Australia | Dec 11 2019
Viva Energy has had a difficult year amid a continued deterioration in retail margins. However, top-line revenue remains strong and fuel volumes are up.
-Timing lags in commercial fuel contract renewals puts pressure on margins
-Earnings opportunity over the next 2-3 years amid improving retail volumes
-Path towards retail fuel expansion likely to remain bumpy
By Eva Brocklehurst
As largely expected, Viva Energy ((VEA)) has guided to a continued deterioration in retail margins while fuel volumes have remained firm. All divisions are likely to have posted weaker earnings over 2019.
Top-line revenue remains strong and volumes are up 4.3%. However underlying net profit guidance of $135-165m is -10% below consensus estimates at the mid point. Operating earnings (EBITDA) guidance for 2019 is $625-655m which compares with $770m in 2018.
It has been a difficult year for the company, Morgans points out, with refining, retail and commercial segments all under the pump at various points in time. The broker trims estimates for 2019 in line with the guidance, which means a -23% reduction in 2019 estimates for earnings per share.
In commercial fuel, guidance implies a reduction of -13-17% in operating earnings, implying a step-down in the second half, given margin pressure on contract renewals and rising freight costs which have not been passed on until after the expiration of short-term contracts.
However, UBS notes the market is rational and Viva Energy is winning share and the main issue has been about the timing of contract renewals and the lag between cost versus price increases. The broker suspects commercial earnings growth is unlikely to outpace retail over the next three years.
Credit Suisse calculates guidance for the fuels marketing segment as a whole implies a -16% reduction in operating earnings/litre in the second half. A number of short-term factors have affected refiner margins in the second half such as light sweet crude premium and an adverse turn in transport markets.
Credit Suisse expects refining margins will deteriorate following the IMO2020 transition. In contrast, while refining margins remain difficult to forecast, Morgan Stanley expects them to be higher in 2020.
Meanwhile, retail margins have continued to deteriorate in December with both diesel and automotive gasoline down. Costs have clearly been an issue here is well. Volumes were better, up 9% in the second half, as the company is regaining retail market share.
Morgan Stanley observes some of the growth in volumes appears to relate to non-alliance volumes, which are lower margin, and notes with interest that Viva Energy's retail business went backwards (modestly) half-on-half whereas Caltex Australia ((CTX)) improved.
UBS points out its forecasts assume no gain in share and/or benefit from a second airport in Sydney over the long-term but Viva Energy is well-positioned on that score.
The company has, by its very nature, a volatile business and this is reflected in a high PE discount to the market. Nevertheless, the broker envisages a significant earnings opportunity over the next 2-3 years amid improving retail volumes, while 2019 and the first half of 2020 are likely to reflect a period of reinvestment.
Credit Suisse finds the valuation reasonable albeit not compelling while potential sale of the company's interest in Viva Energy REIT ((VVR)) could be a potential catalyst for capital management.
Since the new fuel deal with Coles ((COL)), the company is targeting alliance volumes of 70-75m litres per week which is below the more than 100m litres recorded in 2015. UBS considers the strategy is sound, while Morgans notes volumes have continued to pick up despite the larger-than-expected drop in retail earnings..
Yet the broker suspects consensus estimates in this regard are optimistic. Averaging 65m litres of fuel per week in the December half, Morgans assesses Viva Energy is well-placed to recover retail earnings if it can maintain a similar market share once it returns to a pricing strategy that is typical of more premium retailers.
Ord Minnett notes lower prices from the previously higher-priced Coles Express, and for that matter, competitor Woolworths ((WOW)) sites have meant growth is well ahead of population, fuel demand and store sales.
Nevertheless, with a stronger independent sector that has a potentially different return-on-capital hurdle and time horizon, the path towards retail fuel expansion is likely to remain bumpy. Morgan Stanley, too, remains confident the retail strategy is taking shape and profitability will build in 2020.
FNArena's database has three Buy ratings and two Hold. The consensus target is $2.21, suggesting 11.5% upside to the last share price.
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