EUR 850.00 For Business Accounts Only

Morningstar | No-moat Viva Energy Follows Caltex Into the Confessional. No Change to AUD 3.00 FVE.

Our AUD 3.00 fair value estimate is unchanged despite lowering our 2019 replacement cost NPAT forecast by 7.5% to AUD 242 million, including on an equity basis Viva Energy REIT and Liberty Oil earnings contributions. The cause of the decline is a relapse in refiner margins to historically low levels. However, we don’t think such low levels are sustainable and our long-term forecasts stand. Viva Energy shares fell 9% last week in sympathy with peer Caltex’s disappointing earnings guidance, and at AUD 2.04 are materially undervalued. Improvement in regional refiner margins to longer-term averages and progress on restoring Coles Express Alliance volumes to 70 million litres per week near term, and then to over 75 million litres in the longer term, could be key catalysts for share price appreciation to fair value.

Hot on the heels of Caltex’s earnings confession, Viva released first-half 2019 replacement cost EBITDA guidance for AUD 150-180 million, a 45-75% decline on the previous corresponding period’s, or pcp’s, AUD 263 million and 10%-25% below our AUD 200 million forecast. The good news is guidance for the nonrefining portion of the business, where externalities are less volatile than for refining, is little changed. A continued focus on driving efficiencies across all segments of the business has pleasingly had some success. Minor first-half EBITDA guidance declines for retail and commercial are offset by reduced supply, corporate, and overheads costs.

The needle-mover in the first-half earnings decline is refining, with EBITDA guidance at AUD 0-20 million, a 60%-100% decline on the pcp’s AUD 48 million. We reduce to a midpoint AUD 10 million, assuming a refiner margin of just USD 2.25 per barrel for June, bringing the six-month average to USD 4.80, well below the USD 10 three-year average to 2017 or even 2018’s challenged USD 7.40. No-one makes a sustainable return at June’s levels and regional excess supply in refined products will eventually tighten.

Geelong’s refining comprises an approximate one third of our Viva fair value estimate overall, where we assume recovery to an unchanged midcycle refining margin of USD 10 per barrel in 2023 dollars. The other point of recovery focuses on the Coles Express retail Alliance. As discussed previously, retail trading conditions for the half were impacted by weaker than expected fuel margins, predominantly due to the rising cost of oil, but also due to disfunction within the Alliance. In February following a near break-down, it was resolved to extend the partnership through to 2029, but under a new set of arrangements, with Viva responsible for retail fuel pricing and marketing and Coles Express responsible for operating stores and providing the convenience offering. Viva says to date this arrangement has successfully stabilised volumes and it remains confident in eventual growth following continued investment over the course of the year. First-half sales volumes are guided at between 7,050 and 7,150 million litres, up approximately 2% on the pcp, although this includes commercial as well as retail volumes.

Regardless it highlights an innate strength in Viva’s integrated business model, where temporarily weaker volumes through the Alliance, for example, can potentially be offset via growth in other channels. Not all the retail and marketing pertain to Coles, with around 2.2 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.

Our Viva fair value estimate equates to an unchanged 2023 EV/EBITDA multiple of 8.3, P/E of 15.2 times, and fully franked dividend yield of 2.9%. We continue to view longer-term earnings potential as attractive including retail margin improvement assuming Viva’s Alliance efforts bear fruit. In nominal terms, we assume the marketing margin improves to a midcycle AUD 0.068 per litre versus 2018’s AUD 0.052. This supports five-year EBITDA CAGR forecast of 8.8% and underlying EPS growth of 11.6% over the same period, from a challenged 2018 start year. We think the near AUD 2.00 share price factors-in too-low five-year EBITDA CAGR of just 2.2% to AUD 660 million, versus our AUD 905 million base case.