Asian refining margins (a proxy for the ALD refining margin) have slipped below US$10/bbl after a brief period of recuperation following Ampol’s unplanned outage at the Lytton Refinery in 1H23. With refinery margins looking less robust and some questions on how much capital might be returned to shareholders, we lower our recommendation to Hold.
At the 1H23 result in August, ALD pointed to the LRM (Lytton Refining Margin) recovering to US$15.39/bbl in July from the low point of US$5.66/bbl in 2Q23. Even with production capacity remaining fairly tight against demand, margins appear to be settling at lower levels than last year.
The 1H23 Lytton Refinery RCOP EBIT of $100m was down -77% on the same period last year. With the LRM languishing compared to the elevated levels of 2022, the outlook for refinery earnings in FY23 is muted.
The government cap and collar arrangement for Australia’s two remaining refineries remains an important baseline. But edging close to the point where support kicks in is not ideal. Investors would sooner see refining margins closer to or above the long term average around US$10/bbl.
ALD’s Convenience Retail strategy has drawn some criticism for its stop-start nature. The latest decision to review and not progress with the 50 MetroGo store formats was another false start. The stores will instead be converted to ALD’s Foodary brand incurring further costs. The retail strategy is still providing promise as earnings in 1H23 increased 31% on the back of better fuel sales and improved shop performance. Total Ampol branded sites as at 30 June 2023 was 1,816 including 643 company operated sites.
ALD’s balance sheet leverage at 1.8x net debt to EBITDA is well below its target range of 2.0-2.5x. The market has been anticipating capital management of some description, but the Board appears to be hesitating. A slightly higher level of capex has crept into the picture with new capacity required for ultra-low sulphur fuels and aromatics at Lytton. The final capex will depend on finalisation of Australian fuel standards but could amount to $300-350m of which the government will contribute around $125m. Capex for FY23 is therefore pointing towards $450m after $160m was spent in 1H23.
Investment View
The gradual shift towards more non-fuel earnings is apparent for ALD, but progress is taking time.
ALD’s PE ratio has fallen below its long term average. At around 12x FY24 PER, there is arguably an implied ESG discount for the nature of the business.
With refining margins once again dragging the earnings chain, the heavy lifting is up to Consumer Retail. For these reasons, we have tempered our view on ALD and lower our recommendation to Hold.
Risks to Investment View
Crude oil price volatility could affect refining margins and retail margins through a fall in consumption of fuels. Government fuel security package support could change leaving ALD once again exposed to volatility in refining margins.
Figure 1: Asia-Pacific refining margins vs Brent crude oil price
Figure 2: ALD PE ratio
Recommendation
We have lowered our recommendation to Hold.
