An emerging debate among brokers regarding Caltex explores the trends in premium fuel consumption.

– Premium petrol volumes are softer in first half but is this a sign of a continuing trend?
– Brokers await further details on strategy to offset loss of Woolworths contract
– What if regular unleaded is banned in Australia?

For the first time Caltex ((CTX)) has reported declines in premium petrol consumption in the first half, while transport fuel margins have continued to expand despite subdued volumes. The company has guided to net profit for the half of $290-310m and marketing & supply operating earnings (EBIT) of $360-375m.

Morgan Stanley’s suspicions on premium petrol consumption are confirmed with this first time ever decline in premium volumes and suspects higher prices and a slowing consumer sector are having an impact. Admittedly, this is offset by growth in premium diesel.

The broker’s base case assumption is that premium petrol will gradually decline while premium diesel grows, although this could reverse over time as car manufacturing trends in Europe suggest diesel car demand peaked in 2012. The broker expects lower volumes will lead to modest and gradual pressure on prices over time for premium fuels.

Credit Suisse notes the concerns regarding premium volumes in the market but believes that while volumes maybe softening slightly, margins are compensating, bearing in mind that Coles ((WES)) has stepped away from discounting as well. Both Credit Suisse and Citi point to the continued rise in the proportion of premium fuels in the company’s sales mix, irrespective of one fuel type experiencing a modest decline.

Yet, Morgan Stanley argues that over the past few years the company has done well selling premium petrol, and the volumes were always going to make it easier for retailers to pass on the premium margins. With early signs the price differential is starting to have an impact on consumption this should lead to greater price pressure over time, further aggravated by the risk from changes to fuel standards.

Citi brushes aside the negative assumptions finding no evidence as yet that the decline in premium petrol volumes, in isolation, is having an adverse impact on margins and believes it is premature to sound a warning on premium fuels.

The broker retains a Buy rating, which is not reliant on further premium fuels penetration, and suggests flat premium fuel volumes will continue, despite diesel surprising on the upside. Citi also believes the market is yet to give the company the benefit of the doubt about replacing lost Woolworths ((WOW)) earnings and the offsets should come from recent acquisitions and cost reductions, ultimately delivering earnings growth.

Woolworths Contract

The company has indicated it is working on a strategy to offset the loss of the Woolworths fuel supply contract by the end of the year. UBS notes recent acquisitions add $50m in operating earnings versus the $100-140m loss from the Woolworths contract.

This implies $50-90m of efficiency measures are required to fully offset the Woolworths contract. UBS incorporates cost reduction measures in its forecasts which are envisaged more than offsetting more modest fuel sales and retains a Buy rating on a positive outlook.

Ord Minnett maintains a Lighten rating because of a lack of valuation support, particularly given the capital intensity of the business and net debt, as well as the impact of the loss of Woolworths petrol volumes. The broker expects the loss of volumes will deliver a significant decline and reduced scale in Ampol Singapore for Caltex, estimating a reduction in operating earnings of $132.9m.

The broker supports the decision by Caltex to pursue a medium-term growth avenue in convenience and notes early signs at Foodary are positive, although execution risk remains elevated. The broker would be more constructive on the stock at a lower price, which provides valuation upside to the existing business and incorporates more of the downside risk from loss of Woolworths petrol volumes, or when greater confidence can be obtained on the convenience business.

Credit Suisse will welcome the update in August for an opportunity to obtain details of further cost reduction, growth opportunities and associated capital requirements. The broker continues to believe that transactions on almost all of the company’s value chain support a break-up value estimate of around $50 a share.

Fuel Standards

Morgan Stanley flags two implications for Caltex from potential changes to fuel standards. Firstly, it will need to spend money to keep its Lytton refinery open, or spend more to convert it to an import facility. Secondly, Caltex has been making premium margins on premium fuels. If regular unleaded is banned in Australia it will become more difficult to maintain this margin over time.

There are five Buy ratings on FNArena’s database and two Sell. The consensus target is $33.12, suggesting 5.1% upside to the last share price. Targets range from $27.00 (Morgan Stanley) to $39.70 (Credit Suisse).

Extracted from FNArena.