By Guarv Sodhi, 07 July 2015
There is nothing more satisfying than dabbling – and succeeding – in the forbidden arts. We would never recommend timing your buys and sells to capture peaks and troughs because it is impossible to do so.
We don’t believe pretty charts tell us anything about the future and we believe the mere pursuit of precision gives the false impression that it can be attained. Even trying to time the market while knowing it can’t be done is dangerous.
We know all of this. Yet it still feels great to get the timing right, if only by luck. Caltex is a fine example.
There was nothing accidental about our original buy call in October 2013 when the price was at $18.68. Caltex was about to spend $430m to shut down its Kurnell refinery and another $250m turning it into an import terminal.
So, instead of refining crude oil, Caltex’s future profit was going to come from fuel retailing and convenience store sales. “Old” Caltex was characterised by low, volatile margins and woeful returns on capital, classic signs of chronic competition and zero pricing power.
The new Caltex is a far better business. Previously obscured earnings are now illuminated and Caltex is a stable, profitable fuel retailer. That case worked our beautifully and we sold out for a price of $37.83 in February.
Selling is a more mysterious art than buying and we admit to some luck with the timing of our sell call. Since then, the share price has fallen around 18 per cent. What should investors do now?
There was a strong case for selling at $37 but, at the current share price, that case is weaker. If we maintain our EBIT target of $890m, the current share price implies an EBIT multiple of just under 10 times and a likely PER of 15 times.
That’s far more attractive than the 12 times EBIT implied by our previous sell price.
Around $26 would deliver an ideal entry, implying an EBIT multiple of 8 times. That might sound low for a business we’ve dubbed as decent, but there are reasons for the caution.
Most of Caltex’s earnings growth has come from the expansion of retail petrol margins which have doubled over a decade, driven by less competition and a structural shift to higher profit premium fuels. Those conditions won’t be replicated.
Margins won’t double again and industry consolidation is just about complete. There are few options for expansion and we expect growth from the business to be fairly modest, perhaps 2-3 per cent a year.
Little growth means there is little margin for error. This is now a decent business but investors could still lose by paying too much for it.
There are also structural threats to fuel retailing.
Fuel volumes are falling, retail margins are high and the impact of electric cars won’t be a good thing for the business. Then there is the risk of management using its newfound cash to buy growth, which has already been suggested by the chief executive.
Caltex is a far better business than it was two years ago, but still not a great one. Where once it was a turnaround, now it’s a utility and priced as such. Its share price needs to fall further before it’s worth another look.
Guarav Sodhi is an analyst with Intelligent Investor Share Advisor. This article contains general investment advice only (under AFSL 282288). Authorised by Nathan Bell. To unlock Share Advisor’s stock research and buy recommendations, take out a 15-day free membership.
Extracted in full from the Brisbane Times.