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Forte Oil Plc H1'19 - Subsidy income buoys earnings growth

Group turnover slides q/q 

FO’s fuel business reported a turnover of ₦35.9 billion (-6% q/q) in Q2’19, underperforming our estimate of ₦37.2 billion. The q/q drop in fuel revenue, we believe, was driven by lower petroleum products supplies by the NNPC, as other top players (notably Total Nigeria Plc and 11 Plc) in the downstream industry reported declines in Q2 fuel sales. Given the industry trend of a weaker fuel sales in Q3, we expect a marginal decline in fuel revenue to ₦35.7 billion in Q3’19, before strengthening to ₦36.4 billion in Q4’19, buoyed by anticipated increased spending activities during the December festive season. The lubricants business, in contrast, recorded a modest q/q growth of 2%, printing at ₦4.3 billion, which came in line with our estimate. Our FY’19 outlook for FO’s lubricants business remains unchanged, with H2’19 lubes sales forecast at ₦8.7 billion (Q3’19E: ₦4.3 billion, Q4’19E: ₦4.4 billion).

Interest on subsidy propels earnings 

Gross margin worsened to 6.3% in Q2’19 (Q1’19: 7.2%), held down by higher estimated landing costs, as average Brent price advanced to $68/bbl in Q2’19 from $64/bbl in Q1’19. Due to the weaker gross margin and higher operating expenses (+39% q/q) observed during the quarter, FO reported an operating loss of ₦246 million. However, amidst the tough operating downstream environment, FO witnessed some respite in Q2’19 through devaluation of interest on subsidy, which boosted finance income to ₦4.2 billion (Q1’19: ₦198 million). Stripping out the interest on subsidy, FO would have reported a loss before tax of ₦750 million in Q2’19. With our expectation of lower average crude prices in H2’19 alongside increasing lubricants contribution to turnover, we expect gross margin to improve to 7.7% in H2’19 (H1’19: 6.7%), translating to a FY’19 forecast of 7.2% (FY’18: 8.4%). On segment basis, we expect gross margin in the fuel business to come in at 5% in FY’19 (FY’18: 7%); whereas we expect lubricants margin to advance to 24% (FY’18: 20%). By year end, we expect an improvement in FO’s operating margin to 3.1% (FY’18: 2.0%), supported by gains of ₦2.7 billion from the disposal of discontinued operations.  

Valuation and recommendation 

Following our revised valuation of FO, we have lowered our FY’19 estimate for turnover to ₦163.6 billion (previous estimate: ₦169.5 billion). In similar vein, our estimate for gross profit has been trimmed down to ₦11.8 billion (previous estimate: ₦12.2 billion). However, we have raised our estimate for operating profit higher to ₦5.1 billion (previous estimate: ₦3.6 billion), underpinned by gains from assets disposal. Likewise, we have raised our forecast for profit before tax to ₦7.0 billion (previous estimate: ₦930 million), supported by the Q2’19 spike in finance income. Our revised estimates culminate in a ROE of 14.0% (previous estimate: 2.3%) and a target price of ₦34.22 (previous estimate: ₦40.82). FO currently trades at a P/E of 2.6x (industry average: 7.9x), lagging our estimated forward P/E of 3.7x.