Australia | Dec 15 2017
The ACCC has opposed BP's proposed acquisition of the Woolworths petrol business. Brokers suggest a capital return for Woolworths is now less likely and Caltex is less likely to lose -$150m in earnings.
-Decision reflects the greater influence of the Woolworths sites nationally than occurred with the Milemaker acquisition
-Setback raises questions regarding the funding of the Woolworths store refurbishment
-Woolworths supermarkets return to growth, irrespective of the ownership of the fuel outlets
By Eva Brocklehurst
Australia's competition regulator, the ACCC, has thrown a spanner in the works for BP's acquisition of the Woolworths ((WOW)) service stations business. The ACCC has stated it will oppose the acquisition on the basis it would substantially lessen competition in the retail supply of fuel. Notably, the ACCC said the underlying concerns would not be addressed by the divestments proposed by BP.
Ord Minnett had assumed the transaction would occur, but with a significant number of divestments. This was based on the fact that the ACCC allowed Caltex ((CTX)), which is generally a higher-price competitor that leads pricing cycles upwards, to acquire Milemaker, which typically contributes downward pressure to prices.
It appears the greater influence nationally from the Woolworths petrol business versus Milemaker's concentration in Melbourne, along with a large overlap between the BP and Woolworths sites, are factors that weighed more significantly on this decision than many had envisaged.
Brokers now canvass the options available for the fuel business going forward. BP and Woolworths are expected to challenge the decision and Woolworths may seek an alternative buyer, or it might also decide to retain the business.
Ord Minnett suggests, given Foreign Investment Review Board (FIRB) approval is required, and that often requires ACCC approval, forcing the the issue to the Federal Court is unlikely. BP and Woolworths would need to consider whether they were willing to invest further time and money in the process.
Morgans always believed there would be issues with the deal, given the amount of overlapping sites, as well as the fact BP is a premium-price fuel retailer compared to Woolworths being a more discount-oriented operator. Moreover, the broker believes any future deal with an existing major fuel retailer is likely to face similar ACCC concerns.
In the absence of a sale of the Woolworths fuel business the exclusive contract for wholesale supply from Caltex to these outlets will probably continue. Citi suggests Caltex may now supply Woolworths for at least a further 12 months. In addition, the cessation of the BP-Woolworths alliance may also lower competition for the Caltex Foodary roll out.
While Caltex has already offset the potential contract loss through acquisitions and cost reductions, Citi continues to believe the market under-appreciates the opportunity to further offset lost sales via the acquisition of BP re-sellers, if the deal is ultimately successful, or by maintaining wholesale supply if it fails.
Morgan Stanley suggests failure of the deal would be a good outcome for Caltex, although understands that some of the targeted cost reductions were dependent on the loss of the Woolworths supply contract so there might be fewer savings to be had if Caltex retains the business.
The broker considers the ACCC decision puts in focus the retail margins of petrol and diesel, which have trended higher over the past decade and remain high in Australia. The broker expects some standardisation to the margin over time and believes this is also the start of changes to fuel consumption patterns.
Caltex has guided to a -$150m annualised earnings headwind from the resulting sale of the fuel network. If the transaction is not to be completed, Deutsche Bank estimates this would represent a 9% and 8% increase to 2018 and 2019 net profit estimates respectively.
The broker makes no changes to earnings estimates at this stage and, having already factored in delays regarding the sale to its price target, downgrades to Hold from Buy.
For Woolworths, Deutsche Bank believes there were always going to be underlying earnings upgrades irrespective of the ACCC decision. The company does not need this deal as badly as it did a year ago because the balance sheet is in much better shape and the business operations have improved materially. However, keeping the petrol business means there will be no excess capital to return.
Deutsche Bank also highlights the lessening emphasis that consumers are placing on petrol. The broker points out the ACCC's intention to oppose the transaction does not mean the deal is impossible, just much less likely. Meanwhile, Woolworths is turning around its supermarket division, which is more critical to the broker's investment thesis.
Given the strategic nature of the 531 sites, the -4-5% dilution to earnings per share from the sale and the limited benefit from a balance sheet perspective, UBS does not believe retaining the business is a negative and suspects the news will drive modest upgrades to consensus estimates for Woolworths. While the Woolworths business remains challenged the broker believes a return to growth is positive and encouraging, regardless of how the fuel situation is resolved.
Macquarie suggests the setback still raises questions regarding the sustainability of funding the Woolworths store refurbishment program. Despite a strong start to FY18 the broker has not observed funding for refurbishments from the sales performance and expects comparables to get harder to cycle.
Citi re-incorporates the petrol business back into its forecasts, noting the sale would have accelerated repairs to the balance sheet and shifted the business to a net cash position by June 2019. The broker acknowledges prospects for a capital return in the next 2-3 years have diminished but suggests Woolworths is still well placed to use the 531 sites for its convenience food and the online click & collect strategy.
Morgan Stanley agrees the potential for special dividends or buybacks is now limited. The broker considers Woolworths stock expensive, despite the recent improvements in operations and, as more challenging comparable periods are lapped, expects food sales growth to slow and the shares to de-rate.
Woolworths has three Buy, two Hold and three Sell ratings on FNArena's database. The consensus target is $26.32, suggesting -2.7% downside to the last share price. Caltex has four Buy ratings, two Hold and one Sell (Morgan Stanley). The consensus target is $35.49, signalling -0.2% downside to the last share price.
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