Viva Energy Revives Hopes Of Dividends

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Despite the various city lockdowns and restrictions on travel, Viva Energy has grown its fuel volumes, underpinned by agriculture, resources and the regional retail network

-Total fuel sales volumes now ahead of pre-pandemic levels
-Viva Energy grew market share while fuel margins improved
-Upside likely from the “future fuels” options at Geelong
 

By Eva Brocklehurst

The agriculture, resources and regional transport sector have provided Viva Energy ((VEA)) with strong commercial fuel sales, while additions to the retail network have also lent support despite the various city lockdowns.

In the company's update, retail and commercial fuel volumes were well ahead of forecasts as were refining margins. The commercial segment appeared to benefit from new contracts as well as contract retention, Credit Suisse observes, along with retail fuel from the regionally-oriented Liberty network.

Retail margins have outperformed the industry, falling just -2c per litre year-on-year on the broker's estimates which compares with a -6c per litre decline for the industry based on Australian Institute of Petroleum data.

Guidance for operating earnings (EBITDA) of $390-410m in the first half was also well ahead of broker forecasts. Macquarie points out this would be a record result since the company listed in 2018.

The broker is also impressed by Viva's ability to capture market share in both retail and commercial fuel. Retail markets, the company pointed out, have absorbed price increases while returns have been solid.

Macquarie believes the beat to earnings expectations has been largely driven by a material capture of market share as well as better fuel margins. Penetration into premium fuel should also continue to support earnings growth, UBS adds.

The broker notes total fuel volumes are now above pre-pandemic levels amid strong diesel demand in regional Australia, particularly from agriculture and resource industries. This offset weak metro fuel sales that have been affected by lockdowns.

UBS envisages upside from improving refining margins and transport fuel demand as travel restrictions ease, yet does not expect jet fuel to recover to pre-pandemic levels until 2025. As the stock is trading at 18.3x 2021 earnings (EBIT) compared with Ampol ((ALD)) at 13.5x the broker finds more value in the latter.

Dividends

The near-term implication from the update is the likely reinstatement of dividend payments at the first half result in August, and Credit Suisse assumes a 50% pay-out. In addition, Macquarie anticipates a return of up to $100m in capital arising from the proceeds arising from the divestment of the company's service station portfolio to form the listed Waypoint REIT ((WPR)).

Goldman Sachs also believes a return to ordinary dividends is increasingly likely for the first half and expects an interim 2.9c per share. The broker expects performance will be supported in the second half by a recovery in macro conditions and improving returns on equity, including a $100m capital management program.

Refining

Refining margins were US$6.60/bbl for the first half and averaged US$7.30/bbl for the second quarter and UBS forecasts a 2021 refining margin of US$6.90/bbl. Viva received $40.6m from the federal government and due to the refinery subsidy, Credit Suisse calculates the margin would need to exceed US$7.70/bbl to provide a net positive contribution to operating earnings.

Macquarie assesses, following the government's deal to fund 50%, the upgrade work to the refinery's clean fuels will be brought forward to 2022 from 2024. The Commonwealth subsidy for refining, intended to secure the country's refining capacity, was passed into law on June 29.

This fuel security package is expected to last to June 30, 2027, and mitigate some of the downside risk to refining margins, providing payments when the margin environment falls below the long-term cash break-even level of the Geelong operations.

Viva Energy has highlighted preliminary studies are being undertaken to commence necessary upgrades to the refinery in order to manufacture low-sulphur gasoline. The company is also proceeding in the third quarter with a hydrofluoric acid alkylation plant, with an expected investment of $25-35m.

An update on the LNG terminal and hydrogen plants are expected in August and Macquarie ascertains Geelong should now be consistently positive in terms of cash flow, except during any clean fuels upgrades.

The broker envisages upside from fuel marketing and the options for future fuels at Geelong while Goldman Sachs believes the refining subsidy will lower the risk profile of Australian refiners and provide stronger corporate appeal.

UBS also expects Viva Energy will execute on its strategy to lift its alliance with Coles ((COL)) to 70-75m litres over the next 3-5 years and any faster volume growth could mean upside to valuation.

Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, has a Buy rating and $2.70 target while the database has four Buy ratings and two Hold. The consensus target is $2.32, suggesting 11.8% upside to the last share price.

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