16 , 2020 / 08:55 AM / by FBNQuest Research / Header Image Credit: FBNQuest
A potential renaissance for the downstream sector
The downstream oil & gas business is typically a low margin one. However, other factors, mainly constraining policies, have led to historically low investments in the sector over the last decade. In our view, the fortunes of the sector could change with the growing possibility of full pricing deregulation. We believe the re-introduction of a market-friendly pricing template for gasoline in March and the central bank's current attempt at unifying foreign exchange rates increase the prospects of the end of mandated gasoline price ceilings.
Key policy decision expected in Q3
The newly adopted pricing template takes into consideration several factors such as the petroleum product cost and the foreign currency conversion rate at which oil marketing companies import petroleum products. We expect the recent adjustment of the naira official fx rate from N306/US$ to N380 to test the durability of this template within this quarter. Assuming all other inputs remain constant on the most recently published PPPRA gasoline pricing template, an adjustment of the fx rate assumption to current levels raises ex-depot prices by approximately 20%.
Full deregulation could spark medium term investment boom
Competition within major marketers is growing with new ownership/management. Ardova (formerly Forte Oil, not covered) and 11 Plc (formerly Mobil Oil, not covered) are leading the charge. In Q1, Ardova and 11 Plc became the leading distributors of gasoline (23.8%) and aviation turbine kerosene (27.2%) respectively, positions previously occupied by Total Nigeria (Total). In the event that the FG decides to continue with the new pricing template, effectively deregulating the sector, we see competition intensifying over the long term. Under this scenario, reach and distribution will be a key competitive advantage. As such, Total and Ardova are presently in the best position to capture growth.
Near term sector headwinds weigh on outlook
In the near term, we expect the industry to take a hit from measures adopted to stem the spread of the covid-19 pandemic. The implementation of a total lockdown, followed by a partial economic re-opening in key states - Lagos, Ogun and the FCT - should result in declining gasoline consumption in Q2. We estimate a gasoline consumption contraction of between 40-45% in Q2 even though product importation grew 8% y/y to 5.3 billion litres in the prior quarter.
Subdued earnings expected in 2020E
For Total, we forecast sales and EPS declines of -6% and -70% respectively in 2020E. Our projections are driven by both relatively lower petroleum product demand and a double-digit decline in product pricing year-to-date. Our forecasts assume a mild rebound in covid-19 cases and that economic activities are allowed to continue under such circumstances. We have a price target of N117.0 for Total and a Neutral rating for the stock. At current levels this implies a potential upside of 20%.