Wednesday, May 16, 2018 10:28 AM / Vetiva Research
Highlights of Vetiva Analyst Report
• Decent Q1’18 numbers buoyed by Power earnings
• Selling all subsidiaries, retaining flagship fuel retailing business
• Power business divestment comes as surprise
• Targets 6-9 months to complete the proposed restructuring
• Total deregulation of downstream sector very key post-divestment
• Mixed earnings trajectory, valuation revised lower on liquidity challenges
Decent Q1’18 numbers buoyed by Power earnings
FO’s Q1’18 numbers were quite decent, beating our estimates across most line items. Meanwhile, the mixed performance across the company’s business segments persisted in Q1’18. Despite reporting an impressive 14% y/y increase in Revenue to ₦25.8 billion (Vetiva: ₦20.7 billion), the Fuel Retailing segment (largest segment – accounts for 65% of group revenue) reported a 29% y/y decline in Gross Profit (₦1.9 billion vs. Vetiva: ₦2.1 billion) as the tough operating environment in the petroleum downstream sector continued to pressure margins.
Performance of the Production Chemicals segment (smallest segment – accounts for c.1% of revenue) was also weak, reporting a 16% y/y decline in Gross Profit to ₦0.2 billion following a 17% y/y Revenue decline. Bucking the trend however, the Lubricant & Grease segment (9% of Revenue and 3rd largest segment) reported a 16% y/y increase in Gross Profit to ₦0.7 billion amidst a 7% Revenue growth to ₦3.5 billion. Also, the Power Generation segment (2nd largest segment – accounting for 25% Revenue) remained the key driver of earnings growth, reporting a 72% y/y increase in Gross Profit to ₦4.1 billion (Vetiva: ₦3.5 billion) on the back of a strong topline performance (up 54% to ₦10.1 billion). Notably, contribution from the Power Business accounted for 60% of the Group’s gross profit.
Overall, Q1’18 Group Revenue rose 21% y/y to ₦39.8 billion whilst Gross Profit was up 17% y/y to ₦6.8 billion - 15% and 8% ahead of our estimates respectively. With OPEX coming in flat y/y (16% better than estimate) and net finance expense declining 23% y/y (in line with estimate), Q1’18 PBT rose 54% y/y and 38% ahead of our estimates to ₦3.2 billion. In all, Q1’18 PAT rose 57% y/y to ₦3.0 billion (Vetiva: ₦1.7 billion), further supported by lower than expected effective tax rate – 6% vs Vetiva’s 28%
Selling all subsidiaries, retaining flagship fuel retailing business
Forte Oil (FO) recently released notice of its Annual General Meeting (AGM) scheduled for May 28, 2018. Notably, one of the Special Resolutions to be considered at the AGM is a company restructuring plan that would involve the divestment of all FO’s subsidiaries – AP Oil & Gas Ghana Limited (“APOG”, 100% owned), Amperion Power Distribution Company Limited (“APDC”, 57% owned) and Forte Upstream Services Limited (“FUSL”, 100% owned). Effectively, the flagship Petroleum Marketing segment in Nigeria will be the only surviving business line post-restructuring, and the proceeds from the divestments will be used in funding its strategic expansion and repositioning.
Power business divestment comes as surprise
We are not surprised about FO’s plans to sell off its interest in APOG as this is in line with management’s earlier guidance as far back as 2016. We note that the subsidiary has consistently declared losses in the last three years, and the tough operating landscape in Ghana spells further weak earnings outlook. The decision to divest interest in FUSL is also not entirely shocking as contribution from the subsidiary has historically been less significant (c.3.7% of Group’s gross profit since inception in 2011), even as it has been on a downtrend over the past three years. We understand that whilst the Power business remains profitable, cashflow within the segment has been challenging due to huge receivables.
We note that whilst the ₦701 billion Payment Assurance Guarantee Intervention Fund (PAG) introduced by the FG in 2017 has partly supported Power Generating companies’ liquidity, there are still huge power receivables on FO’s books (FY’16: ₦14.6 billion, FY’17: ₦32.6 billion). Meanwhile, the facility is also said to have been fully disbursed with no clear signals of another funding on the horizon. Subject to shareholders approval, we understand the proposed restructuring could be concluded by the end of the year.
Total deregulation of downstream sector very key post-divestment
We believe that the renewed full focus on the Petroleum Marketing segment is heavily supported by expectations of total PMS deregulation in the near term as well as the belief that the company can compete profitably within the space. For us, we do not expect a full-deregulation until much after elections and/or the commencement of operations at Dangote refinery. Aside from the challenges of capped margins in the PMS segment, we believe that the Nigeria Petroleum downstream sector is quite attractive particularly for big players with large asset base and sound logistics (like FO) given that it is a volume-play business.
Particularly, we highlight that post the currency devaluation in 2016, working capital requirement in the downstream business has increased significantly – putting pressure on cashflow and increasing the need for additional capital. We understand that FO might be open to possible M&A as part of its expansion plans for the Petroleum Marketing business (post-divestment of its subsidiaries); this should further strategically reposition FO in the industry.
Mixed earnings trajectory, TP revised lower on liquidity challenges
Our long-term outlook on FO has changed significantly following the plan to divest all its subsidiaries. Post-divestment, FO will transform from running an integrated energy model to a slimmer business model focused on petroleum products retailing on a larger scale. And as earlier highlighted, we believe that the full deregulation of the petroleum downstream industry is key to unlocking the sector’s value regardless of the scale of operations of industry players. As such, we hold a bearish outlook on FO’s new/proposed business model (entirely petroleum products marketing) in the near term.
We do not expect the divestment to be completed before the end of the year, hence, we expect FY’18 earnings to enjoy the full contribution of the Power Business amongst other subsidiaries before its divestment. Pending further details on the restructuring plan and expansion plans for the petroleum retailing business, we continue to base our forecasts on the current diversified business model. We revise our FY’18 PAT to ₦7.7 billion (Previous: ₦6.4 billion) amidst revision to FY’18 revenue estimate to ₦154.1 billion (Previous: ₦138.6 billion), Net finance expense to ₦6.4 billion (Previous: ₦4.9 billion) and FY’18 tax rate assumption to 20% (Previous: 28%).
Notwithstanding our higher revisions to earnings, our target price is reduced to ₦77.75 (Previous: ₦83.57), largely weighed by dimmer outlook on FO’s operating cashflow and increasing working capital need. We have also placed the stock on a HOLD recommendation pending further clarity on the planned divestments.
Tominiyi Ramon email@example.com