One of the most interesting stories of recent years is the slow but steady decline in the quality – and quantity – of IPOs on the European markets. Looking at the numbers for the third quarter of 2019, across Europe they are down 40% and, in the UK, down 20%. On some measures, we’re now back to levels last seen in 2013. Curiously the quality of the businesses being listed is also declining – if by quality we mean scale. According to PwC numbers in the 3rd quarter the average market cap of IPOs declined precipitously.

A large part of what’s going on, as I’ve mentioned on this blog already, is that private equity is allowing quality growth companies to stay private longer. Private equity outfits also have easy access to super cheap leverage (sub 2%). And of course private equity is also contributing to the malaise by continuing to float crap businesses on the stock market at inflated prices. I’m sure we’ve all lost count of the number of former PE businesses that have disappointed within 18 to 24 months (AA, Saga, Luceco to name just a few).

But we can’t completely blame private equity. Governments also share the blame with ever-increasing regulatory and reporting burdens on businesses. And then there’s also the Saudi’s. I hate the single out our strategic friends in the Middle East but surely someone should quietly tell them that their Aramco listing is not going to help the cause of building a sensible IPO pipeline. I haven’t bothered reading through the prospectus if only because I can’t see any earthly reason why I’d want to own the stock. Why my cynicism? In sum

  • We’re at the early stages of decarbonising and thus oil is going out of favour
  • The equity stake up for sale is tiny and as outsiders we’ll have no real effective control over the assets
  • If the Saudi royal family is ever removed from power, I’m certain that Aramco would be fully nationalised overnight
  • Its assets can easily be attacked by drones and its main reserves are within a short flight from Iran
  • Its shares don’t look cheap

I have a few more arguments up my sleeve but I think it best to leave the final word with those professional energy investors who’ve actually taken the team to read the Saudi IPO documents. Cue the team at Guinness Global Energy .

At the end of last week, they brought out a cracking crib sheet of useful facts about the IPO no one in their right mind should touch. I’ve shamelessly précised their conclusions below.  I stick with my initial comment – who on earth would want to buy these shares?

Step forward index funds who might eventually have no other choice than to buy the shares, especially if they are Saudi ETFs.

Guinness Global Energy High (low)lights

  • It has 227 billion barrels of oil/NGL reserves, equivalent to over 20% of global oil reserves (according to the BP Statistical Review of World Energy) and equal to 5x the proved oil/NGL reserves of the ‘super-majors’ combined (Exxon; Chevron; Royal Dutch Shell; Total; BP).
  • With oil production of around 9.9m b/day and NGL production of around 1.2m b/day, its proved reserves will last for over 50 years (versus around 12 years for the super-majors).
  • The operating cost of producing a barrel of oil is less than $3/bl, putting the company at the bottom of the industry’s cost curve
  • Saudi Aramco has particularly high exposure to the upstream (exploration and production) business, with 98% of 2018 EBIT coming from the production of oil and gas and only 2% coming from downstream operations.
  • Saudi Aramco is a highly free cash flow generative Based on an oil price of $60/bl, we see Saudi Aramco generating a free cash flow return versus capital employed in 2020 of around 22%. This is noticeably higher than the super-majors (who average around 8%), and reflects the lower cost of production and lower capital intensity.

    Saudi Aramco has a pristine balance sheet and will essentially have zero net debt over 2019 and 2020 if Brent oil prices average around $60/bl Brent.

  • the company is currently delivering a very high return on capital employed relative to its peer group. We note Saudi Aramco has $61m of capital employed per produced barrel versus the super-majors at around $165m. On our assumption of $60/bl Brent oil, we seeing ROCE falling back towards 25-30% over the next five years but it still being much higher than the Super Majors (at around 7%).

  • The company currently has 10m b/day of oil production with an estimated total oil production capacity of around 12m b/day.
  • Every year, Saudi Aramco’s oil fields will suffer a natural production capacity decline. Most oil companies suffer a 4-6% natural decline rate but we understand that many Saudi Aramco oil fields are still reasonably early in their development phase (i.e. ramp-up), so Saudi Aramco’s decline is likely to be at the lower end of the range.

Valuations ?

  • We see Saudi Aramco’s valuation as looking quite rich versus the super-majors and also versus our modelled group of Emerging Market integrated oils and to the Guinness Global Energy fund as a whole (on our initial assessment based on a $60/bl Brent oil price).

    In terms of 2020 EV/EBITDA and P/E ratios, Saudi Aramco would likely be trading at around 8x and 17x. For reference, the Super Majors would be in a range of 5-7x and 10-17x respectively, whilst the Emerging Market integrated oils would be at only 2-5x and 4-10x respectively.

    Saudi Aramco would be trading at just under a 5% dividend yield for 2020. The Super Majors currently offer a range of 4-7% and the Emerging Market Oils offer 3-10%.

Summary valuation metrics based on $1.6trn market cap for Saudi Aramco
Source: Guinness Asset Management estimates, Bloomberg