EUR 850.00 For Business Accounts Only

Morningstar | Viva Energy Creditably Beats Prospectus Guidance Despite Soft 1H Refiner Margins.

We make no change to our AUD 3.00 per share fair value estimate for no-moat Viva Energy. First-half 2018 replacement cost operating profit, or RCOP, of AUD 145 million creditably beat prospectus forecast of AUD 138 million by AUD 7.0 million or 5%. We include equity earnings from Viva Energy REIT and Liberty Oil, which Viva excludes from its RCOP estimate. The earnings beat was all the more impressive given a weaker-than-expected Geelong Refining Margin of USD 7.30 per barrel versus prospectus forecast at USD 8.30. However, the deficit was more than made up for by a strong retail, fuels and marketing performance, head office savings, and lower property costs, as well as lower than guidance statutory tax.

Refining EBITDA more than halved to AUD 48 million, below our AUD 68 million forecast, on lower regional refiner margins. The Singapore margin plumbed sub-USD 3.00 per barrel lows in June but is now back above USD 6.00, boding well for Viva's second-half refinery performance. Our midcycle Geelong Refiner Margin forecast is unchanged at USD 9.00 per barrel in 2018 dollars, 10% below the three-year average of USD 10.00 to December 2017. First-half retail, fuels and marketing segment EBITDA of AUD 474 million beat our AUD 465 million target, with total fuel volumes of 7.0 billion litres ahead of 6.9 billion litre prospectus guidance, and other revenue also beating target. Our midcycle marketing margin assumption remains AUD 6.0 cents per litre, ahead of the first-half AUD 5.3 cents performance anticipating improvement via Viva's V-Power premium diesel push, still in its infancy. Corporate costs of AUD 260 million were less than the AUD 266 million anticipated reflecting overhead savings and reduced property maintenance costs.

Viva provided no new guidance outside that in the prospectus. Despite this, we increase our fiscal 2018 and fiscal 2019 underlying EPS forecasts by 6.5% and 13% to AUD 0.175 and AUD 0.20, respectively.

The upgrades reflect the solid first-half performance outside refining, and a slightly softer AUD/USD exchange rate assumption of 0.73 from 0.74 prior. But longer-term fair value drivers are not impacted.

Dividends are still anticipated from second-half 2018, with the policy to pay out 60% of underlying NPAT for the nonfiscal year to June 2019. Thereafter the intended payout ratio is between 50% to 70% of underlying NPAT. Our 2018 and 2019 dividend forecasts stand at AUD 0.06 and AUD 0.12, equivalent to a worthwhile if not earth-shattering 2019 fully franked 5.0% yield at the current AUD 2.40 share price. We think Viva shares remain materially undervalued, with realisation of margin gains from the premium diesel strategy a potential key catalyst for share price convergence.

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. Viva says it made good first-half progress on network growth and on V-Power's introduction.

Our Viva fair value estimate equates to a 2022 EV/EBITDA multiple of 8.5 to Caltex's 8.3, high enough we think given risks. Investing in older and far smaller refineries than Asian mega-cousins is a potential trap that must be carefully navigated, and the distant but regardless real threat from electrification of transport is an inevitable market detractor. 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.

Negative first-half net operating cash flow of AUD 56 million came in weaker than expected, but reflective of AUD 140 million in unfavourable working capital moves and an outstanding AUD 117 million tax payment from 2017. These are expected to unwind in the second half. Net debt stood at just AUD 288 million at end June, net debt/EBITDA is conservative at 0.5, or 2.4 including operating leases as debt.