Friday, May 17,
2019 / 09:03AM / CardinalStone Research
After the recent sale of the power and upstream businesses in Nigeria as well as the downstream operation in Ghana, Forte Oil Plc (FO) is well positioned for growth through an expansion of itsretail footprint in the Nigerian downstream oil and gas space. In this report, we adjust our forecasts to reflect the impact of recent asset sales and ongoing retail expansion drive in Nigeria.
FO is aiming to expand its retail footprint by 40.0% over a 3-year period
Revenue is likely to increase by 36.4% YoY to N183.7 billion in FY19E
Our revenue forecast is driven by anticipated volume increases across FO’s product portfolio, aided by recent retail expansion efforts. According to management, volume growth (Q1’19) in the PMS (+71.0% YoY), AGO (+16.0% YoY), and lubricant (+13.0% YoY) segments was driven by the introduction of 23 new outlets in the preceding twelve months. Thus, in spite of the regulatory cap on PMS pricing in Nigeria and a 5.1% YoY contraction in crude oil prices, FO was able to grow revenue from its fuels and “lubricants & greases” segments by 54.3% YoY and 12.1% YoY to N38.4 billion and N4.2 billion respectively, in Q1’19. Overall, pass-through from the ongoing expansion resulted in a 50.0% YoY increase in group revenue to N42.6 billion in Q1’19. For FY’19E, we expect volumes to increase by over 25.0% across key product segments such as PMS, AGO, and DPK. We also expect the company to grow its lubricant volumes by 12.8% YoY in FY’19E.
FO has disposed of its upstream, power, and Ghana assets
The decision to divest represents a significant departure from FO’s prior plan to pursue M&A activities along the energy value chain and acquire marginal oilfields to boost its upstream business. We believe the verdict to sell the Nigerian power business may have been influenced by the persistent liquidity crisis in the sector (power accounted for c.65.2% of FO’s outstanding receivables in FY’17), while the decision to divest from the Ghana operations likely reflected sustained weaknesses in its operating performance. The sale of the assets led to a loss on disposal of N1.6 billion that was booked in FO’s Q1’19 income statement. Thus, our revenue forecasts for FY’20E (and beyond) now excludes contributions from the divested businesses. Notwithstanding, we expect FO to grow its revenue at a CAGR of 10.0% over our 5-year forecast horizon, aided by management’s ongoing investments in retail footprint expansion in Nigeria.
Efficient handling of S&D costs is likely to drive EBIT margin to 4.3% in FY’19E
We expect management’s improved freight cost containment to largely support EBIT margin in FY’19E. The company is also likely to enjoy some scale-induced cost benefits as it continues its footprint expansion in Nigeria. In addition to this, we believe the sale of the Ghana business, which is typically margin dilutive, is positive for group operating performance going forward. On this wise, we now forecast FY’19E EBIT margin 2.3ppts higher YoY. We note that our EBIT margin expectation is also significantly higher than the historical average (3.8%). Looking back, we note that FO experienced sharp margin compression in FY’17, following a dip in volumes across its product portfolio, occasioned by the discontinuation of private importation of PMS. Operating margin was further driven to an eight-year low of 2.0% by significant increases in the cost associated with changes in inventories on higher global crude prices (+32.5 YoY) in FY’18. Thus, aided by the low base implied by the FY’18 numbers, we now expect EBIT to grow at a CAGR of 26.9% over our five-year forecast horizon.
Free Cash Flow to Equity (FCFE) is likely to remain negative in FY’19E
The firm experienced lesser cash management set-back in Q1’19, reporting a 41.5% YoY decline in FCFE deficit to negative N518.3 million. The smaller FCFE deficit was driven by improvement in cash flow from operations (+49.4% YoY), with days of inventory reducing to 81 days in Q1’19 (vs. 95 days as at Q1’18). We also note the significant improvement in receivables management in Q1’19 (days of receivables: -50.7% YoY to 336 days). Going forward, we expect the company’s FCFE to strengthen to N8.8 billion in FY’19E, compared to negative N6.1 billion in FY’18, on significant cash inflow from sale of assets. Precisely, FO realized N13.0 billion from the sale of its upstream, power, and Ghana businesses that could net-off a c.N1.8 billion capex burden in FY’19E. The sale of these assets is also likely to reduce receivables burdens and provide support for operating cash flow.
On a broader note, we highlight that the working capital risk in the downstream sector stems from a complete reliance on the NNPC for PMS imports and allocation. This weakness is likely to limit scope for material gains in FCFE beyond FY’19E. FO trades at a FY’19E EV/EBITDA of 6.4x compared to 9.1x for Bloomberg peers. We have a 12-month TP of N44.54 and a BUY recommendation on the stock.