A confluence of factors have tightened the refining market leading to incredibly strong refining margins for Ampol. At US$32.96/bbl for the second quarter, ALD is likely to generate more EBIT in 1H22 from refining alone than the whole group delivered in CY20. Projecting further elevated refining margins is no sure thing, but shareholders should brace for buybacks.
Refining margins of ~US$35/bbl through May and June are unprecedented. A significant increase in the SWAM (Singapore weighted average margin) was the key driver reaching US$33.62/bbl for the quarter as COVID demand recovery, low product inventory, Russian sanctions and Chinese export quotas all conspired to push the LRM to a record level of US$32.96/bbl for 2Q22.
Lytton produced 1,564 ML in the quarter (1,413 ML in 1Q22 at US$10.59/bbl) so it is likely that the refinery has made more EBIT in 2Q22 than the aggregate EBIT across 2018-2021. ALD did not say anything about its retail business, but we know that fuel price increases at the bowser were steep, and this would have stifled the retail profit margin for the period.
Investment view
The key question is how long such lofty refining margins can be sustained and therefore, how much extra cash flow is likely to flood into ALD’s accounts? Refining margins have slipped in July to around US$25/bbl but this still towers over the long term historic average of around US$10/bbl.
Given the new government cap and collar support arrangement for Australia’s two surviving refineries, and the lack of new refining capacity globally over the foreseeable future, there is good reason to think that the long term average refining margin could justifiably be higher.
Conservatively assuming an average long term refining margin of US$12.50/bbl would place ALD on a FY23f PE less than 10x with a 7.3% dividend yield. We think consensus numbers are due for a substantial upgrade. ALD has about $600 million of franking credits available so with net debt/EBITDA heading south of the consensus 1.8x by the end of FY23f, there is substantial room for share buybacks or higher dividend payouts noting the company’s target range of 2.0- 2.5x.
ALD’s free cash flow will also be boosted with the integration of Z Energy and it synergies of about A$60-80 million pa by the end of year 3.
Risks to investment view
Crude oil price volatility could affect refining margins and retail earnings through a fall in consumption of fuels. Government fuel security package support could change leaving ALD once again exposed to volatility in refining margins.
Recommendation
We have retained our Buy recommendation.
FIGURE 1: LRM US$/BBL
