Saudi Aramco has gone further than it ever dared before. The oil giant on Sunday kicked off a long-awaited initial public offering for the world’s biggest crude producer. The relationship between valuation and credibility is more complex than it might look.
Crown Prince Mohammed bin Salman has long wanted to sell 5 per cent of Aramco at a $2 trillion valuation. He also wants to attract top-tier global investors. A listing in London or New York is out for now. The company will initially sell a sliver of just 1-2 per cent on the local Tadawul exchange, including an offering for Saudi retail buyers.
Aramco is keen to tout its financial might. It produces 10 million barrels of oil per day, generated net income of $111 billion last year, and earned a 41 per cent return on average capital employed. These measures put it miles ahead of the five major oil companies – Royal Dutch Shell, Exxon Mobil, Chevron, BP and Total – it regards as stock market peers.
Those listed companies trade on an average dividend yield of 5.6 per cent , based on Refinitiv estimates of their expected payouts for next year. Aramco is promising to distribute at least $75 billion to shareholders in 2020. At the hoped-for $2 trillion valuation, its shares would yield just 3.8 per cent .
In reality, international investors will probably demand a substantial yield premium to buy into a company which saw half its production knocked out by rocket attacks in September. With a dominant state shareholder and a small free float, Aramco looks more like Rosneft, whose shares yield a hefty 8.3 per cent.
Aramco is not subject to the international sanctions which hang over its Russian peer. But even a more modest yield of, say, 6 per cent would imply a market capitalisation of just $1.2 trillion.
Dividends are not the only valuation benchmark. A Breakingviews model which values Aramco on the basis of discounted cash flows, and incorporates new lower royalty payments to the Saudi government, spits out a price of close to $1.6 trillion. But with a potential demand-led oil glut next year, active institutional investors will remain wary.
Accepting a valuation well below $2 trillion might look like a defeat for MbS. But setting the price too high would force Aramco to lean on rich Saudis and retail investors to get its IPO underway. The credibility of the country’s attempts to diversify away from oil may depend on it accepting a lower price.