Uncertainty Over Woolworths Fuel Dogs Caltex

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Caltex has provided 2016 profit guidance, prompting some brokers to review their numbers, but uncertainty remains linked to the Woolworths fuel business.

-Strong marketing earnings envisaged stemming from margins, as volumes down around 1%
-Better transport fuel volumes and premium fuel margins appear offset by "externalities"
-Market likely pricing in worst possible outcome from the loss of Woolworths fuel business
 

By Eva Brocklehurst

Caltex ((CTX)) has delivered its guidance for 2016 profits and created a divergence in the views of brokers, although there are suggestions the plethora of numbers makes analysis confusing for the market.

The company has outlined guidance for net profit, on a replacement cost of sales operating (RCOP) basis, of $500-520m. Excluding certain “externalities”, underlying RCOP EBIT (earnings before interest and tax) guidance is $820-850m.

At the EBIT line the guidance is better than Ord Minnett had forecast, because of a stronger refiner margin. That said, the broker takes the opportunity to review its investment thesis and downgrades to Lighten from Accumulate.

More conservative estimates are incorporated with a view that the risk from the potential loss of Woolworths ((WOW)) petrol volumes is not sufficiently discounted in the share price.

The broker would become more constructive at a lower share price that provides valuation upside for the existing business, and incorporates more of the downside risk from the loss of Woolworths petrol volumes.

Credit Suisse takes a different view. The broker acknowledges the various aspects to the company's guidance are confusing, yet considers the marketing EBIT of $735m a "cracking" result, up 9% on the prior year.

As volumes are clearly down by around 1%, the marketing result is assumed to have stemmed from the margin, which many, in the broker's opinion, do not want to believe will increase. Margin keeps surprising the market to the upside, although Credit Suisse acknowledges it takes a more optimistic starting point.

Nevertheless, the broker is at a loss to justify the market reaction, and can only assume the market is comparing the non-underlying number to the underlying number that is usually assumed in most analyst modelling. An Outperform rating is reiterated firmly.

Citi notes better transport fuel volumes and premium fuel margins were more than offset by $35m in "unfavourable externalities ", which include FX and pricing lags. These externalities appear to be a cost more often than not, so the broker now includes $15m of additional costs in its forecasts.

Citi believes consensus forecasts failed to capture these losses and, hence, the market may look through them. 2016 earnings per share estimates are downgraded by 3% and 2017 and 2018 earnings per share estimates are upgraded by 7% and 2% respectively.

There was no update on the fuel business with Woolworths and the volume currently supplying retail fuel sites that would be foregone if the business was acquired by a competitor. Citi believes the market has already priced in the worst possible outcome, that all 3.5bn litres of fuel is lost, and considers this overdone.

There was also no update on capital management plans. The broker notes the stock has underperformed since its results in August, largely because of the risk of losing the Woolworths supply agreement if it does not acquire the business.

Citi considers the risk to its Buy recommendation is one of the timing around the news regarding Woolworths fuel. A deal is expected to be finalised by the end of the year.

Morgan Stanley observes marketing volumes show signs of modest declines, which match recent industry trends that suggest declining diesel volumes across Australia over the past few months. It appears to the broker that margins per litre are falling slowly.

Thus far, Morgan Stanley believes Caltex has done a good job in managing margin in the supply and marketing business. This may become more difficult if volumes were to decline at a faster rate.

Australian petroleum statistics appear to show diesel consumption is falling across the country at a rate of 4% per month. The broker concedes it is too early to know whether this is a short-term slip or the start of a longer term trend.

While wage under-payments by franchisees remain a risk, the company has been working with the Fair Work Ombudsman over the past year and has cancelled some franchise agreements where inappropriate practices were found.

The broker believes the company is on the front foot in managing this area, and there is potential for more service stations to be managed in-house over time, potentially increasing the cost of running the retail business.

Morgan Stanley considers the company is entering a challenging phase in the Australian economy, but over the longer term it has a strong track record of growing earnings in the marketing and supply business.

Guidance was below UBS forecasts. Again, the miss is attributed to the impact of these externalities that are particularly difficult to forecast. The move away from a 5% EBIT growth target a couple of years ago raised concerns that incremental growth may be more difficult to achieve, but it seems clear now to UBS that the company has more levers to pull.

Net debt forecasts of $450m are well below UBS estimates, although the broker's estimates were inflated by the inclusion of the Milemaker acquisition, which will not be completed until the first quarter next year. A better net debt position reinforces the view that Caltex has capacity to undertake another off-market buy-back if further acquisitions do not eventuate.

In terms of premium fuel usage, this continues to surge, as the broker highlights Vortex diesel volumes were up over 10% versus 2015. The main negative, UBS believes, is the impact of increased competition in commercial/wholesale markets on margins. The investment thesis is unchanged and recent weakness in the share price is attributed to concerns around the loss of the Woolworths fuel supply agreement.

FNArena's database shows a consensus target of $33.87, suggesting 14.8% upside to the last share price. This compares with $35.26 ahead of the announcement. Targets range from $27.50 (Ord Minnett) to $40.00 (Credit Suisse). There are four Buy ratings, two Hold and one Sell (Ord Minnett).
 

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