Treasure Chest | Nov 02 2011
By Greg Peel
What?
As management at Caltex ((CTX)) is believed to be considering selling the loss-making oil refineries, execution of such strategy could unlock significant value, which should have a commensurate impact on the share price.
Why?
Caltex management has decided to review the company's Australian oil refining business which is loss-making and detracts from profitability in its refined product distribution business. Were Caltex to close its refinery operations and refurbish those sites into storage terminals, Macquarie sees the potential to unlock value that would imply a net asset value of up to $21.00. CTX shares closed yesterday at $13.40.
Macquarie had an Outperform rating on Caltex Australia ((CTX)) but has now added the stock to its Marquee Ideas portfolio which contains stocks for which the analysts have a strong conviction.
Background
Caltex is at present the only remaining company operating refineries in Australia which convert crude oil into petrol, diesel, jet fuel and other petroleum products. Caltex operates one refinery in Sydney and one in Brisbane and otherwise engages in the marketing of products, right down to its retail service station chain. In recent years its refinery operations have become net loss-making in the face of competition from fully imported products from Asia. Macquarie estimates the refining business deducts $4 per share of value from CTX.
The company is thus now reviewing its refinery business. Last week it announced the pending closure in around a year's time of two facilities at its Kurnell refinery – one producing gasoline and the other bitumen. The closure of one gasoline facility was prompted by two units on site running at only 50% capacity due to a gradual fall in petrol demand and the growing popularity of diesel.
Given CTX is in the process of reviewing its refinery business altogether, analysts are assuming this is the first step towards a complete withdrawal, albeit management has suggested the decision was unrelated. Macquarie's stock recommendation is nevertheless based on Caltex becoming stand-alone fuel marketing business.
Were CTX to cease refining and convert its sites into storage terminals for imported product, considerable remediation costs could be deferred and valuable tax credits would be created via asset write-downs, Macquarie suggests. CTX could also increase its storage capacity to ensure greater security of local supply and to allow for the arrangement of robust supply agreements with Asian refineries.
Such a strategy could also release up to $800m in working capital and offer the chance to gear up a balance sheet which to date has remained conservatively positioned against the potential volatility of the refinery business. The only problem the analysts foresee here is a lack of actual investment opportunities in Australia's existing wholesale and retail businesses, but then a capital return could be on the cards instead.
As a distributor only and no longer a refiner, CTX's PE multiple should re-rate, Macquarie suggests, given the greater risk inherent in refining. While the analysts don't see CTX re-rating all the way to match typical distribution-led retailers they do note there are retailers listed at present with more challenged growth outlooks that still enjoy a 13% PE premium to CTX.
The risks to Macquarie's excitement begin with the analysts' own acknowledgment that nothing is going to happen quickly, and indeed they only ascribe a 20% chance of a move away from refining in the “near term”. Beyond that, UBS analysts have raised the issue of the potential difficulty of securing enough Asian product which both satisfies Australian demand meets tougher Australian specifications.
There is also a suggestion of the risk to Australia's sovereign energy security if there are no longer any refineries in the country. This might imply a dreaded entry into the debate by Australian politicians.
Macquarie nevertheless considers Caltex to be worth an implied “Buy With Conviction” rating and has set a twelve month price target of $15.50.
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