Viva Energy: Emphasis Swings Toward Convenience Retail  

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

Brokers assess a convenience retail acquision which will further diversify earnings for Viva Energy.

-Acquisition of OTR Group set to diversify Viva Energy’s earnings 
-The new deal complements the recent Coles Express transaction 
-Ord Minnett is wary of capital required to achieve synergies 
-Upside scenarios for earnings and valuation 

By Mark Woodruff

The share price of Viva Energy ((VEA))) closely tracks the difference between the price of crude oil and the prices of refined products, referred to as the crack spread.

The company is the second-largest refined fuel supplier in Australia with a 24% market share of the 60bn litre market, behind the 27% share garnered by Ampol ((ALD)).

Viva imports, blends and delivers fuels, lubricants, solvents and bitumen through its national and international supply chains.

Only last month, Morgan Stanley noted the company’s Geelong Refinery generates around 50% of total earnings, which helps explain why Viva’s market capitalisation follows the crack spread so closely.

This correlation may be set to change, however, after the company announced the acquisition of South Australian-based, family-owned fuel and convenience business OTR Group, formerly called “On the Run”.

UBS highlights the acquisition will not only contribute $165m to annual earnings (EBITDA) for Viva, but also diversify earnings into convenience retail away from Refining & Fuels.

Non-fuel earnings would rise to 50% from 30% of gross profit post completion, according to the broker.

Such a material repositioning prompts Macquarie to suggest Viva is realising its vision of becoming “a convenience retailer that sells fuel, rather than a fuel retailer with a convenience offer”.

The $165m in additional yearly earnings includes synergies of $60m, notes this broker, which will take two to three years to achieve. Of this $165m, $15-20m will be attributed to Viva’s Commercial division and $145-150m will accrue to the Convenience segment.

There are other potential advantages from the transaction, suggests UBS, given Viva  struck a $300m deal with Coles Group ((COL)) just over six months ago to take full control of the Coles Express fuel and convenience retailing network. 

The analyst believes this new deal de-risks and improves the potential upside from the Coles Express acquisition by capturing the brand rights and capability of the highly regarded OTR team. 

Macquarie concurs with UBS by noting the proposed deal resolves uncertainty around Viva’s rebranding exercise on its existing Coles Express network.

Apart from $60m in quantified synergies, the transaction offers further potential synergies if Viva can capture some of the upside from OTR's store format, suggests UBS. At present, OTR generates an average sales per store around 2.5 times higher than Coles Express.

The deal may, however, raise competition red flags for the ACCC, as it combines OTR’s circa 160 integrated fuel and convenience stores in South Australia with Viva’s 43 Coles Express sites.

As a result of this regulatory uncertainty,  Macquarie, Ord Minnett and UBS do not yet incorporate the transaction into their forecasts and retain their respective 12-month target prices.

Moreover, Ord Minnett doesn’t anticipate a material change to its current fair value/target price of $3.35, when it does allow for the OTR deal.

Additional capital expenditure and more overall capital overall will be required to secure annual synergies in the areas of procurement, marketing and functional support, cautions this broker.

A commensurate increase in risk to equity can arise from higher earnings funded by increased debt, observes the analyst, a factor often overlooked by the market.

The acquisition cost of $1.15bn is to be funded via $1bn of debt/working capital and $150m of equity issued to the sellers.

Potential  upside for earnings and valuation

Potentially, investors will apply a higher multiple to Viva's earnings stream as it diversifies away from fuel distribution, suggests Evans and Partners, which has a Positive rating and $3.40 valuation.

Canadian convenience style retail company Alimentation Couche-Tard trades at an around 9-10 times enterprise (EV/EBITDA) multiple, compared to the 7.25 times multiple used for the broker’s Viva valuation.

UBS envisages EPS accretion of more than 20% by 2027, assuming Viva converts 150-200 of existing sites to the OTR format over three years, and can capture just half the earnings uplift per store differential that currently exists between OTR and Coles Express. 

This broker believes Viva can continue to payout 70% of earnings providing a 6-7% dividend yield. Once synergies are achieved, it’s expected net debt to EBITDA will remain below the bottom end of the company’s 1-1.5 times target range.

The average target price for Viva Energy, derived from four brokers monitored daily by FNArena, is $3.36. This target suggests just 5% upside to the latest share price.

Of the four brokers, two have a Buy (or equivalent) rating and two have Hold recommendations.

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