Australia | Nov 24 2020
This story features AMPOL. For more info SHARE ANALYSIS: ALD
Enthusiasm for Ampol has softened despite a positive update, as the market awaits a decision on the Lytton refinery amid a cloudy outlook for fuel margins
-Re-stated intention to lift returns from existing assets
-Buyback signals improved underlying cash flow
-Decision on Lytton overhanging the stock
By Eva Brocklehurst
Cost reductions, a buyback and renewed expectations of a medium-term uplift in earnings have raised confidence in Ampol ((ALD)) yet several brokers are holding back as the stock has rallied strongly.
The company has announced a further $40m in cost reductions by 2022 and there appears, in Morgan Stanley's view, to be greater conviction about the performance of the convenience business.
Ampol has reaffirmed its intention to lift returns from the existing asset base and lower expenditure for retail store fit-outs. Management has reiterated the basis for the 2024 uplift in earnings (EBIT) for convenience retail of $85m and fuels & infrastructure (F&I) international of $70m.
Yet Morgan Stanley downgrades to Equal-weight from Overweight, believing sustained momentum is required for the stock to re-rate. Ampol has a history of surprising the market with earnings updates so investors may be sceptical until expectations are confirmed.
The stock is trading at around 7.5x enterprise value/operating earnings and Morgan Stanley assumes very little profit from refining in 2021. Some growth is expected over the next year in the higher-value part of the business so the broker acknowledges its valuation may be conservative.
Nevertheless, a more attractive entry point is sought. Upside risks involve delivery of cost reductions, a stronger US dollar and better refinery and retail fuel margins.
Ord Minnett also downgrades to Hold from Accumulate, highlighting the rally in the share price as Ampol benefits from a broader recovery in mobility. While there is greater investment confidence in the delivery of cost savings, valuation support is reduced and the output for Lytton remains uncertain so the risk/reward balance is less compelling, in the broker's view.
Ord Minnett also points out one-off cost savings in 2020 stemming from the pandemic must also be cycled. Macquarie still considers the business improvements that are being implemented are consistent with potential ongoing takeover interest from Couche-Tard, among others.
The $300m buyback splits the cash from the recent property divestment to debt reductions and a shareholder return. This is ahead of Macquarie's expectations and the main positive aspect of the update.
It provides evidence not only of the property transaction finalisation ($635m) but also an improvement in underlying cash flow throughout the second half of 2020 as oil prices and operations stabilised.
Ord Minnett notes the proceeds from the property sale was slightly higher than guided in August while the buyback is consistent with the capital allocation framework and should drive earnings accretion of around 4.5% by 2022.
UBS upgrades to Buy from Neutral to reflect upgrades to earnings estimates and the buyback, anticipating further capital management over the next 12 months. The broker notes convenience retail earnings are now back at pre-pandemic levels and retail fuel margins remain above long-term historical averages.
While there was no actual update on the Lytton refinery review, the company has signalled that the storage facility at Kurnell could support a federal focus on improved domestic fuel security.
UBS believes the facility can take advantage of the government's $200m grant for the construction of new diesel storage tanks and the site has capacity for an additional 200m litres of fuel storage.
Ampol could offer open access to to the facilities in return for government support and a right-of-use fee. Any earnings uplift would depend on the level of government support, as UBS calculates Ampol would require a return on capital of more than 12%, which is the return that fuels & infrastructure delivered over the last 12 months.
A decision on Lytton in the first half would be a positive, Credit Suisse asserts. Continuation would require government support and/or a vote of confidence in the outlook for the refinery, whereas closure or sale would provide more stable earnings and flexibility for the balance sheet.
Furthermore, Credit Suisse ascertains capital expenditure of $200-300m is required to meet new fuel quality standards along with ongoing expenditure of $70m per annum and this compares with a one-off cost for closure that would be less than the $430m spent to close Kurnell.
Macquarie suspects the review of Lytton is still evolving, agreeing that the fact an upgrade to a fuel import terminal is still being considered indicates it would cost less than the Kurnell import terminal conversion.
Goldman Sachs anticipates closure of Lytton from 2022 and warns that any federal government funding support faces political risk as to the size and timing of payments. The broker highlights the growing capital intensity of the business, which is a risk to capital return expectations in the short term.
Moreover, 2024 growth targets are capital intensive, although this may be more than offset by the potential closure of Lytton. Capital investments to 2024 include the buyback, the re-branding to Ampol, convenience format roll-out and F&I international expansion.
Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, prefers its exploration & production coverage to the refiners, and without a recovery in commodity prices envisages downside risk for Ampol, retaining a Sell rating and $23.30 target.
The database has two Buy and three Hold ratings. The consensus target is $31.84, suggesting 6.2% upside to the last share price. Targets range from $29.37 (Credit Suisse) to $35.15 (Macquarie).
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