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Morningstar | No-Moat Caltex’s 1H Shocker Reflects Extraordinary Challenges. No Change to AUD 33.50 FVE.

We make no change to our AUD 33.50 fair value estimate for no-moat Caltex. That’s despite a first-half fiscal 2019 shocker. Caltex provided unaudited guidance for a 40%-45% decline in underlying EBIT to AUD 240-270 million, well below our AUD 498 million forecast which itself would have been a 13% decline. But we don’t think the key driver of low fuel margins, down due to weakness in the Australian economy and high board prices, is sustainable. That said, we reduce our first-half 2019 underlying NPAT forecast by 39% to the high end of AUD 120-140 million guidance. And our full-year underlying NPAT forecast declines by 21.5% to AUD 400 million.

The market vented its displeasure, the shares down approximately 20% intraday. But at AUD 23.40, we think Caltex shares are materially undervalued. Recovery in fuel margins to sustainable levels is the likely key catalyst for share price rerate to fair value. Demonstrable growth from convenience retail would be a bonus. Caltex says green shoots are just beginning to emerge, aided by a lower crude price, though not soon enough to register in the first half. We still expect convenience retail improvement for the balance of the year, a slow first half now baked-in from unsustainable lows.

Our fair value estimate equates to a little changed 2023 EV/EBITDA of 7.6, P/E of 14.1, and dividend yield of 3.6%. We still assume five-year group EBITDA CAGR of 6.3% to AUD 1.5 billion in 2023, the CAGR flattered by 2018’s profit dip. At the weakened share price, our 20% reduced AUD 0.96 DPS forecast for 2019 equates to a utilitarian but non-earth-shattering 4.1% fully franked yield. We expect DPS to grow at 16.5% CAGR in nominal terms to 2023, from 2019 levels, assuming maintenance of the 60% payout. Caltex still anticipates convenience retail growth in 2020 and maintains a target of AUD 120-150 million in annual EBIT uplift by 2023/24, including ongoing development of the Foodary concept.

The major disappointment is the convenience retail segment, with first-half 2019 EBIT guidance of AUD 75-80 million, half previous corresponding period levels and well below our AUD 118 million forecast. A slowing Australian economy and heightened fuel competition with high crude prices slashed margins. Caltex did gain retail market share, small comfort for the half, but more useful as recovery takes hold. Industry sales volumes fell 2% with the transport, agriculture and construction sectors featuring in the normally resilient diesel market.

First-half EBIT guidance for Lytton refinery is a negligible AUD 0-10 million, down from AUD 105 million last corresponding half. While of greater magnitude than the convenience retail shortfall, refinery earnings are typically volatilely leveraged to regional refiner margins, and large swings are expected. Regional refiner margins are recovering more slowly from historical lows than we’d allowed for and unplanned outages compound woes. Caltex reported an improved USD 10.96 per barrel for the month of April, the fourth consecutive monthly improvement from a historic circa USD 5.50 per barrel lows plumbed in December 2018. But the May margin fell back to USD 7.82.

First-half fuels & infrastructure EBIT, excluding Lytton, is guided at AUD 190-200 million, down only marginally from the previous corresponding period’s AUD 209 million, and would have exceeded it if not for AUD 40 million negative impact from the repriced EG Group (Woolworths) supply contract. Caltex’s integrated fuel supply chain allowed it to hold market share with guidance in line with our little changed first-half 2019 AUD 205 million EBIT forecast. The fuels & infrastructure segment is a point of strength for Caltex, supporting infrastructure not readily replicable by non-integrated players.