Has Caltex More Fuel In The Tank For Woolworths?

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This story features WOOLWORTHS GROUP LIMITED.
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Caltex has raised speculation over the bidding process for the Woolworths fuel outlets after its acquisition of a small Victorian re-seller.

-Acquisition of Milemaker does not stand in the way of the Woolworths bid, but seen reducing likelihood
-Management confident it can replace profits if it loses the Woolworths supply agreement
-Caltex likely a beneficiary in terms of its network if BP does acquire the Woolworths sites
 

By Eva Brocklehurst

Caltex ((CTX)) will purchase Milemaker Petroleum's retail fuel assets in Victoria for $95m. It is not the significance of the acquisition which has provoked broker attention but rather what it implies for the bidding process currently taking place for the Woolworths ((WOW)) petrol stations.

There is unlikely to be much in the way of incremental sales volume as a result of the transaction, UBS ascertains, as Milemaker is already a Caltex re-seller and the acquisition is small in scale. The broker finds nothing to link this acquisition to the implications for any bid for the Woolworths fuels business.

Others, such as Citi, consider the transaction is evidence that Caltex does not need the Woolworths petrol stations to secure growth. The broker's base case is that Caltex loses its supply agreement with Woolworths, following a change in control to another suitor for the retail sites, but notes that management is confident it can replace forgone profits it possibly loses via the Woolworths supply agreement.

The broker estimates that several opportunities will present to Caltex, such as payments for the use of infrastructure, reduced competition and higher margins, a need to spin off some of the Woolworths petrol stations, further M&A, buy-backs and an accelerated convenience strategy. These all more than offset lost earnings from the Woolworths agreement.

In the event that BP acquires the Woolworths fuels business it would, currently, not have sufficient import terminal capacity or distribution networks to supply the retail outlets in Victoria or NSW. Therefore, the options for BP would be to spend money on replicating the Caltex network or, alternatively, pay Caltex to use its established network. Earnings forecasts assume a modest $15m per annum rental for infrastructure, but Citi acknowledges this could be materially higher.

The broker views this little accretive acquisition as confirmation that Caltex will not chase a higher bid for the Woolworths business and risk diluting value for shareholders, despite any underlying strategic rationale. The broker hastens to point out Caltex could acquire the business but that it is now less likely.

Will it be a good outcome for Caltex if no one buys the Woolworths business? Credit Suisse believes so. The broker struggles with the concept that BP would be willing to pay 9-10 times or more the EBITDA (earnings before interest, tax, depreciation and amortisation) for around 500 leasehold sites, with infrastructure disadvantages that are complicated by an ongoing relationship with the seller. If Caltex truly walks away the broker asserts it would be a touch nervous if it was in Woolworths' shoes.

Credit Suisse understands the Woolworths transaction will drive sentiment for a while longer and it is hard to quantify the lost earnings for Caltex if BP is the winner, but suspects BP will be reliant on Caltex for some of the supply. All up, at this stage, the broker considers Caltex a compelling valuation and retains a Outperform rating.

Macquarie upgrades to Outperform, finding the pull back in the share price below $30, associated with the risk of losing the Woolworths fuel volumes, as improving the stock's credentials. Caltex has allocated capital to defend Milemaker volumes rather than expand its scale.

While Milemaker is a re-seller, rather than a franchisee, the broker would prefer Caltex to either consolidate franchisees at minimal cost or consolidate re-sellers that are not currently supplied by Caltex. Based on analysis of the earnings sensitivity, the broker believes the market is now factoring in much of the downside from a loss of the Woolworths contract. The reality may not be as bad as feared, Macquarie suspects, given alternative sources of demand and the remaining Caltex balance sheet capacity.

Milemaker has 46 service stations throughout Victoria with the majority in Melbourne. Caltex already has around 1450 operational retail sites across Australia of which 475 are owned, 320 are under long-term lease and a further 655 are owned by others.

While not completely ruling out the bid for the Woolworths business, Morgan Stanley suspects it is over. The broker does not believe Caltex would have executed on this transaction if management was confident it remained in a good position to secure the Woolworths retail business.

The Milemaker transaction will require ACCC approval, and this may mean some sites could need to be divested. Deutsche Bank observes that Milemaker has been a Caltex branded re-seller and customer for over 32 years and expects little change in volumes and the main value driver is that Caltex will now pick up the retail margin at the sites.

There are four Buy ratings on FNArena's database and three Hold. The consensus target is $35.17, suggesting 20.2% upside to the last share price. Targets range from $32.60 (Morgan Stanley) to $40.00 (Credit Suisse).

See also, Caltex: The Battle For Woolworths' Petrol Business on October 20 2016

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