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Morningstar | Viva Sensibly Resets Alliance with Coles Express including Right-to-Price and Additional Margin.

We make no change to our AUD 3.00 fair value estimate for no-moat Viva Energy. Our fair value didn’t anticipate the Coles impasse with associated volume degradation would persist. Viva and Coles have allowed common sense to prevail and rearranged their Coles Express retail alliance. Viva Energy will take full responsibility for retail fuel pricing and marketing, while Coles Express will remain responsible for operating the stores and provide the convenience offering. Viva will now collect the full retail fuel margin and receive an enhanced royalty from Coles on convenience sales. But it will pay a commission per litre on fuel sales in addition to a one-off AUD 137 million payment to Coles to be funded from debt facilities. Net-net we view the arrangement as value-neutral, particularly given Viva expects to reinvest newly acquired margin to restore sales growth. Viva will continue to receive lease and licence fees associated with Coles’ right to occupy its sites. Viva’s alliance with Coles Express has been extended through to 2029.

This deal provides better alignment and delivers Viva the right to price fuel with additional convenience margin. It will be better placed to optimise volumes and pricing and arrest the recent decline in sales volumes. That decline was a function of high oil prices and too-high pump prices at a time when peers were cutting prices to retain share. Viva has reaffirmed a first-half 2019 underlying retail EBITDA forecast of AUD 321.9 million, and now expects the second half to be in line with the first half, driving a full-year underlying retail EBITDA of AUD 644 million.

The second half being in line with the first is a marginal decline on our prior expectations and we reduce our 2019 group underlying EBITDA forecast by 3% to AUD 618 million from AUD 636 million. Our 2019 EPS forecast declines 6% to AUD 0.15 from AUD 0.16. Our 2018 forecast is unchanged at AUD 0.135.

The longer term is enhanced by the more favourable Coles Express terms and our 4.5% 5-year EBITDA CAGR forecast to AUD 873 million by 2022 improves on our prior 4.1% 5-year CAGR forecast. Viva shares rallied 13% on the announcement but at AUD 2.20 remain materially undervalued. Restoration of alliance volumes to 70 million litres per week and then to over 75 million litres as new alliance programs mature could be a key catalyst for share price appreciation to fair value. By our reckoning an AUD 2.20 share prices-in too-low 5-year EBITDA CAGR of zero to AUD 692 million in 2022.

Our Viva fair value estimate equates to an unchanged 2022 EV/EBITDA multiple of 8.4, high enough we think given risks. Our fair value equates to a 2022 P/E of 14.9 times and dividend yield of 3.2%, both discounted at WACC, or 9.9 times and 4.8%, respectively, at today’s fair value. We continue to view longer-term earnings potential as attractive including margin improvement assuming 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.

In nominal terms, we assume the refiner margin improves to a midcycle USD 9.80 per barrel versus 2017’s USD 10.20, and that the marketing margin improves to AUD 0.067 cents per litre versus 2017’s AUD 0.051. The refiner margin for December was just USD 3.30, under pressure due to excess regional supply. We expect this circumstance to resolve, the margin to head back towards the average for the three years to 2017. Marketing margin in 2018 suffered from high crude prices, a weak Australian dollar, and the impasse with alliance partner Coles. All three components have now eased. We don’t think we are being overly aggressive. In real terms our margin forecasts are considerably below recent historical averages.