We recently researched Ampol (ASX:ALD) in The Dynamic Investor. Lower retail fuel volumes and weaker refining margins have weighed on sentiment recently. Having started to recover off its recent lows, do current levels present a more attractive entry point? Or is the risk/reward balance still unfavourable?

About Ampol

Ampol (formerly Caltex Australia) is the largest integrated fuels company in Australia & New Zealand. The Company has four operating divisions:

• Fuels & Infrastructure – Sources, imports, refines and distributes crude, fuels and lubricants to a diverse customer base, including retail and wholesale customers.
• Convenience Retail – ALD operates 636 Company-owned retail sites across Australia. Company-controlled sites include ‘Company Owned Company Operated’ sites and ‘Company Owned Retailer Operated’ (franchise) sites and diesel stop sites.
• New Zealand – This division includes Z Energy (acquired in May 2022), which is one of New Zealand’s largest transport energy companies and includes the Z and Caltex branded retail networks, and supplies and distributes fuel to commercial and wholesale customers.
• Lytton Refinery (Brisbane) – The Lytton refinery has an extensive storage and distribution network that supplies ALD’s retail network.

Key Fundamental Drivers

Is Ampol’s Convenience Retail Offering Inferior?

Earnings for Convenience Retail in the 1st quarter of 2024 (1Q24) were slightly ahead of 1Q23, as the weaker fuel volumes were more than mitigated by improved fuel margins. The Company is prioritising fuel margins over volume. This enabled Convenience Retail earnings to be slightly ahead of 1Q23. However, ALD continues to lose market share in base grade petrol to discounter competitors, as ALD pushed rising import prices through to consumers.

To mitigate the impact from higher store costs, the Company is fast-tracking its Quick Service Restaurant (QSR) growth strategy. The QSR rollout and investment in premium sites is expected to drive earnings growth into the medium term. However, we note that the earnings growth outlook over FY23-27 (+0-3% on a CAGR basis) is well below the double-digit earnings growth outlook for its key competitor.

Refinery Margin Remains Under Pressure

Refining margins are still the largest swing factor for ALD’s earnings. The FY22 period likely saw the peak of the refining cycle. In that year, Refining accounted for 52% of ALD group EBIT with a Lytton Refiner Margin (LRM) of US$18/bbl. With a normalisation in refining margins and growth in ALD’s non-refining businesses, Refining is expected to account for ~20% of group EBIT in 2024/25.

While the Lytton refinery returned to normal operations in early April. refining margins weakened through April, initially driven by higher crude prices and lower production. More recently, the weakness appears more driven by weaker diesel demand. Profit margins for diesel are slumping as new refineries boost supplies and as mild weather in the northern hemisphere and slow economic activity impact demand. The lower refining margins for diesel, one of the world’s key industrial and transport fuels, have already prompted some refineries in Asia to trim the volume of crude oil they process to reduce their diesel output.

Gearing to Remain Below Target Range Despite Weaker Earnings Outlook

Gearing (on an adjusted net debt to EBITDA basis) remains below the 2.0-2.5x target range. It is expected to remain below the lower end of this target range over the medium term. This is because the Company typically generates strong cashflow despite higher CAPEX guidance. In turn, this positions the Company to pay further special dividends and provides flexibility to pursue Merger & Acquisition opportunities.

The Company typically consider capital returns where gearing is <2.0x (or where sufficient headroom exists within the target gearing range). Gearing is expected to rise in 1H24 on a weaker EBITDA figure and higher dividend payments. However, there is still balance sheet scope for further special dividends.

The sustainability of capital returns is a key investor consideration. To this end, the Company has paid towards the top end of payout range in recent years. In addition, the Company has and provided additional returns in the form of share buybacks or specials dividends for three of the last four years.

Fundamental View

While the share price has de-rated, so too has the EPS growth profile. Earnings over the short term are expected to remain under pressure from several factors. These include: i) Lower FY24 Lytton production (from the unplanned outage in 1Q24 and the planned turnaround in early 2H24), ii) Expectations for LRM to remain under pressure in the short term and (iii) Lower retail and Australian wholesale volumes in 1Q24, with the medium-term outlook for retail fuel volume is facing increased headwinds.

Accordingly, we take a cautious view in ALD shares at current levels.

Charting View

Ampol has been falling back sharply since peaking in early April. It is coming back towards its uptrend line where it may find support closer to $32. That would provide a slightly more attractive entry point than current levels. Otherwise, if that cannot hold, then the next support level down is near $31.

 

Michael Gable is managing director of Fairmont Equities.

 

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