Over the last 12 months, Viva Energy Group (ASX:VEA) shares have been hampered by several factors. These include declining refining margins, challenges in progressing its retail strategy and higher gearing levels (on the back of lower earnings). With the shares having recently recovered off its lows, we recently researched the Company to assess whether there was scope for a further recovery.

About Viva Energy Group

Viva Energy Group listed on the ASX in 2018 following restructure of Viva Energy Holdings and has three operating segments:

1. Convenience & Mobility (C&M) – The C&M network is the largest convenience retailer in Australia, with ~1,000 stores. These convenience sites are operated through various channels such as Coles Express (676 sites), OTR (214 sites) and Liberty Convenience (110 sites).

2. Commercial & Industrial (C&I): VEA is a significant supplier of fuel, lubricants and specialty hydrocarbon products to commercial customers across several sectors.

3. Refining: The Company owns and operates the strategically located Geelong Refinery in Victoria. The Geelong Refinery supplies more than 10% of Australia’s total fuel requirements (more than 50% of Victoria’s fuel demand).

Key Fundamental Drivers

Convenience Retail Strategy Facing Challenges

By way of background, VEA announced the acquisition of Coles Express for $300m in September 2022. The acquisition created the largest fuel and convenience network under a single operator with 710 sites. Subsequently, VEA acquired the fuel and convenience business OTR Group (‘OTR’) in early April 2023 for $1.15b.

Aside from recent performance being impacted by declining convenience sales, as well as additional costs incurred to progress the strategy, VEA continues to face challenges in progressing its retail strategy. The integration of Coles Express & OTR is proving more challenging that the Company anticipated. Notably, the rollout is occurring during a period of lower refining margins, a more challenging consumer environment, and declining tobacco sales (which is impacting visitation).

Cost Reduction Strategies to Support Earnings

To combat pressures on the C&M operations, VEA announced that it will accelerate programs to capture $30m synergies in C&M and cost reduction of $50m across the group in FY25. The Company noted that the initiatives could contribute ~A$160m EBITDA in 2026 as some cost savings are offset by investment in growth. The initiatives imply A$700-820m EBITDA in 2026 excluding other earnings improvement from OTR conversions offsetting tobacco sales decline.

Elevated Gearing Levels Raise Concerns About Covenant Breach

An elevated gearing level over the last 18-24 months has detracted from VEA’s investment appeal. Following the OTR acquisition, the balance sheet swing from a net cash position to gearing (on a net debt to EBITDA basis) of 0.6x-0.8x, as the acquisition via $1b of debt & working capital, and a $150m equity issue. Gearing as at FY24 rose to 1.5x.

Accordingly, a key question for investors is whether VEA is likely to breach its covenants. This is because the gearing level is expected to rise further in FY25/26. Gearing is expected to begin declining by the end of FY27, as the intensive CAPEX period concludes and earnings growth/cost savings initiatives take effect.

A key covenant is that the Leverage ratio (defined as Term Debt/12-month trailing EBITDA), must not exceed 2.0x. This measure was 1.3x in FY24 and is expected to rise to ~1.4x in FY25. VEA’s target range for the Leverage ratio is 1.0x – 1.5x.

Management has ample levers available to manage capital demands on the business if the operating environment deteriorated further. Whilst the convenience growth (new stores OTR conversions) will increase capital demands on the business, VEA is expected to remain within its target Term Debt / EBITDA range.

For VEA, maintaining within required credit metrics over the next two years broadly requires group EBITDA >$500m per annum. The Fuel Services Security Payment can provide up to $100m of EBITDA support over 12 months (assuming the refinery remains in production). This factor, in combination with FY24 EBITDA of ~$470m of EBITDA in C&I provides comfort that VEA will remain clear of financial covenants.

Fundamental View

The Company is well positioned to grow earnings through store conversions of legacy Coles Express sites to refurbished formats including the OTR offer, and deliver on cost reduction programs to support a ~40% EBITDA step change into 2026. However, we highlight several factors underpinning our cautious view:

i. Further weakness in refining earnings and margin, given the planned turnaround in 3Q25. It is worth noting that VEA has reported worse-than-expected margin in recent quarters, which has resulted in a de-rating in the shares notwithstanding steady results from the non-refining segments (i.e. C&I and C&M). Further, global tariffs present a downside risk to margin.

ii. The higher expected gearing level is not expected to result in a covenant breach. However, we would not rule out an equity raising in light of the upward trajectory in the gearing level expected in FY25/26.

iii. Execution on the retail convenience strategy (in particular the integration of Coles Express & OTR) continues to be impacted by several ongoing challenges. The potential sales uplift is significant. VEA’s food & beverage (F&B) sales on converted stores have potential to yield double the sales in F&B compared the Coles Express network. Notwithstanding, the biggest risk to return on investment is the higher-than-expected cost of converting stores.

Charting View

VEA broke below the long-term uptrend in mid-2024 and has been falling ever since. Short-term it is recovering but we need to see a series of higher highs and lows before we can be comfortable that the stock is turning around. Holders should consider a stop just under the April low near $1.40.

 

Michael Gable is managing director of Fairmont Equities.

 

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