Australia | Dec 18 2015
-Margins at record levels
-But are they sustainable?
-Potential for buy-back mounts
-Yet company priority on growth
By Eva Brocklehurst
Caltex ((CTX)) has lined up all the positives in 2015, issuing upgraded guidance, with brokers observing the marketing and supply numbers are better than expected. Refining margins have also been supportive throughout much of the year.
Net debt has now fallen to $420m and brokers are developing the view that there is scope for a larger off-market buy-back next year. The company's guidance is for RCOP of $615-635m in 2015, which is Caltex-speak for replacement cost of sales operating profit.
Caltex expects its marketing business will contribute earnings around $670m, which Deutsche Bank calculates, on an underlying basis represents growth of 5.0% on 2014.
Risk was to the upside and the upgraded guidance has confirmed this for Credit Suisse but the broker will await the actual results in February for more detail on where real strength lies. With volumes still low, albeit recovering, it appears at this stage that margins are the main positive feature.
This is likely because the volume losses have been in low-margin jet fuel and diesel. With no new refining capacity in 2016 risks to earnings in that segment are to the upside but Credit Suisse considers it too early to make such a call on 2016.
Macquarie also notes higher sales of premium grade fuel which point to higher indicative retail margins in the December quarter. The broker suspects the Lytton refinery's performance also underpinned the earnings upgrades for 2015, although this stellar performance is unlikely to be sustained in 2016, while resilient marketing and supply has been evident despite a highly competitive commercial market.
Macquarie suspects the balance sheet could support a buy-back of $300-400m, while still preserving some capacity for acquisitions. The broker increases its pay-out estimates for the final dividend to 60%.
Credit Suisse also notes, in the absence of capital management or acquisitions, Caltex would be net cash by the end of 2017. In the current climate, prudence and a sustainable dividend are to be applauded, but the broker suspects there is a need to address a very under-leveraged balance sheet.
Credit Suisse remains partial to the stock, given its highly predictable cash flow business in supply and marketing, with upside from refining, and does not consider the stock expensive at all.
Nevertheless, the share price has had a strong run so Citi pulls its rating back to Neutral from Buy. Expecting the company will continue to focus on business optimisation, the broker cautions that acquisitions cannot be forecast and special dividends may not be as high as the market appears to be anticipating.
Morgan Stanley also warns about presuming a buy-back, given the company's stated priority is marketing and retail growth. The broker's main concern is the outlook for refinery margins, being nervous about the sustainability of record levels. Still, Morgan Stanley gives the company the benefit of the doubt, as margins have surprised to the upside over 2015, and revises up earnings expectations for 2016 and 2017.
UBS expects Caltex to invest heavily in growth although expects, in the interim, its lower net debt provides an opportunity for an off-market buy-back. UBS makes a case for $300m in the first half of 2016. The broker forecasts a 14% jump in 2016 marketing and supply earnings, driven by a full year's impact from Tabula Rasa and margin gains from Ampol Singapore.
UBS believes material investment in growth will be necessary over the next 2-3 years for the company to remain in the top quartile for total shareholder returns in the medium term. Supply chain optimisation and premium fuel can only do the job to some extent. Acquisitions will probably feature but UBS notes this increases the risk profile.
Moreover, the broker suspects the market finds it difficult to forecast the company’s refining business, given its volatility and unpredictability, and largely discounts the value of refining in forward estimates. Lytton was profitable in 2015, thanks to a good operating performance and high margins, supported by a weaker Australian dollar. Hence, the broker believes the market will factor in some value for the refining operations.
UBS considers five times “normalised” earnings is appropriate, with normalised earnings based on its 2017 forecasts of $194m, when the refinery margin is expected to be back at US$11/bbl from the 2015 guidance of US$16/bbl.
JP Morgan believes the transport fuels margin, Ampol Singapore and refining all provide sources of potential upside. The broker considers the Ampol Singapore opportunity – which is sourcing fuel in the region and leveraging significant infrastructure advantage – provides the potential for earnings growth from pricing below import parity and making freight savings in the new supply and marketing division.
FNArena's database has two Buy and five Hold ratings for Caltex. The consensus target is $36.58, signalling 1.8% upside to the last share price. Targets range from $33.50 to $40.00.
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