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Convenience Retail Seen Oiling Caltex Growth

Australia | Mar 20 2019

This story features VIVA ENERGY GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: VEA

The renewed alliance between Viva Energy and Coles is making life more difficult for Caltex, although brokers still envisage the long-term opportunity from convenience retailing is substantial.

-Further pressure forecast for Caltex volumes and margins
-Retail margins expected to normalise in the second half amid US crude supply growth
-Is the market adequately valuing the Caltex convenience offer

 

By Eva Brocklehurst

While a rebound in oil prices has likely contributed to margin weakness for Caltex ((CTX)) recently, a rise in competitor discounting remains the biggest concern for brokers over 2019. This has been caused by the re-setting of the alliance between Viva Energy ((VEA)) and Coles ((COL)), with aggressive pricing in January materialising ahead of the change.

Deutsche Bank suspects this dynamic is not going to ease off any time soon, as the alliance has a clear mandate to grow volumes. Hence, further pressure is forecast for Caltex volumes and margins. The broker believes this makes the company's retail uplift target even less achievable.

Ord Minnett agrees the new competitor alliance will make gross margin expansion more difficult. Market share losses are expected at Caltex customer Woolworths ((WOW)) and to a lesser extent at Caltex itself.

Underlying fuel and infrastructure growth has also slowed, as international business moderates, and Woolworths is considered to be a long-term contract burden. Ord Minnett expects earnings from the Lytton refinery to fall because of lower volumes and volatile refining margins.

A plant shutdown at Lytton is expected to reduce production by 200-250m litres while 2019 production guidance for 5.8bn litres has been reaffirmed. Fuel retail margins were lower at the end of February, affected by diesel pricing and competition in petrol retailing. The negative impact from diesel is likely to reverse at some stage during the year, Credit Suisse assesses.

Credit Suisse takes a positive view on the company's market share, which appears to have stabilised. The increased competition in petrol retailing appears to the broker to be a tactical move by Caltex to stabilise market share ahead of changes in the Viva Energy/Coles contract and the transition of Woolworths fuel to EG Group.

Morgan Stanley retains an Underweight rating and expects the new pricing strategy from Viva Energy will affect margins in the second quarter, although there may be some offset from the oil price after the large increase in the first quarter.

UBS reduces 2019-21 estimates for earnings per share by -5-18%, largely because of lower refining margins, the Lytton shutdown and retail margin and volume weakness. Retail margins are expected to normalise in the second half as crude prices are impacted by supply growth in the US.

Convenience

Ord Minnett has reduced confidence in the execution of the convenience retail strategy, as earnings targets are being pushed back and not reiterated. However, longer-term, the convenience business remains an opportunity. Credit Suisse agrees the main levers for growth continue to revolve around developing convenience formats and fuel infrastructure.

The broker assumes price competition continues throughout the first half, partially offset by a recovery in refining margins. The Caltex refining margin has improved from the January low, averaging US$7.00/bbl over the two months to February. The broker increases forecasts for margin to US$7.50/bbl in the first half, resulting in an earnings upgrade for Lytton.

UBS believes pressures from competition are likely to continue and reduces retail earnings estimates by -3-10%. Despite the near-term earnings risk, the broker considers there is medium-term upside via the successful execution of the convenience business.

UBS assesses the market as attractive, as there are high barriers to entry amid growth across convenience and commercial business. Industry profitability is seen improving as fuel sites increase their share of sales of higher margin, higher returning convenience and food. The broker does not believe the market is adequately valuing the convenience offer.

FNArena's database shows four Buy ratings, two Hold and one Sell (Morgan Stanley). The consensus target is $29.16, signalling 7.4% upside to the last share price. Targets range from $25 (Morgan Stanley) to $33 (Macquarie, yet to comment on the update). The dividend yield on 2019 and 2020 forecasts is 4.0% and 4.9% respectively.

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COL VEA WOW

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For more info SHARE ANALYSIS: WOW - WOOLWORTHS GROUP LIMITED