Retail Fuel Drives Better View For Viva Energy

This story features VIVA ENERGY GROUP LIMITED. For more info SHARE ANALYSIS: VEA

Viva Energy provided an upbeat outlook for the remainder of 2020 and, further afield, outlined a strategy to develop its Geelong site.

-Industry feedback suggesting strong recovery in fuel volumes
-Aviation fuel volumes the main uncertainty
-Geelong energy hub could be a major opportunity
 

By Eva Brocklehurst

Retail fuel volumes are expected to turn around quickly as Australians start driving to work again and domestic travel resumes, underpinning the outlook for Viva Energy ((VEA)). Credit Suisse considers the company's update a clear positive relative to some bearish forecasts, and notes guidance for net profit of $20-50m for the first half implies a $30m FX and oil derivatives benefit.

Goldman Sachs retains its more conservative forecasts but notes industry feedback that signals a stronger recovery in volumes, with the run rate equivalent to 90% of demand prior to the pandemic. Morgans, while encouraged, assesses the positive news is probably not enough to offset weak investor sentiment, which has been bedded down over multiple years of difficult operating conditions.

However, there is now an opportunity, the broker suggests, as the stock is at a discount to valuation. The business is leveraged to a recovery in fuel volumes and easing restrictions should result in higher domestic fuel demand, while the potential recovery in international travel, i.e. aviation, appears longer dated.

The business is cyclical by nature, UBS points out, which explains a large historical price/earnings (PE) discount compared with the market. However, at around 13x 2022 PE estimates (considered to be the "normal" year) the broker believes the risk/reward is attractive.

Guidance for the first half operating earnings (EBITDA) of $257.5-287.5m is well ahead of UBS estimates and drives a 56% upgrade to its 2020 forecasts. Volume pressures appear to have been more than offset by strong retail margins but the benefits are starting to wane, the broker notes.

Retail

Retail fuel volumes declined in the first half of 2020, offset by an increase in retail margins because of a weakening wholesale price. Credit Suisse assumes volumes return quickly to pre-pandemic levels in the second half and margins are reduced as wholesale prices increase.

The key issue for Morgan Stanley is whether the retail fuel market has now turned around while expecting retail fuel margins will move structurally higher after 18 months of intense competition and lower profits.

Ord Minnett agrees retail earnings remain supported by a rational industry structure which has experienced significant retail fuel margin expansion in 2020. The irrationality that pervaded 2019 appears to have passed. Moreover, despite an already-lean cost base, Viva Energy has been able to reduce costs further and the broker is pleased with the judicious approach to capital expenditure.

Demand throughout the winter from cruise companies is likely to be lower while resource, transport and specialties have been relatively unaffected by the pandemic.

Aviation is the main uncertainty and Credit Suisse assumes volumes recover to 40% of the pre-pandemic levels in the second half and 70% in 2021. The Geelong refinery will be operating at 70% of capacity from July to October. Capital expenditure guidance for 2020 has been lowered because of the deferral of a major turnaround of the HFA unit to 2021.

A decision regarding the return of $680m to shareholders from the listed property sale is still being thrashed out, with a $50m buyback all that has been affirmed to date. Morgan Stanley suggests further share buybacks could be another catalyst for the business along with a resumption in driving across Australia.

Geelong

The company has outlined a strategy to develop its Geelong site into an energy hub, through an LNG import supply and storage facility, although Credit Suisse notes there is plenty to contemplate before a dollar is spent on any undertaking.

The company will assess the merits with various industry operators and then move to a formal assessment of the options. Morgan Stanley considers this a 3-5 year initiative and agrees it will be unlikely to drive earnings or capital expenditure for some years.

However, the expansion potential should be well received by investors, particularly because of the uncertain outlook for refining. Ord Minnett agrees that the hub will present an option for the use of valuable industrial land and is a sign of the company's broader ambitions.

Viva Energy hopes to attract third-party interest in building a terminal attached to the Geelong refinery and Goldman Sachs believes it is one of the best positioned to compete for the increased storage volumes that are likely to be required for Australia's future fuel security.

The company is also considering other options such as solar and hydrogen. At this stage Goldman Sachs ascribes no value to the options but a successful tender for increased fuel storage from the Australian federal government would drive upside to valuation.

Morgans points out the company is in a difficult position at its Geelong refinery which remains in deep loss-making territory. The gross refining margin remains depressed at US$3.50/bbl, which has not improved much from the first quarter average of US$3.10/bbl. This is well short of break even at US$4.50-5.00/bbl.

Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, has a Buy rating and $2.15 target. The database has four Buy ratings and two Hold. The consensus target is $2.08, suggesting 12.9% upside to the last share price. Targets range from $1.74 (Credit Suisse) to $2.40 (Morgan Stanley).

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