SECTION A $[40$ MARKS$]$

Read the case study below and answer ALL the questions that follow.

SASOLS LAKE CHARLES: ARE CRACKS STARTING TO SHOW

Sasols latest shocker that the costs of its Lake Charles chemicals project in the US will overrun by a further US$$1\mathrm{.}1$

billion has sent the companys share price into a nosedive, with both investors and analysts now questioning the

continued credibility of Sasols management. The news around Lake Charles is disappointing, to say the least, and points to

a serious disconnect between senior management and whats happening on the ground at the company. The long$-$term

investment case for Sasol remains intact and provided by analysts, however. The risk$-$reward ratio for investors remains

skewed to the upside.

Since March, the company has dropped yet another bombshell to leave investors reeling in an operating update on $22$

May, Sasol indicated that its Lake Charles chemicals project, which is $94\%$ complete, will now cost a total of US$$12\mathrm{.}9$

billion. Its the fourth time the project cost has been increased, and the second time in four months. The cost of the venture

is now $45\%$ above its original budget of US$$8\mathrm{.}9$ billion announced in $2014.$ In general, its not uncommon for projects of this

scale to go over budget. The world$-$scale cracker, which essentially breaks down ethane into ethylene, and six downstream

units, are set to transform Sasol from a predominantly South African energy company to a global chemicals company. The

reasons given for the latest overrun of US$$1\mathrm{.}1$ billion do point towards poor management and execution, however. In the

update, the increases have been broadly divided into three categories:

US$$530$ million relating to cost assumption changes compared to an earlier update in February. This includes a

US$$230$ million investment allowance from the state of Louisiana which was counted twice in the budget. This is

particularly concerning how can a listed company of this size not pick up the duplication of an amount of this

magnitude?

US$$470$ million relating to new issues emerging since the February update. These include the knock$-$on costs of

replacing defective steel forgings and increasing costs of finishing construction in general.

US$$300$ million for contingencies such as bad weather, lower productivity and defective bolts that may need to be

replaced.

On a slightly more positive note, a further two of the downstream manufacturing plants have started production ahead of the

revised schedule $($the linear low$-$density polyethylene plant came online in February$).$ The ethane cracker, which is the main

component of the project feeding its output to the downstream facilities, is still expected to be up and running by July. Of the

three remaining downstream units, only the Ziegler plant is expected to see its schedule delayed by one month. Sasols

balance sheet will be stretched in the near term, and management therefore aims to cut all non$-$essential capital

expenditure in the $2020$ financial year. Overall, should there be no further cost overruns and$/$or a collapse of oil prices to

below US$$50$ per barrel, theres still sufficient liquidity to fund the remaining stages of the project with existing cash flows.

The dividend is also unlikely to be cut.

In the update, Sasols management announced the sale of US$$2$ billion of non$-$core assets within the next $12$ to $18$ months.

This doesnt amount to a fire sale it forms part of a larger capital review programme initiated two years ago. The sale

estimate has, however, increased from the US$$1$ billion announced in February. The management team also lowered its

medium$-$term EBITDA guidance for the project from US$$1\mathrm{.}3$ billion to US$$1$ billion in $2022.$ This is a result of the price

forecasts used by external consultant IHS and is based on oversupplied near$-$term chemicals markets. The long$-$term view

of US$$1\mathrm{.}3$ billion remains intact, however.

The financial impact of the latest cost increase translates to around R$21$ per Sasol share. In addition, cutting near$-$term

chemical price expectations to reflect the views of management further reduces the value by R$15$ per share. The market

response was more brutal in the aftermath of the update, however, with the share down by R$55(-13\%),$ dropping to R$375$

per share at the close of day on $23$ May. This reaction is understandable, given that the market may have been worried

about further negative surprises. It does seem that further increases of this magnitude are unlikely, however, and that this

time management really did throw the kitchen sink. As viewed by analysts, the update points towards a serious disconnect

between executive management and whats happening on the ground at Sasol. The cost of the Lake Charles project has far

exceeded initial management estimates and has led to the expected internal rate of return decreasing further from $7\mathrm{.}5\%$ to

$66\mathrm{.}5\%($depending on price assumptions used$).$ However, this large capital outlay is now largely a sunk cost and has been

included in the current price paid for the company.

Even with depressed chemical prices expected in the medium term, Sasols cracker project is expected to make US$$1$

billion EBITDA by $2022$ and similar cash flow because of tax rebates translating to cash flow of around R$23$ per share.

Sasol is anticipated to make around R$65$ per share overall in free cash flow by $2022.$ Despite all the negative news, the riskreward equation for investors remains skewed to the upside, and most shareholders are likely to maintain their exposure to

the share.

Source: Bothma, C $(2019$

QUESTION $2(20$ Marks$)$

Sanlam is a leading financial services group headquartered in South Africa, with a significant presence across Africa and

operations in various international markets. The company operates through multiple business segments, including

insurance, investments, wealth management and asset management, serving millions of customers across diverse

markets. Examine the strategies that the organisation should consider when responding to financial risks. Relevant

examples should be provided.