Wednesday, May 30, 2012 / ARM Research

•Oando Plc (Oando) reported 54.8% YoY revenue growth to N586.6 billion in FY’2011 – 32.8% ahead of our N441.4 billion forecast for the period. Oando’s strong sales growth was underpinned by significant increases in volume sales of refined petroleum products and a higher YoY turnover contribution from Oando’s upstream division, which was well ahead of our forecast, due to higher crude oil prices. Oando also recorded significant improvements in turnover from its Gas & Power Division due to an increased gas uptake and growth in its client base.

On QoQ basis, Oando’s revenues grew 56% to N194.3 billion in Q4’2011, 108% above our N93.4 billion forecast. We believe that Oando’s performance in Q4’2011 may have been driven by increased volume sales in upcountry locations where insecurity has deterred most competitors.

Oando’s exceptional turnover growth in Q4’2011 was the primary source of divergence between our forecast and Oando’s FY’2011 turnover performance. Indeed, Q4’ 2011contributed 33% to full year revenues, 12% above its 5-year average.
 

Operating costs weigh on margins 

•In line with the rise in its turnover, Oando’s cost of sales grew 59.5% YoY to N518 billion. Gross income rose 26.44% YoY to N68.4 billion which nevertheless implied a 261bps compression in gross margin to 11.67% YoY.  Margin compression was not peculiar to Oando in FY’2011. Industry margin trends reflected higher product prices and increased demurrage charges on petroleum products imports.

•Total expenses rose 68.4% YoY to N50.1 billion on the back of increased administrative expenses, associated with the operation of its upstream asset (OML 125), greater depreciation charges on its Akute Power Plant and its swamp rig OES Passion. Oando also recorded higher selling expenses as a result of increased volume sales to upcountry locations. Consequently, operating margin declined 224 bps YoY to 5.9% in FY’2011.
 

Exceptional charges weighs on depressed earnings 

•Oando announced an exceptional charge of N9.6 billion, relating to impairment of some upstream assets, additional projected expenses from its recent capital raising exercise, and the termination of its Technical Service Agreement (TSA) with Ocean and Oil Holdings. These provisions had been announced earlier in the year, sparking a sell-off in the stock---management provided no basis for the valuation of the TSA termination.

•PBT declined 38.6% YoY to N14.9 billion, 38.6% lower than our N25.8 billion forecast for the period.  Without the exceptional charge of N9.6 billion, the company’s PBT was unchanged from FY’2010 at N24.5 billion; this would have left the company’s PBT performance 5.1% below our estimate for the period. PAT declined 76% YoY to N3.44 billion. Once again, stripping out the exceptional charges; we estimate that Oando’s FY ‘2011 PAT would have come in at N13.1 billion, a 9.1% YoY decline and 18.1% below our N16.1 billion forecast for the period. 
 

Strong volume’s growth continues in Q1 2012 

•In its unaudited financial performance for the 3 months ended March 31st 2012, Oando posted a 37.9% YoY revenue growth to N158.6 billion; 7.8% above our expectations for the period. Revenue growth in this quarter was the best Q1 performance in over a decade, which we believe was underpinned by increased PMS sales volumes and distribution -as the company’s import volumes also increased-, higher average crude oil prices for the period and additional revenue from EHCG[1] following its commencement of full service delivery to its anchor customer[2] in 2012. Revenue was supported by the effects of reduced competition from independent marketers in Q1, after the PPPRA increased the import quota for the major marketers.
 

Margin compressions still a hindrance 

•As was the case in FY 2011, cost of sales was again on the uptick, rising 45% YoY to N143 billion in Q1’2012, 10.7% above our estimate. Again, rising costs was attributed to increased volume storage of petroleum products during the period and is also possibly linked to further demurrage charges on imported products. Consequently, gross profit margin declined 5% YoY on the back of lower margins on PMS sales due to higher product costs and also possibly reflecting the fallout events surrounding the partial deregulation of petroleum products prices.

•Selling and administrative expenses grew 20% YoY on the back of higher marketing costs of petroleum products sold to upcountry locations due to the security challenges in Northern Nigeria, lower cost of recovery in its OML 125 operations as well as additional operating costs and depreciation incurred on the operationalisation of swamp rig OES Passion and EHCG. Operating income declined 31% YoY to N5.3 billion in Q1’2012 resulting in a 330bps decline in operating margin to 3.4%. We believe that Oando’s increased opex is also related to the refurbishment of assets (Respect rig) which is due for operational deployment.

•In line with operating income, Oando’s PBT declined 12% YoY to N4.9 billion, 14.9% lower than our estimate of N5.7 billion for the period. Consequently, Oando experienced a 23% YoY decline in tax charges to N1.9 billion, muting the impact of higher charges on PAT, which declined 4% YoY to N3.1 billion; 6.7% below our N3.2 billion forecast.
 

•In line with management’s guidance, Oando’s long term debt rose 9% during the period, reflecting additional funding requirements to finance new capital projects. Also, the expensing of interest instead of capitalization on newly operational assets[3] led to a 26% increase in interest expense nullifying the benefits of an appreciating Naira during the period.

Strong fundamentals but cost pressures may weigh on performance

•We believe Oando continues to operate in a supportive environment across its business segments. In the downstream segment, we expect the fallout of the January 2012 removal of petroleum product subsidy to strengthen the position of major marketers. However, we also expect Oando’s throughput and operating earnings growth to moderate YoY, as competition intensifies among major marketers and Oando’s operating costs remain elevated. 
 

•In the Mid-stream division revenues growth should be supported by the completion of the EHGC[4] pipeline, which has started the supply of gas to its anchor customer in H2’2012.  We expect upstream revenue growth to be impacted by Oando’s inability to significantly increase crude oil production and recently reported a decline in net 2P reserves from ~14mmboe to ~9mmboe which suggests that some of its drilling exercises has been unproductive. Furthermore, we are concerned about the potential for earnings growth in this division as our outlook for crude oil prices is stable to negative, and as increased costs associated with the operation of OES passion weigh on profitability. We note that Oando’s profit potential largely remains hinged on improvements in its upstream division.

Valuation still attractive 

•Given the foregoing, we have maintained our market share estimates for Oando’s downstream division but revised our crude oil production and price estimates for the upstream division lower. The net result was marginal, increasing our turnover growth forecast to 10.96% YoY and implying in a forecast revenue of N654 billion for FY’2012. This puts the 3-year CAGR forecast for the company at 10.1%, in line with our growth estimate for the sector. Also, we adjusted our opex forecast higher to reflect the higher anticipated depreciation charges and administrative costs in FY 2012, as noted above. The net result of these adjustments was a 23% decline in our PAT forecast for 2012 to N13.9 billion.

•The manner of the removal of the TSA appeared to reinforce lingering corporate governance concerns among investors. While we view its removal as positive for earnings going forward, we believe the event has had a negative impact on investor perception. Thus we reflect the impact of this event, in addition to the increasing importance of the more embryonic—and volatile--midstream and upstream businesses and increasing uncertainties around global energy prices by adjusting our discount rates higher resulting in an upward revision of WACC by 119bps.

•We also reduced our growth rate estimate for the company to 5% to reflect increased competition ahead of impending deregulation in the sector.  Following the changes made to our model, we arrive at a target price of N32.81 which gives the stock a 96% upside on current market price of N16.75, in spite of our more bearish outlook for the stock--Oando currently trades at a current and forward PE of 10.88x and 2.6x respectively, compared to 9.6x and 6.8x respectively for its peers—and, as such, maintain our BUY rating on the stock.

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