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Morningstar | Oil Price Relief for No-Moat Z Energy with Earnings Guidance Increased. FVE Upgraded to NZD 8.30.

Z Energy has upwardly revised fiscal 2019 earnings guidance by around 5% to NZD 420-450 million in replacement cost, or RC, EBITDA, accounting for a decline in the crude price and reversal of the price lag. In a falling crude market, Z Energy enjoys better retail and commercial trading conditions as fuel becomes cheaper for customers, and reduced their price-sensitivity shifts consumption towards full-service offerings. Prior to crude’s retreat, Z Energy had been experiencing the most challenging operating environment in its eight-year history. But Brent fell 40% to December, from a high of USD 86 to USD 51 per barrel, providing some relief. We recently reiterated earnings detractors were short term in nature only. Recovery is now underway, though not soon enough to completely recover fiscal 2019 earnings. Z Energy previously made two earnings guidance cuts from an original RC EBITDA guidance estimate of NZD 450-485 million. Latest guidance is still around 7% below that original midpoint.

Z says crude markets remain volatile with Brent already having risen back above USD 60. Upgraded guidance assumes crude remains within a range of USD 60-70 per barrel for the remainder of the fiscal year to March. DPS guidance is also increased to NZD 0.38-0.47, inclusive of the interim NZD 0.125 paid in December. Z had previously downgraded DPS to an unspecified range, from an original target of NZD 0.50-0.55. Our DPS forecast had overoptimistically remained at the high end of expectations.

Our new fiscal 2019 RC EBITDA and dividend forecasts are set at guidance midrange levels of NZD 435 million and NZD 0.425; changes of plus 14% and minus 5%, respectively. We had been expecting a higher dividend payout ratio of 110% versus 83% now. Our fiscal 2019 EPS forecasts increases 25% to NZD 0.51. Fiscal 2020 is little changed at NZD 0.60. Our fair value estimate increases by 3.8% to NZD 8.30 per share, largely equivalent to time value of money.

Longer-term assumptions including five-year nominal EBITDA CAGR of 3.2% to NZD 520 million by fiscal 2023 are unchanged, recognising the small low-growth market that is New Zealand. At around NZD 6.00, we think Z Energy shares remain materially undervalued. Our NZD 8.30 fair value estimate equates to a non-onerous fiscal 2023 EV/EBITDA of 8.2 and P/E of 12.7, both inflated at WACC. In nominal terms, the P/E improves to 8.7.

Z Energy retains appeal as an income stock. Our guidance midrange fiscal 2019 DPS forecast of NZD 0.425 equates to a fully imputed yield of 7.1% before imputation at the current share price. And the potential annualised second-half fiscal 2019 yield is 10% given Z paid only NZD 0.125 in the first half. Our fiscal 2020 DPS forecast of NZD 0.51 on an 85% payout equates to 8.5% yield. Z has committed to a long-term payout of 80-100% of underlying free cash flows (net operating cash flow less maintenance capital expenditure less principal debt repayment), such that net debt/EBITDA is allowed to fall to 1.4-1.6 by fiscal 2021; annualised net debt/EBITDA was 2.8 at end first-half fiscal 2019. We think this accommodates the fiscal 2020 dividend on our unchanged NZD 0.60 EPS forecast.

Net debt/equity is currently elevated near 100%, but manageable with net debt/EBITDA less than 2.0. Our forecast high dividend payout ratios still permit net debt/EBITDA to fall below one by as soon as fiscal 2022.