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Morningstar | Corporate Action: No-Moat Caltex Weathers Historically Low Refiner Margins and Announces Buyback

We retain our AUD 33.50 fair value estimate for no-moat Caltex. The company reported a 10% decline in underlying 2018 NPAT to AUD 558 million, slightly above AUD 533 million-AUD 553 million guidance and our AUD 543 million expectations. The earnings decline reflects lower regional refiner margins and high crude and product prices during the second half. The Caltex refiner margin fell by a quarter to USD 9.85 per barrel and an unplanned outage at Lytton refinery in October reduced EBIT by a further AUD 20 million. Excluding Lytton, fuels and infrastructure EBIT creditably increased by 21%. Transition costs reduced convenience retail EBIT by AUD 20 million as Caltex continues to take back operatorship of stores and undertakes the Foodary roll-out.

Caltex anticipates an improved 2019 with continued growth from the fuels and infrastructure business to more than offset contract repricing for Woolworths’ fuel supply. Regional refining margins have had a soft start to 2019 but are expected to improve from historical lows. Despite this, our 2019 EPS forecast falls by 7% to AUD 2.30 from AUD 2.47 due to higher than previously anticipated depreciation. Caltex guides for a 10%-20% increase in Convenience Retail depreciation to AUD 105 million-AUD 115 million and a doubling in corporate depreciation to AUD 15 million-AUD 20 million from investment in Foodary and bringing petrol stations into the fold.

Caltex announced an AUD 260 million off-market tax effective buyback, anticipated to yield AUD 3 per share of value to participants and 3%-4% EPS accretion. It has just over AUD 1.0 billion in franking credits and is sensible to quarantine some from potential regulatory changes. The quantum is relatively small, likely to consume less than AUD 90 million of the franking balance. The buyback quantum therefore appears light-on, a circumstance likely to disappoint some. But Caltex is sensibly treading cautiously, particularly given the current mid-single-digit refiner margin.

Caltex shares have strengthened from December sub-AUD 25 lows but at AUD 29 remain somewhat undervalued. The buyback tender period will open on Monday 18 March and close on Friday, April 12. Shares trade ex-entitlement for participation on Friday 1 March. Tax-effective buy backs typically appeal to low taxed entities including super funds, though we urge independent tax advice before participating.

Caltex targets 1.5-2.0 adjusted net debt to EBITDA in order to support growth in its business model. Net debt stood at AUD 955 million at end December, net debt to EBITDA of 0.88 or 1.75 adjusted for operating leases. Including capital commitments, dividends, and the buyback, we project adjusted net debt to EBITDA falling from now on to sub-1.0 levels by 2022 including operating leases. This leaves room for further capital management in the future and already captures a recently increased dividend payout ratio of 50%-70% versus the 40%-60% historical. Caltex paid a better-than-anticipated final dividend of AUD 61 cents, the new 60% payout ratio coming sooner than expected, bringing the full year to AUD 118 cents. At the current share price, our AUD 1.38 DPS forecast for 2019 equates to handy 4.8% fully franked yield.

Our fair value estimate equates to a 2023 EV/EBITDA of 7.4, PE of 14.1, and dividend yield of 3.6%, all discounted at WACC. In nominal terms, the PE and yield would be 9.4 and 5.4%, respectively. We assume group EBITDA CAGR of 5.9% to AUD 1.4 billion in 2023, the CAGR flattered by 2018’s profit dip. The underlying is regardless in contrast to hectic double-digit growth rates to 2015 enjoyed from Caltex’s first mover advantage into premium diesel fuel and is assumed despite efforts to re-invigorate convenience retail. We think there is a capable competitor in Viva Energy, while still leaving some room for growth.
Net operating cash flow in 2018 fell 27% to AUD 540 million, lower than expected including unfavourable working capital moves. We forecast annual net operating cash flow to push AUD 900 million going forward and free cash flow to exceed AUD 600 million, barring unforeseen acquisitions. Major capital investment in terminals and other fuel infrastructure is largely complete.