The Company That Turns Rocks into Gold

The clock is ticking.

We don’t have much time.

That’s not just the opening line of the upcoming season of “24,” it’s the statistical reality of the world’s petroleum reserves.

Fact: The world consumes 80 million barrels of oil every day.

Fact: There are 1.3 trillion barrels of proven oil reserves.

Fact: At the present rate of consumption, we will run out of oil in 40 years. And that’s presuming that every barrel of proven reserve is recoverable (unlikely) and that demand doesn’t rise (extremely unlikely).

Many oil-industry experts say demand will begin to eclipse new-found supply in just a few years.
What’s going to happen? Well, check the highlight reel. We’ve already had a glimpse of what the rising demand for oil can do to crude’s price. Oil was $10 a barrel in 1998. From that low ebb the price started to rise, then soar. It eventually crested at $147 in 2008. Now, while prices have fallen back to about $70 per barrel today — as a result of lax demand in a recession, not a profusion of new finds — the laws of supply and demand that drove oil to its high are likely to begin to push prices higher as the world’s economies recover.

Even setting aside the economic reality, the political climate vis-à-vis oil has evolved. The environmental movement, once a collection of loons on the fringes of the political spectrum, has become a mainstream concern, one that’s drawing international attention right now in Copenhagen. Climate-change legislation and emissions control will incentivize companies to look for alternative sources of energy. These economic and political factors will converge, making oil more expensive and generating huge demand for alternative sources.

Sasol Ltd. (NYSE: SSL, $39.85) is a South African energy and chemical company that uses coal-to-liquids and gas-to-liquids technology to convert low-cost coal and natural gas into higher value liquid fuels like gasoline, diesel fuel, jet fuel and petrochemicals.

Our StreetAuthority Market Advisor readers first learned of Sasol in January of 2007. We singled it out as a company that would benefit from increasingly strict government pollution controls. A year later it was up +42.2%.

The company mines coal in South Africa and produces natural gas in Mozambique. It processes the material through fuels plants in South Africa. Sasol also refines imported crude into gasoline, diesel and jet fuel. The company basically turns cheap coal and gas into high-value liquid fuels and chemicals.

The company has grown earnings at more than +17% per year on average for the past five years. Sasol achieved a compound annual growth rate in operating profits through fiscal 2008 of 39% per year. Sasol’s shares have averaged a superior +19% total annual return for the past 10 years. The S&P 500 Index‘s performance was negative for the same period.

Sasol’s growth prospects are the most intriguing. Sasol is aggressively expanding its main plant in Secunda and growing its international presence at the same time. As one of the world’s few existing players in gas-to-liquid and coal-to-liquid technology, the company is on the short list of suitable partners for other energy companies wishing to establish the technology.

The world’s biggest emitters of CO2 are automobiles (40%) and coal-fired electric plants (35%). Gas-to-liquids produce cleaner-burning diesel fuel for transportation. The coal-to-gasoline technology has huge possibilities in the United States and China, both of which have hundreds of years’ worth of coal reserves.

Sasol has already formed a partnership with Chevron (NYSE: CVX) to develop a gas-to-liquids plant in Nigeria, and Sasol’s coal-to-liqulien technology has massive potential in China. China has largely powered its massive industrial expansion with dirty coal and is desperately trying to clean up its pollution and become more energy efficient. Sasol is collaborating with Chinese joint-venture partners for several projects there. The company also has already launched projects in Iran and India.

That said, profits have significantly diminished during the past year, as lower fuel prices squeeze margins. Sasol’s average price of oil in the fiscal year ended June 30 was $68.13 per barrel versus an average of $95.51 for the year before. Chemical prices have also fallen off a cliff from 2008 levels. As a result, net income for the company has fallen more than -40% from fiscal 2008 levels, to about $1.7 billion.

But things are turning around. Oil prices have rebounded. The world’s economies are recovering. Given those two factors, many predict the price of oil will see further increases. Investment bank Goldman Sachs (NYSE: GS), for instance, predicts oil prices will reach $90 in 2010 and $110 in 2011.

Higher prices will mean increased earnings which typically translate into a higher stock price, as well as more generous dividends. The company pays dividends twice a year; they fluctuate with earnings. Sasol paid $1.05 per share in calendar 2009 for a trailing yield of 2.7%, however, the company paid annual dividends of $1.60 in 2008 when earnings were higher. The 2009 dividend marked the first time since its listing in 1979 the year-over-year dividend was reduced.

The company has a solid balance sheet with more cash than debt, $19 million versus $18 million respectively. The solid balance sheet is a testament to the strength of the company’s business model and Sasol is fully capable of pursuing growth opportunities.

The stock still sells at just 13 times trailing earnings, compared to an average of 22 times for the S&P 500. This company could benefit in a huge way from the worldwide energy situation in future years. The current recession and lower fuel and chemical prices have presented an excellent entry point for Sasol.