Geopolitical disruption and a global decline in refining capacity and production has handed Viva Energy a windfall. Refining margins in Australia are in orbit and producing an avalanche of cash for VEA. The non-refining business is also performing very well.
Suddenly, owning a refinery is a licence to print money. VEA’s unaudited 4-month EBITDA of $308 million is already at 92% of 1H22 consensus and poised to go higher if elevated May refining margins persist, which seems entirely feasible at the moment.
The Geelong Refining Margin (GRM) reached US$26.40/bbl in April, dwarfing the US$11.50/bbl recorded in March 2022 and an average of US$8.30/bbl in the March quarter this year. The April GRM alone probably generated EBITDA of $100 million. We understand that refining margins in May are running above April levels.
It might be tempting to hope that refining margins can remain in the stratosphere, but gravity will eventually take hold. If we assume US$15/bbl GRM for 2H22f (remember US$8.40/bbl 1Q22), then it would justify a very large consensus earnings upgrade.
Market caution is understandable as conditions can change swiftly. VEA points the finger at the strong global demand for refined products, especially diesel, and a tightening supply as a result of refinery closures, coupled with reduced exports from China and sanctions on Russian oil purchases for collectively pushing up refining margins.
While it may seem premature to expect global harmony to joyously erupt any time soon, VEA has the added comfort of the government support for refining in Australia.
Investment view
Refining margins are generating very large amounts of cash for VEA right now. From a valuation perspective, this cannot be capitalised, but the cash is real and VEA now finds itself in the happy circumstance of planning how to dispense it.
Consensus forecasts place VEA on a 13x PE ratio in FY23f and a 4.6% net dividend yield. Our sense is that VEA could easily follow up this home-run update with another in short order, leaving consensus forecasts a bit skinny.
Risks to investment view
The price of crude oil can be volatile, and it affects not only refining margins but retail and commercial demand for refined products. Economic activity also determines the level of demand for VEA’s products, so if this turns negative, it would affect earnings.
Recommendation
We have retained our Buy recommendation.
