Time To Buy Caltex?

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Brokers diverge on whether Caltex’ profit warning represents deep-seated problems or an opportunity to buy. 

-Caltex dogged by economic slowdown, high oil prices and refinery problems-
-Retail petrol and convenience stores underperform
-Refining margins expected to bounce back as part of medium-term recovery 

By Nicki Bourlioufas

The analyst community split sharply in response to profit guidance by Caltex Australia ((CTX)) for the six months to June, in which the company warned profit would be about half that of the same period in 2018. The stock closed at $26.99 on June 19 before the announcement, plunged to $21.00 at the opening on June 20 and has since climbed back above $24.00.

Analysts revised their valuations radically in the wake of the guidance, coming up with target prices that range from UBS’s $23.30 to Goldman Sachs’ $29.00.

The analysts diverged on whether the warning represented deep-seated problems or an opportunity to buy.  The pessimists tended to focus on the poor performance of the convenience stores, while the optimists looked more at the drop in refining revenues, which they see as a temporary blip.  

The more sanguine analysts also point to the likely impact of new regulations set by the International Maritime Organisation, which will come into effect on January 1 next year. The rules, known as IMO2020, require ships to slash sulphur emissions by more than 80% by switching to lower sulphur fuels. While most brokers believe this could favour Caltex, UBS believes it could hurt its bottom line.

Caltex under siege from economic forces, refinery shutdowns, petrol price competition

Caltex’s revenue comes from refining, distributing and selling petroleum products, and operating convenience stores throughout Australia and the north island of New Zealand. The company blamed high crude oil prices and low refining margins, combined with the Australian dollar’s low exchange rate. It also pointed the finger at the slowing domestic economy and fierce competition in the retail fuel market, as well as unplanned shutdowns at its Lytton refinery in Brisbane.  

For the June half, Caltex cut its net profit guidance to $120-$140m, down from $296m in the same period in 2018. A major factor is the outages at Lytton, which have depressed refining revenue to less than $10m, down from $105m. The rest of the Fuels and Infrastructure business remains resilient, but Convenience Retail is tipped to fall by about half.

Pessimists concerned by petrol prices, poor performance of convenience stores

The most pessimistic broker was UBS, which downgraded its rating to Neutral from Buy, with a target price of $23.30, down from $30.20. UBS cited uncertainty around why retail margins deteriorated so materially in May, given that management said at the April AGM it saw improving trends.
UBS was also sceptical about the impact of IMO2020, saying there is little clarity as to how it will affect refining margins. “On one hand, it is likely to accelerate demand for middle distillates (diesel, jet). On the other hand, it will result in higher sweet oil prices, raising Lytton’s key input cost.”

Shaw and Partners took a similar view, raising its risk assessment to medium and lowering its target price to $24.20 with a Hold recommendation. Shaw said the 50% collapse of revenue from convenience retail diminished its conviction that the business was “consumer defensive”. 

Shaw and Partners said: “This should be a ‘recession proof’ activity, but instead CTX’s strategy to re-acquire franchises and grow has exposed investors to increased earnings risk.” Nevertheless, the Shaw team tipped an improvement in refinery margins due to IMO2020, saying Lytton income should start to recover next year.

Ord Minnett maintained its Hold rating, while noting the increased risk, but lowered its target price from $28.00 to $25.00. Ord Minnett noted retail fuel margins have been more volatile than expected, with Coles Express ((COL)) losing its ability to price above the market as Viva Energy Group ((VEA)) gains pricing control and the independent sector becomes more competitive.

Morgan Stanley remains Underweight (Sector: In-Line) on the stock, with a target price of $25.00. But the Morgan Stanley analysts noted the valuation could rise if Caltex undertook a buyback or capital management “to return more than A$800m of franking credits, particularly in relation to an infrastructure divestment or property divestment”.

Optimists see recovery driven by capital management, return to sustainable margins

Most positive on Caltex was Goldman Sachs, which upgraded its recommendation to Buy and pushed its target price to $29.00. Goldman Sachs noted refiner margins have dipped to current levels for only seven separate months in the past decade, and it expects current pricing to stimulate supply. With IMO2020 looming from January 1, it is factoring in a refiner margin of US$10.79 per barrel next year.

Credit Suisse lowered its target price slightly to $28.94 from $30.50, but still rated the stock Outperform. The team said fuel margins are unsustainably low, and thus likely to improve in the second half of the year, and Caltex may have to consider reducing costs and managing capital more tightly.

Citi set a target price of $26.89, down from $29.95, but maintained its Buy. Citi characterised Caltex’s problems as cyclical, not structural, and said earnings were on a “compelling” pathway back to mid-cycle levels.

Citi said it foresees a modest but structural benefit from IMO2020, more rational margins on retail fuel, some very modest long-term growth in Fuel and Infrastructure volumes, and the potential for closures of unprofitable petrol stations.

Macquarie retained its Outperform rating and set a target price of $26.50.  The Macquarie analysts said “the stock looks oversold at these levels” and the interim result to be announced on August 27 is expected to include “cost control changes and recognition of value from certain locations”.

FNArena's database shows three Buy ratings for Caltex, three Hold and one Sell. The consensus target is $25.79, suggesting 6.8% upside to the last share price of $24.15. Targets range from $23.30 (UBS) to $28.94 (Credit Suisse).

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