Monday, September 03, 2018 01:32 PM /ARM Research
Having received approval from its shareholders in May 2018 to dissolve its subsidiaries, FO released its first financials detailing the performance of both the continuing and the discontinued operations1. As at H1 18, revenue from discontinued operations printed at N21 billion (vs N18 billion in H1 17), with net earnings of N7.8 billion, accounting for 99% of the company’s profit. Using comparable company analysis, the minimum expected proceed for the discontinued operations stands at N49.7 billion which is still a premium to its current net asset value (NAV) of N35 billion.
For clarity, as at H1 18, the assets sum up to N94 billion, with liabilities of N34 billion, translating to a net asset value of N60 billion. Overlaying FO’s stake2 in the subsidiaries to the total NAV of N60 billion, translates to an asset value of N35 billion. Overall, given the expected proceeds from this sale, we think the company is likely to create more value for investors, given management’s guidance of using the proceeds for expansion of its downstream operations. To add, the proposed divestment will steer special dividend payment in 2019, in our view.
Estimating the worth of the continued business
Focusing on FO’s continuing operations, we adjust our model to mirror the new business model (Nigerian downstream operations and solar systems). To recall, major pressure points for the company in 2017 was higher input and finance cost – related to power loans. However, given the new business structure, we foresee a significant drop in its finance charge, following the reduction in its borrowing and the extinction of the power business. For context, the company’s borrowings dropped from N20.7 billion as at FY 17 to N7.2 billion to H1 18.
On our 2018 numbers, we forecast a revenue estimate N107 billion (+18% YoY) driven by increased receipts from petroleum products and lubricants. On petroleum products, we expect FY 18 volumes to print at 507 million litres (+22% YoY) which overlaid on our expected average petroleum products3 price forecast of N186.25/litre, should settle FY 18 revenue at N94.6 billion. For context, petroleum products sold over H1 18, by our estimate, stands at 300 million litres (H1 17: 218 million litres) – a fallout of significant supply by the NNPC in a bid to combat fuel scarcity. However, over H2 18, we see a moderation in supply as NNPC normalizes its importation of PMS. In addition, we expect a soft growth in lubricants’ sales (+5% YoY to N12.7 billion).
For us, we perceive the input cost pressures would likely persist over the rest of the year, given the uptrend in the landing cost of petroleum products in line with rising crude oil price. That said, we model a 91% cost to sales (FY 17: 88%) ratio, which translates to N97 billion for FY 18. Accordingly, gross profit would drop to N9.8 billion with respective margin at 9.2%.
Elsewhere, given that the turbine related depreciation expense would no longer reflect in its financials, the company’s operating expense is expected to print at N8.3 billion. Overlaying the numbers with other income of N1.7 billion translates to an operating income of N3.2 billion. Another positive is a reduction in finance cost, given that the company paid down a significant portion of its long-term debt as at H1 18 to N7.2 billion (Dec 17: N20.7 billion). We therefore forecast a net finance cost of N2.0 billion (FY 17: N3.6 billion) which should settle PBT for the year at N1.2 billion and PAT at N839 million.
Beyond 2018, we model a gradual growth in sales with our 4-year CAGR of 5.1% hinged on the possibility of upward adjustment in domestic PMS price, while cost is expected to rise at a slower pace with 4-year CAGR of 3.1%. Accordingly, we forecast gross margin to average 13.1% over our forecast horizon (vs 5-year historical average of 10.2%). Elsewhere, we also perceive a moderation in finance cost as our estimate of proceeds of sale from the discontinued operations should reduce its borrowing burden in the near term. Also, the company has given no indications of raising funds in the debt market in the near term. That said, we expect earnings CAGR of 56.4% to N4.7 billion in 2022.
Therefore, on our revised numbers, we now have a blended FVE of N34.35 (vs N61.44 in previous communication) using a blend of DCF and Residual Income with respective weights at 50% each. Relative to last closing price, this translates to 58.3% premium and a BUY rating on the shares. The company currently trades at a forward P/E of 5.37x which is at a discount to peer average of 7.54x.
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