How to value Saudi Aramco

“After more than two years in the planning, reports suggest that Saudi Arabia is about to press the button for the initial public offering of its state-owned oil firm, Saudi Aramco. Institutional investors will therefore have to weigh up the pros and cons of the deal and decide whether the investment case is sufficiently strong and the valuation is attractive enough to offer their clients a chance of making a return that more than compensates for the risks involved,” says Russ Mould, AJ Bell Investment Director.

“All of the standard checks that apply to any IPO will apply to Saudi Aramco, as it looks to list in both Riyadh, and become part of the Tadawul index, and overseas, with New York, London and Singapore thought to be in the running.

“Investors will therefore need to assess whether:

•    The company has a good management team who can be trusted, which can point to a good track record and ideally owns a chunk of the shares too, to align their interests with those of shareholders. King Salman recently replaced longstanding energy minister and Saudi Aramco chairman Khalid al-Falih and handed control of the energy ministry over to one of his sons, Prince Abdulaziz bin Salman. CEO Amin H. Nasser has been with the firm for more than 30 years and in that post since autumn 2015.

•    The company has a sound business with a strong competitive position. Saudi Aramco’s accounts for 2018 show that it has a net cash balance sheet (even allowing for a $6.2 billion pension obligation) so that is a good start. Saudi Aramco also has huge reserves of 263 billion barrels of oil and 320 trillion cubic feet of natural gas, according to an independent audit, which was commissioned to tackle complaints over a lack of transparency in this important area. 

Total production in 2018 came to 10.3 million barrels of oil equivalent per day (BP managed 2.2 million, including Rosneft, and Shell 1.8 million), although Saudi Aramco is a less dominant player in natural gas. Its 2018 output of 8.9 billion square cubic feet per day compared to 8.5 billion at BP and 10.8 billion at Shell.

However, Saudi Aramco did lose its exclusive perpetual rights to the kingdom’s oil resources following the imposition of a new 40-year time limit in 2017 (although that could be easily extended again). Investors will also keep an eye on how the business is taxed. Riyadh introduced a new regime in 2019, whereby Aramco pays a 15% royalty on for Brent crude oil prices up to $70 a barrel, 45% for between $70 and $100 and 80% above $100 – so the higher oil goes, the more tax it pays.

•    The valuation is attractive. Saudi Aramco’s oil output therefore towers over that of both BP (market cap £100 billion, or $127 billion) and Shell (£181 billion, or $230 billion). Its earnings power is huge, too. In 2018, Aramco made a net profit of $111 billion, compared to $9.6 billion at BP and $23.4 billion at Shell.

It therefore seems logical to assume that Saudi Aramco will come with a much higher price tag. But Riyadh’s apparent desire for a valuation of $2 trillion could still be difficult to justify.

Saudi Aramco’s plan is to pay out an annual dividend in 2020 of $75 billion, as a minimum. On a market cap of $2 trillion, that implies a dividend yield of just 3.8%, well below the yield available on most of the world’s major oil firms – and although Chevron and ConocoPhillips both offer lower dividend yields, the former is running a share buyback programme worth $5 billion a year (2.2% of the current market cap) and the latter has a $3 billion buyback in place for 2020 (4.8% of the market cap). Throw those in and their cash returns, as a percentage of their market valuations, dwarf those planned by Saudi Aramco.

“Under those circumstances, a $2 trillion valuation for Saudi Aramco looks ambitious, even allowing for Aramco’s reserves, earnings power and strong balance sheet, as well as the reform programmes underway across Saudi Arabia that are designed to boost its economy and make it a more attractive venue for overseas investment. 

“The inclusion of Saudi equities in the MSCI and FTSE Russell Emerging Market indices with a weighting of around 3% may also raise the profile of the Tadawul and generate buying from passive, index-tracking funds. But a $2 trillion price tag still looks lofty. 

“A dividend yield of 5% to 6% could be tempting for global investors in a low-interest-rate world. That would imply a price tag of $1.25 to $1.5 trillion and also compensate buyers for some of the risks involved, notably any influence that the Government may have over Saudi Aramco and also the Middle East’s potential for geopolitical tensions. Whether this is acceptable to the seller, or potential buyers, remains to be seen.”

Valuation of leading global oil companies

Source: Bloomberg data, consensus analysts' forecasts