EUR 850.00 For Business Accounts Only

Morningstar | Market Vents on Viva Earnings Downgrade and Coles Alliance. Our FVE Unchanged at AUD 3.00.

We make no change to our AUD 3.00 fair value estimate for no-moat Viva Energy. The company downgraded fiscal 2018 earnings guidance due to weaker than expected regional refiner margins, together with lost refinery production due to disruption in electricity supply. Further, high crude prices, a weak Australian dollar, and an impasse with alliance partner Coles, are crimping retail earnings. While disappointing, we view none as likely to persist and our midcycle assumptions stand. We downgrade our fiscal 2018 replacement cost EBITDA and NPAT assumptions by 15% and 18% to AUD 543 million and AUD 280 million, in line with company advice. On an unchanged 60% payout ratio for the second half, our fiscal 2018 DPS forecast declines 30% to AUD 4.2 cents from AUD 6.1. But our fiscal 2019 EPS and DPS forecast of AUD 19 cents and AUD 11.0 cents are unchanged. At Viva’s announcement-punished AUD 1.85 share price, the fiscal 2019 dividend equates to a healthy 6.1% fully franked yield, and we think Viva is materially undervalued.

The share prices of all three ASX-listed refined fuel retailers we cover have all fallen in response to recent market forces. Refining margins have been impacted by weak regional refining margins, and high U.S. dollar oil prices in conjunction with a weak Australian dollar have crimped retail fuel demand. Compared with August 2018 highs, Caltex Australia shares have fallen 22% and Z Energy shares have fallen just over 20%. Viva shares were travelling in similar step until today’s announcement which has particularly disappointed the market. Viva’s share price fall from August 2018 highs is now an outsize 28%. The difference appears to be a high-profile to-ing and fro-ing between Viva and its alliance partner Coles over fuel prices. Neither has been willing to take a sufficient margin haircut, with understandable consequences for volumes in a price-conscious market. There was no word on how the impasse is going to be resolved and the market vented.

While extremely disappointing given Viva’s only recent ASX-listing, we assume common sense prevails in the medium term, and the parties resolve an outcome to their mutual satisfaction and benefit. Viva leases the majority of supplied retail sites from Viva Energy REIT and the majority of these, or just over 700, are Coles Alliance-operated sites. Viva supplies fuel on a wholesale basis and receives site lease and licence income from Coles Express, as well as royalties from convenience sales by Coles Express in excess of agreed sales thresholds. Viva's control of Coles Express sites, by virtue of the leases, provides Viva certainty of use for the site in the longer term regardless of Coles' actions. But it is preferable that a workable relationship with Coles persists. Caltex has been undertaking a costly buyback of sites from franchisees and is forging a closer relationship with partner Woolworths. Viva and Coles will need to be on the ball to meet this formidable challenge effectively.

Viva is forecasting fiscal 2018 EBITDA of AUD 150 million from refining, and approximately AUD 900 million from fuel retailing and marketing--declines of 30% and 4%, respectively, versus original prospectus guidance. Not all the retail and marketing pertains to Coles, with around 4.5 billion litres or a third of total volumes comprising jet fuel, marine and other specialities, and around 20% of the balance going to non-Coles dealer/agent operated sites including Liberty. Overall, we estimate somewhere in the vicinity of a third of the business pertains to Coles, still very meaningful. Viva will need to get the relationship right.
Our Viva fair value estimate equates to an unchanged 2022 EV/EBITDA multiple of 8.5 to Caltex’s 8.3, high enough we think given risks. Our fair value equates to a 2022 P/E of 15 and dividend yield of 3.3%, both discounted at WACC, or 9.9 and 5.0%, respectively, at today’s fair value. We continue to view longer-term earnings potential as attractive, including a five-year revenue CAGR of 5.9% and underlying EPS growth of 6.2% over the same period. Margin improvement assumes Viva has a far keener eye on the marketing ball than when under the Shell umbrella, in addition to the new V-Power diesel offering.