Australia | Nov 26 2019
Brokers welcome the potential for a future capital return as Caltex announces plans to spin off an interest in most of its freehold retail property.
-Retail earnings appear to have accelerated in the second half
-Caltex margins outperform peers over most of 2019
-Divestment monetises the value of assets in a mature industry
By Eva Brocklehurst
Caltex ((CTX)) has provided a positive market update, with convenience retail and refiner margins better than many brokers expected. The company plans to spin off a stake in 250 freehold fuel retail sites, representing most of its freehold retail property holdings.
Morgan Stanley considers the company's strategy sensible, as it improves the balance sheet and brings net debt, adjusted for operating leases, nearer 1.0x. It also offers the potential for buybacks of up to $500m in the second half of 2020.
Timing is also pertinent, as there are longer-term implications to consider such as electric vehicles and how property investors will view petrol stations over time. Caltex has announced retail earnings (EBIT) will be $190-210m in 2019, which implies an acceleration in the second half because of improving retail fuel margins and efficiency gains.
UBS considers the trading update positive, with a capital return the potential future catalyst. However, the broker maintains concerns about the retail convenience opportunity for Caltex and looks forward to the strategy briefing on December 5.
Morgan Stanley upgrades to Overweight, having previously held off because of the lack of earnings momentum. However, this latest announcement provides the trigger. At the same time retail fuel margins appear to have improved, reducing downside risk.
Citi has previously argued that retail fuel margins were likely to be irrational and had only estimated a recovery in 2020. Guidance now suggests a return to a more rational pricing environment has occurred sooner than expected.
Moreover, margin contraction for Caltex has been lower than the broader industry, as the company benefits from a favourable mix. Caltex reported a refining margin for October of $12.01/bbl.
Citi suspects the higher margins in October were driven by one-off events, such as the recent attacks on Saudi Arabia, and remains comfortable with a second half forecast of $10.10/bbl. Better margins have meant Caltex has outperformed industry peers over most of 2019.
Ord Minnett increases 2019 estimates for earnings per share by 4.4% on the back of the update, with 2020 and 2021 unchanged. The broker remains cautious about the trends in the industry although expects the company to enjoy a boost from the imposition of the International Maritime Organisation standards in 2020.
Credit Suisse also notes refining margins remain strong ahead of the implementation of the standard and upgrades near-term retail fuel and refiner margin estimates.
IPO
The company has proposed the initial public offer (IPO) of up to 49% of 250 retail property sites and expects to use proceeds to return capital to shareholders. This is in addition to the 50 sites that will be sold separately.
The sites will be placed in a property trust and Caltex will enter into a long-term lease agreement over each site, with rental payments of $80-100m in the first year. Completion of the IPO is expected in the first half of 2020, subject to approvals and market conditions.
Credit Suisse believes this proposed divestment is attractive from an economic perspective as it monetises the value of assets committed to a structurally mature industry. The broker still questions the likely value emanating from the implementation of a convenience retail strategy and believes the reduction in near-term capital allocation is positive.
Furthermore, Credit Suisse does not consider a compelling case has emerged for additional capital to be allocated to convenience retail but suspects a low-cost position built on site automation and the absence of labour may be more sustainable.
Citi calculates that, net of fees, proceeds could amount to $700m at a 6% capitalisation rate. The broker expects proceeds will be used to buy back shares and $700m buyback would increase estimates for earnings per share by 5%.
Citi also points out there has been speculation that a spin-off would be a poison pill for a financial sponsor suitor, as a freehold IPO would remove one avenue for a capital release to be used to pay down debt and fund a leveraged acquisition of Caltex.
Ord Minnett envisages share price upside from property divestments and estimates 6-7% accretion to earnings per share if there is an off-market buyback.
FNArena's database has four Buy ratings and two Hold. The consensus target is $30.25, suggesting -9.7% downside to the last share price. Targets range from $27.97 (Macquarie, yet to comment on the update) to $34.00 (Morgan Stanley).
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