly rated majority shareholder (the Saudi government) and affiliate (Public Investment Fund, or “PIF”)[2] which collectively own more than 98% of the company. I also recently read that Aramco is the most profitable company in the world.
Having said this, my view on pre-IPO view on the valuation has not been terribly wrong in that whilst shares of Aramco have increased 32% since its IPO, Petrobras, the XLE ETF, ExxonMobil and Chevron have increased even more. Also keep in mind that the price of Brent has risen 58% over the period. The table below shows the change in the price of the shares of Aramco and certain other peers since the IPO date, as well as the current market capitalisation of each company and the forward dividend yield, especially important to the government of Saudi Arabia since the company is still over 98% directly and indirectly state-owned.
At a current price of SAR 38.45/share, Aramco has a market capitalisation of SAR 8.45 trillion ($2.25 trillion-equivalent), nearly double that of the combined market capitalisation of ExxonMobil, Chevron, TotalEnergies, Shell and BP.
Valuation of Aramco – does it make sense?
In spite of its reasonably strong performance, Aramco’s stock still looks over-valued to me when it is compared to the stocks of other IOCs. The Saudi government remains solely in control of the company with its 98%+ stake, although this overwhelming controlling interest cuts both ways. On one hand, one might argue that Aramco’s shares lack liquidity and true price transparency – at least compared to stocks traded on international markets – as the shares only trade on the Tanawul, principally involving a domestic audience. On the other hand, the dividend from Aramco provides a key component of the government’s funding needs, and the extremely low likelihood of the dividend ever being reduced provides downside protection to investors. For reference, the company’s annual dividend is around $75 bln/year, of which most goes to the Saudi government.[3] It is also relatively easy for the company (or the government) to repurchase shares to support the price if it were to fall below a level not acceptable to the government, perhaps more a matter of pride than economic good sense. Remember that you are dealing with the crown jewel in what is a fairly closed emerging markets country. In many respects, this raises the question of whether or not an investor is better off investing in Aramco’s bonds than its equity, as post-IPO, Aramco has proven on multiple occasions that it has ready access to the international bond and the domestic Sukuk markets in significant size, at long maturities and at tight pricing.
Current valuation of Aramco is expensive vis-à-vis peers
As I mentioned earlier, Aramco currently has a market capitalisation that is nearly double that of the combinedmarket capitalisation of ExxonMobil, Chevron, TotalEnergies, Shell and BP. However, as you can see in the table below, the five IOCs collectively have 2.5x the revenue of Aramco and produce around 25% more hydrocarbons/day.
Even though they are smaller, the state-controlled Brazilian energy giant Petrobras and Chinese state-energy company PetroChina have market caps that are less than 10% of Aramco’s. Squaring the valuation of Aramco at the current level to those of the other IOCs starts to sound a lot like trying to make sense of Tesla’s valuation[4]. It doesn’t make sense and is nearly impossible to justify under any circumstances.
The table also shows that the forward P/E of Aramco is out of line with its peers. Even though the company has the best operating margins because it has the largest pool of reserves with the lowest lifting costs, the fixed leverage in the business means that Aramco – like its peers – is held hostage to the price of oil. I can hardly make a case given the drivers of growth that the forward P/E should be more than double that of the average five IOCs included in the table. If you want to defer to the dividend yield and – more importantly – the reliability of the dividend as support for Aramco’s price, there is perhaps some legitimacy in this. However, as you can see in the table, Aramco’s dividend yield is 68bps less than the average dividend yield of the five IOCs. I would go so far as to say that the combination of:
the inflated stock valuation (which means there is a downside bias),
the relatively low dividend yield on the stock, and
the level of prices at this point of the oil price cycle,
make Aramco’s bonds a better bet than its shares.
Perhaps saying that the bonds look good compared to the stock is not a completely fair comment because I suspect that the IOCs, Petrobras and PetroChina might all have bonds outstanding, too, offering attractive current yields. However, what bothers me about Aramco is the high valuation of the stock, and this makes the stock price vulnerable to a downturn, even if it is simply due to the normal oil price cycle. The bonds, on the other hand, are indirect risk of a A1/A- rated sovereign, albeit admittedly an emerging market country located in what many consider to be a geographically sensitive region. The bonds are also traded in the global marketplace, which means there is higher confidence that the current prices of the bonds reflect an international consensus of the credit risk of Aramco.
Conclusion
Aramco is a global energy giant with many advantages vis-à-vis all other global energy peers, including public, state-owned and state-controlled international oil companies located around the world. Aramco’s shares have performed relatively well since its IPO, even though the rich valuation at the listing arguably has resulted in the return of the shares being lower than it might have otherwise been, especially given the significant increase in the price of oil and the demand-supply imbalances that have occurred since. Even though the shares were richly priced at the IPO vis-à-vis international standards, the good news for legacy investors is that they remain richly valued. If you want a solid income stream and protection from the possibility of Aramco shares one day reverting to a valuation that is closer to its peers, perhaps the global bonds of Aramco would be a better bet. They are available in the international capital markets, unlike the shares. The bonds would also shield investors from a decline in oil prices, probably inevitable at some point given the historic boom-bust cycles of oil. Of course, looking at the equity of Aramco on a relative value basis is a purely hypothetical exercise unless you have a brokerage account in Saudi (or perhaps elsewhere in the GCC). Lastly, keep in mind that ESG concerns will come back to the forefront once the current crisis has passed, and this will influence the valuation of all energy companies depending on their stated ambitions and plans to gradually transition away from carbon fuel extraction and into clean energy.
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[1] Note that the company awarded a bonus share for every 10 shares held by shareholders on May 15th, 2022. The legacy IPO pricing reflecting what was effectively a 1.1:1.0 share split is SAR 29.09/share, or $7.76/share in Dollar-equivalent. [2] It was announced in February 2022 that the Saudi government had transferred 4% of Aramco to the Saudi sovereign wealth fund, Public Investment Fund (“PIF”). No other details were provided. See here. [3] I also recently read that at the IPO, the government reduced the tax rate of the company from 85% to 50%, since the dividend principally goes to the government by virtue of its 98%+ ownership (and hence must cover much or more than the foregone tax). [4] Tesla (TLSA) is worth more than 1.5x the combined market value of the next 12 largest global automotive companies.
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