The Wrap: Refining, BNPL, Oz Utilities, Oz Banks

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Weekly Broker Wrap: Refining package revives Viva/Ampol, BNPL users a disloyal mob, Oz utilities squeezed by renewables, Oz banks cut costs

-Canberra's rescue package improves Ampol/Viva’s earnings outlook
-Global BNPL transaction forecast to grow to US$2.7trn by 2030
-Wholesale electricity prices forecast to remain under $60/MWh until 2026
-Westpac leads bank cost-cutting

 By Mark Story

Refineries: Rescue package

In an attempt to ensure Australia’s two last remaining refineries owned by Viva Energy ((VEA)) and Ampol (formerly Caltex Australia) ((ALD)) stay open until at least 2027, the federal government has released a fuel security package for the local downstream and refining industry. Morgan Stanley believes government announcements will give the investment community more confidence that both companies can hit 2022 consensus forecasts.

On the strength of the government’s rescue package, the broker has increased earnings estimates for both companies and believes there’s sufficient upside to re-rate Ampol to Overweight from Equalweight.

After factoring in the fuel security package, Morgan Stanley has increased Viva Energy’s FY21 and FY22 refining earnings (EBIT) estimates by $24m and $60m, and retains an Overweight rating on the stock. In FY22, the broker forecasts refining margins of $9/bbl and therefore assumes a fuel security package payment $45m.

By comparison, Morgan Stanley has increased Ampol’s FY21 and FY22 refining earnings estimates by $24m and $60m. In FY22, the broker forecasts refining margins of $8.7/bbl and therefore assumes a fuel security package payment $60m.

Based on the production of each refinery, payments will range from a maximum of $2.9/bbl under weaker market conditions, decreasing to nil once the refineries achieve over a $10.2/bbl refiner margin. Under the maximum payment, when refiner margins are below $7.3/bbl, around 30-40% of operating costs for the refinery are paid by the government.

The fuel security package provides Viva and Ampol with access to a variable fuel security services payment for six years up to mid-2027, with the option to extend.

There are maintenance caps too, with the government stumping up to 50% of the capex required to convert the refineries to produce lower sulfur fuel. It’s understood each refinery needs to spend around $250m before assistance, which is then capped at $125m each.

While it’s still possible that the refineries may lose money at the earnings level in a very tough year, Morgan Stanley suspects the rescue package reduces the significant bear case of refineries losing a lot of money.

While the market will need to value these refineries with lower earnings cyclicality courtesy of the refining package, the broker reminds investors that the jury is also out on whether they will remain open after 2027. Both Ampol and Viva have the option to abandon the fuel security package and close their refineries, should the package not prove adequate and/or as the result of other adverse events.

But on a more positive note, Morgan Stanley also reminds investors that signs of refiner margin improvement for both Viva and Ampol have been evident since 2020, well before the government offered assistance.

The broker believes Ampol and Viva retain significant leverage to the broader economy reopening, particularly through a recovery in driving and aviation volumes, plus demand-led recovery in refining.

Morgan Stanley thinks Ampol is best positioned for an earnings recovery as driving miles continue to increase and jet fuel demand gradually increases as domestic air travel rebounds. Once oil prices stabilise, there’s further potential, adds the broker, for industry retail fuel margins to move higher at a time of strong domestic road travel.

Morgan Stanley regards retail food/shop strategy as a key potential turning point for Ampol. The company has gained momentum in the last 6-12 months and a more aggressive Metro rollout is planned for the 2H21. The broker suspects that further signs of sustained retail improvement could bring multiple expansion.

Meantime, while Goldman Sachs maintains a Buy rating on Viva Energy, and target price of $2.40, the broker remains cautious on Ampol due to re-branding complexity, and ongoing litigation with key customers. Goldman Sachs has a Sell rating on Ampol and target price of $23.40. However, the broker expects the corporate appeal of Ampol to improve along with greater certainty on the Lytton refinery.

While Goldman Sachs concedes government funding removes the downside risk for Viva and Ampol in periods of commodity price volatility, the broker thinks it has limited impact to 2022 earnings estimates, and no impact to 2023.

BNPL: US users fickle & price sensitive

Results of a Macquarie Buy Now Pay Later (BNPL) survey of 1,000 respondents from the general US population reveals BNPL users plan to use more over the coming year, while non-users have little intent to use BNPL. Commissioned to better understand general trends and preferences within the BNPL space across brands, the survey's results also highlight limited brand loyalty among BNPLs.

Around 70% of BNPL users prefer signing up with a different BNPL rather than switch stores. The finding was true in the case of both Afterpay ((APT)) as well as when asked about and BNPL in general. Macquarie’s takeaway from this is that it is ultimately the merchant that owns the customer rather than the BNPL.

This finding further elevates the importance a strong two-sided network as a competitive advantage when comparing BNPLs.

Survey results also suggest BNPL users are relatively price sensitive when it comes to the cost of using a BNPL. Less than half the respondents stated they were willing to pay a fee greater than 1% to use BNPLs, while 75% were unwilling to pay more than 2%.

Macquarie suspects this may be more of a potential risk for the Australian market, where no surcharging has come up as a topic of regulatory debate.

Within its survey, Macquarie forecasts gross merchandise value (GMV) in BNPL to reach US$3trn, with the EU being one of the major regions, contributing over 40% of global GMV. Macquarie forecasts GMV in BNPL to see a 19% compound annual growth rate from 2020 to 2030, at which time the broker forecast BNPL to contribute 20% of online and 7% of total retail sales.

Aggregating the GMV from the largest listed BNPL companies, Macquarie estimates that BNPL transaction value for A&NZ was $9.3bn in 2020. Based on this, the broker's forecast for A&NZ was 2.7% of total consumer in 2020 and 27.5% of online retail sales.

The broker forecasts BNPL penetration as a percentage of total consumer retail and online retail for A&NZ to reach 53% and 17% respectively by 2030.

Macquarie estimates global BNPL transaction value was US$420bn in 2020 and forecasts for this to grow to US$2.7trn by 2030. This assumes global BNPL penetration of online sales doubling from 10% in 2019 to 20% by 2030.

In-terms of brand perception, among the brands Macquarie surveyed, PayPal, Affirm and Afterpay ranked in the top three in that order.

In this report, Macquarie upgrades Afterpay to Outperform (previously Neutral), retaining a $120 target price.

Oz Utilities: Wholesale prices flat for longer

Due to renewable penetration continuing to put downward pressure on prices and weaker outlook on grid demand, UBS has cut average wholesale electricity price forecasts to 2030 by up to -$7/MWh. Around 2.5GW of new committed renewable capacity is expected to enter the grid over 2021-22 continuing to suppress rising wholesale electricity prices due to higher gas and coal prices.

The market is currently expecting 2021-23 prices to range between $37 and $57/MWh—up to 37% higher than futures prices three months ago, indicating a market response to a cold weather trough through April-May in NSW and Victoria.

UBS now expects wholesale prices across the national electricity market to average $50MWh in 2021 and grow modestly between now and 2030 due to rising gas prices, and as 5.5GW of coal-fired power station capacity exits the market. The broker’s new wholesale electricity price forecast assumes average wholesale electricity prices are under $60/MWh until 2026.

Given that it’s the marginal price required to signal investment in firm generation, UBS maintains a long-term view of $70/MWh. Near term, the broker sees government subsidies supporting new firm gas-fired generation, which should offset the impact of 5.5GW of coal capacity planned to exit the market over the next 10 years.

UBS expects a modest electricity price recovery from 2022, led by rising gas prices and the exit of coal-fired power stations into the medium term. However, the broker’s view government subsidies for specific proposed gas-fired power stations will ensure average wholesale prices do not exceed $70/MWh until 2030—even with further coal-fired power stations signaling an accelerated closure date.

While UBS attributes mild weather to the slow start to the year for grid demand, the broker is now of the view that grid demand will not recover to pre-covid levels as rooftop solar and energy efficiency offsets the impact of higher energy consumption. Rooftop generation continues to rise with average daily output in May 2021 up 20% year-on-year.

The influx of rooftop solar and slower demand growth due to lower immigration means the Australian Energy Market Operator forecasts a -3% decline year-on-year in operational demand in 2021. The operator expects this to remain flat until mid to late 2030s when demand lifts with rising electric vehicle penetration.

UBS expects lower electricity prices to drag on AGL Energy's ((AGL)) and Origin Energy’s ((ORG)) earnings. UBS’s revised outlook cuts AGL's price target to $7.60 with earning per share (EPS) cut up to -34% over FY21-23. Origin's price target also reduces to $5.15 with EPS cut by up to -28%.

Oz banks: Westpac’s cost program has most upside

While cost programs are the theme du jour for the sector at large, Credit Suisse notes that of all the cost programs announced by the banks, Westpac Banking ((WBC)) has the most upside compared to the announced cost target.

Westpac has outlined a three-year plan and is targeting an $8bn cost base by FY24. Versus an $8bn FY24 target, consensus expenses for FY24 currently sit at $9.14bn. While Credit Suisse expects this to have much of the yet to be divested Specialist Businesses ($750m), this still leaves at least $400m upside to consensus expenses if executed.

The broker notes the market appears to have already factored cost aspirations for National Australia Bank ((NAB)) and CommBank ((CBA)).

Given the size of cost-out in Westpac’s program, Credit Suisse is not surprised the market hasn’t given it the full benefit. The broker’s analysis of 25 years of cost programs concludes it takes 12–18 months for a well-executed program to be factored into share prices.

As a result, Credit Suisse thinks it’s reasonable to believe Westpac could be at or below the lower end of the time range if it executes on the sale of the remaining three Specialist Businesses assets. The broker considers this to be a catalyst for the market to re-evaluate.

Execution risk aside, upside to consensus cost estimates is one of the reasons for Credit Suisse’s preferential view on Westpac. The broker thinks the market will begin to move to this view upon announcement of further divestments.

By comparison, ANZ Bank ((ANZ)) currently has an $8bn FY23 exit rate cost ‘ambition’ rather than a hard target. Credit Suisse thinks there’s little risk in ANZ not achieving a reduction in the ‘run the bank’ cost base. However, the broker suspects the risk being a potential elevated level of investment that would see the bank optically miss the $8bn aspiration.

In addition, the broker notes that the current CEO is five years into his tenure and any change in CEO prior to the milestone date (exit FY23) could result in a strategic realignment that could see a different view taken on costs.

Meantime, NAB is targeting lower costs of $7.7bn over three to five years. The broker does not see this as a large transformation and as such poses much less execution risk compared to Westpac. That said, Credit Suisse notes NAB has a history of below-par execution and so welcomes the business as usual approach.

Then there’s Commbank which, while having an absolute cost reduction goal, has recently de-emphasised it to further invest in technology opportunities. In Credit Suisse’s view two questions stem from the differing approach from Commbank.

Firstly, if each of the other majors is targeting an $8bn cost base, why does/should CBA need $11bn-plus to run the business? Secondly does Commbank’s increased technology investment highlight under- investment by the other banks in their $8bn targets?
 

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