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Morningstar | Caltex Checks any Remaining Market Enthusiasm with Another Guidance Downgrade. No Change to FVE.

We retain our AUD 33.50 fair value estimate for no-moat Caltex. That’s despite an 8% reduction in our 2018 EPS forecast to AUD 2.08 from AUD 2.26. The new forecast is at the midpoint of updated company guidance for replacement cost NPAT of AUD 533-553 million, and reflects the impact of lower regional refiner margins, and high crude and product prices during the second half. Further, an unplanned outage at Lytton refinery in October reduced EBIT by an additional AUD 15-20 million. We don’t expect these drivers to be long-lasting with falling crude and product prices in the fourth quarter testament.

Caltex anticipates an improved 2019 with continued growth from the fuels and infrastructure business to more than offset contract repricing for Woolworths’ fuel supply. Our 2019 EPS forecast is little changed at AUD 2.47. Total capital expenditure is expected to be around AUD 350 million, a reduction of 30% on 2018. That’s despite continuation of the convenience retail store rollout including the joint Metro store rollout with Woolworths, and Caltex’s own Foodary rollout.

Caltex shares have continued to weaken from August AUD 33.60 highs and at AUD 25.25 are firmly in 4-star territory, meaningfully undervalued. Our fair value estimate equates to a 2022 EV/EBITDA of 7.1, P/E of 13.1, and dividend yield of 4.0%, all discounted at WACC. In nominal terms, the P/E and yield would be 8.6 and 6.0%, respectively. Despite reinvigoration of the retail strategy, we continue to assume group EBITDA growth will slow to just over 4.0% CAGR, in contrast to hectic double-digit growth rates to 2015 enjoyed from Caltex’s first mover advantage into premium diesel fuel. However, Caltex will from 2019 increase its dividend payout to 50%-70% from 40%-60% currently. At the current share price, our AUD 1.48 DPS forecast for 2019 equates to a handy 5.9% fully franked yield.

Caltex says the 2018 convenience retail EBIT outlook of AUD 295-305 million is above the guidance range it provided in October, thanks to falling crude and product prices in the fourth quarter. And fuels and infrastructure EBIT excluding Lytton refinery is forecast to increase by 21% versus 2017. But the refining side, always volatile, has worked against Caltex in 2018, with Lytton EBIT more than halving to AUD 155-165 million.

Fuels and infrastructure benefited on the international side with the 2018 acquisition of 20% of Seaoil in the Philippines, a first full year’s contribution from Gull New Zealand and increasing contribution from the Ampol trading and shipping arm in Singapore. International volumes are expected to be 3.4 billion litres in 2018, up 34% from 2017. But the Australian business grew also, Caltex’s estimate for 16.9 billion litres approximately 2% higher than the 16.6 billion litres recorded in 2017. Wholesale sales volumes growth is higher than market with the integrated supply chain being flexed to protect and grow share.

Net debt is forecast to be approximately AUD 1.0 billion at end December, little changed from June. Net debt/EBITDA of just below 1.0, or 2.0 including operating leases, is higher than recent history due to acquisitions and franchisee buybacks, but remains sufficiently conservative. We project net debt approaching negligible levels by 2022, and net debt/EBITDA including operating leases approaching 1.0 by 2022. That is all else being equal. Caltex has hinted any excess capital will be returned to shareholders, as highlighted by the upped payout ratio, but potentially also via off-market buybacks. The company held AUD 936 million in franking credits at end 2017 which could be put to use. We’d view any buyback favourably at the current share price, especially with the threat a Labor government might pose to franking and tax-effective buybacks.