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Morningstar | No-Moat Caltex’s Refiner Margins Recover from Historical Lows. No Change to AUD 33.50 FVE.

Regional refiner margins continue to recover, no-moat Caltex reporting an improved USD 10.96 per barrel for the month of April, over its particular product suite. This is the fourth consecutive monthly improvement in the Caltex Refiner Margin, or CRM, from a historic circa USD 5.50 per barrel low plumbed in December 2018. The low is around half annual averages including just over USD 10.00 in 2018, down from just over USD 13.00 in 2017. The March margin was USD 8.67 but would have been even higher at USD 10.67 if Lytton refinery hadn’t undergone a shut-down to rectify power interruptions. The April margin is fast approaching our unchanged midcycle USD 13.00 per barrel Caltex Refiner Margin in 2023 dollars.

The margin still matters because even though Caltex’s exposure to refining halved in 2014 with closure of Kurnell in Sydney’s east, the remaining Lytton refinery in Brisbane is still meaningful to group earnings. Lytton’s earnings are highly sensitive to refining margins. At 2017’s USD 13.00 CRM, Lytton generated AUD 327 million in EBIT or 33% of group total. In 2018 at the lower USD 10.00 CRM, Lytton generated just AUD 161 million in EBIT or 20% of group total. And in the first quarter of 2019 at USD 7.53, Lytton generated only AUD 5 million in EBIT or less than 5% of group total, worsened by an outage. This is still much better than what could have been had Kurnell still been in operation. The ageing refinery regularly reported losses at far better refiner margins.

We maintain our AUD 33.50 fair value estimate, while reducing our 2019 underlying EPS forecast by 6% to AUD 2.02. Refiner margins are moving in the right direction, but the convenience retail environment remains challenging. While we still expect convenience retail improvement for the balance of the year, a slow first quarter is now baked-in. Convenience retail EBIT to March was AUD 40 million, down from AUD 90 million in the previous corresponding period.

Caltex 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. We credit a low-end AUD 115 million in convenience retail EBIT uplift to AUD 423 million by 2024 versus 2018’s AUD 308 million. We think the competition for customer wallet will remain keen. But we think the risk that Convenience doesn’t pick up again is relatively low. In addition to Foodary optimisation, Caltex’s convenience retail plans include continuation of the transition to company owned sites via buy-out of franchisees and roll-out of initial Metro pilot stores in second half 2019 through the Woolworth’s alliance. Ownership enables improvements to be leveraged across the entire network. Caltex had 65% network control at end 2018, up from 40% in 2017 and targets 80% by end 2019. Combined Foodary/Metro store numbers hit 55 by end 2018, up from 23, and the target is for 65-70 in 2019. The aim is to have 100% company operated network and around 500 Foodary/Metro stores within a five to six year horizon.

Caltex shares have strengthened marginally from March AUD 25.65 lows but at AUD 26.70 remain undervalued. Sustainable recovery in refiner margins and demonstrable growth from the Convenience Retail segment are potential catalysts for continued price rerate. Our fair value estimate equates to a little changed 2023 EV/EBITDA of 7.4, P/E of 13.2, and dividend yield of 3.9%. We assume five-year group EBITDA CAGR of 6.1% to AUD 1.5 billion in 2023, the CAGR flattered by 2018’s profit dip. At the current share price, our AUD 1.22 DPS forecast for 2019 equates to a handy 4.6% fully franked yield.

Caltex’s balance sheet remains sound, we estimate AUD 1.2 billion in net debt, up from AUD 955 million at end December, post the recent AUD 260 million off-market buyback. Net debt/EBITDA is 0.9, or 1.7 including operating leases. This is comfortably within Caltex’s 1.5-2.0 target range including operating leases, and the average maturity profile is more than four years.