After years of speculation and controversy, Saudi Arabian Oil Company or Aramco (SE:2222) shares are set to begin trading on Wednesday. The company will be the largest IPO ever with a market cap of $1.8 trillion and will raise over $25 billion according to Fortune. Yet while the Saudi government hopes that the company shares will rise in value and hit the symbolic target of $2 trillion, Western investors have been much more skeptical and hoped for a valuation closer to $1.3 trillion.
This IPO fundamentally is about whether you trust the numbers or the narrative more. There is no denying that Aramco’s numbers are good, and the company is not expensive compared to Western oil companies. The scary part of this stock is not whether it is overvalued, but rather concerns about its corporate governance, the security of Aramco and Saudi Arabia in general, and how the oil market will move in 2020 and beyond.
The Fundamentals
The case for Aramco (SE:2222) is simple. It is the most profitable company in the entire world as its prospectus states that it recorded a net income of $111 billion in 2018 and revenue of $355 billion. Revenue has risen by 164% compared to 2016, though this is to be expected as the price of oil rose by a similar percentage during that same timeframe. With a net income of $111 billion, Aramco is asking for a P/E ratio of 15.3 at the valuation of $1.7 trillion. By comparison, Dutch Shell (LON:RDSa) (AMS:RDSA) has a ratio of 11.34 while Chevron (NYSE:NYSE:CVX) is at 16.14 and Exxon (NYSE:NYSE:XOM) is at 20.03.
It is thus clear that Aramco’s valuation does not appear to be outsized compared to its competitors. But no one is investing in Aramco as a typical high-growth IPO, especially as forecasters are predicting negative pressures on the price of oil next year. Yet despite those potential concerns, Aramco is offering a 37.5 cent per share dividend which will be upheld until 2024 regardless if the price in oil falls. That condition does mean that we can expect a fall in share value in 2024 as Aramco will look to renegotiate such an agreement.
Corporate Governance and Security
There is nothing in Aramco’s financial profile or valuation which makes it a worse investment than any other energy company. But if there is something which should concern investors, it is its corporate governance structure and the relationship between Aramco (SE:2222) and Saudi Arabia.
Aramco’s IPO may be the largest ever, but it is also one of the smallest IPOs in terms of shares offered. Only 1.5% of shares will be in free float, which Bloomberg observes is tiny compared to major corporation like Alphabet (NASDAQ:GOOGL) or Amazon (NASDAQ:NASDAQ:AMZN) where nearly all shares are public. Aramco (SE:2222) leadership will thus do what is best for itself or Saudi Arabia as opposed to the interest of the shareholders. And while those large corporations employ tools such as special stock classes which let owners establish control over the company, shareholders may trust the leaders of Facebook (NASDAQ:FB) or Apple (NASDAQ:AAPL) more than the Crown Prince of Saudi Arabia who wants to use Aramco as a piggy bank for his plan of economic diversification.
Finally, there are security risks. Aramco (SE:2222) notes the Straits of Hormuz and the Suez Canal as shipping routes which could be a security risk and mentions the incidents this year where Saudi oil processing facilities and tankers were attacked by sabotage and terrorism. Yet it should be noted that in the September 2019 attack on two Saudi oil processing facilities, the Saudis were able to quickly restore production and the oil market was minimally affected. The Middle East may be chaotic, but Saudi Arabia itself appears to be relatively stable.
Is it Possible to Invest?
American investors will not be able to purchase Aramco (SE:2222) shares directly, but instead will have to be part of a mutual fund or ETF which purchases the shares. The Saudi government may have launched this IPO as an attempt to diversify Saudi’s economy, but this IPO is primarily for Saudi investors hoping for a dividend payout or large institutional investors. However, one of the largest online brokerages in the world has already listed Saudi Aramco’s stock as a CFD which will allow international investors join in the party. Furthermore, there are no plans for Aramco to go public internationally.
From that perspective, Aramco’s IPO is not a particularly huge deal despite its size, as it will only be a
small portion of certain large mutual funds. It is also possible to see mutual funds that could invest in Aramco (SE:2222) pass due to ethical concerns about the Saudi government. For most American investors, Aramco should be viewed as a vehicle to think about how oil markets, and by extension the global economy, will perform in 2020.
But if you have an opportunity to invest in Aramco, whether through mutual funds or individual shares, Aramco appears to be an underrated stock despite its size. The company is not outsized, is profitable, and has shown an ability to rebound from setbacks. If you believe that oil prices will continue to climb, you should absolutely consider this company.