CardinalStone Research - Forte Oil Plc_Higher Fuel Margins, Geregu Upgrade, A Plus for 2016 Earnings

8/17/2019 CardinalStone Research - Forte Oil Plc_Higher Fuel Margins, Geregu Upgrade, A Plus for 2016 Earnings

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Company Update

Forte Oil PlcEquity Resea

On Wednesday, 24th

February, 2016, we visited Forte Oil’s Geregu Power Plant in Ajaokuta,

Kogi State. Based on feedback from the visit and the release of the company’s trading and

operational update for the year ended 31st

December, 2015, we raise TP to N297.69

(Previous: N183.61) and upgrade the counter to a HOLD. Kindly see our update on the

company below;

We expect earnings to improve in FY16E … A combination of factors

should help improve the company’s bottomline in FY’16E. First, we highlight the

petroleum motor spirit (PMS) margin increase for retailers from N4.60 per litre to

N5.00 per litre and the rise in the retail price for kerosene from N50.00 per litre to

N83.00 per litre. Secondly, the fall in crude oil prices has led to a corresponding fall

in base oil prices which should be supportive of revenue from lubricants. Also, we

think an improvement in the subsidy management scheme which saw zero subsidy

paid in January should help working capital management. According to the Minister

of State for Petroleum Resources, Dr. Emmanuel Ibe Kachikwu, the novel pricemodulation mechanism currently in place will ensure that the Federal Government

records zero expenses on fuel subsidy in 2016.

Following from a tough 2015 as supply disruptions dampened

sales: 2015 was a markedly tough environment for downstream operators who

battled with FX challenges and delayed subsidy payments by the government. FO

reported a 27% YoY revenue decline in FY’15 as PMS supply disruption weighed on

sales. With lower PMS volume coming into the revenue mix, FO’s margins were

boosted significantly by contribution of the higher margin lubricants and power

segments. FY’15 gross margin came in at a historic high of 14.7% (FY’14: 10.9%).

Despite the reduction in sales throughput, OPEX continues to rise – up by 17% YoY.

PAT was up by 30% YoY to N5.7 billion as the benefit from a 189% YoY rise in

exceptional income fed through.

We revise our recommendation to a HOLD: We have raised our target

price (TP) on Forte Oil Plc (FO) to N297.69 (from N183.61) after adjusting for

expected higher earnings from Geregu and improved operating environment in the

downstream sector, and therefore place an HOLD recommendation on the counter.

The stock is trading at 63x earnings compared to comparables (TOTAL and MOBIL)

average P/E of 14x. Our target price implies a 2% upside from current price.

Catalyst and Risks: The deregulation of the downstream sector in 2016 would

have a material impact on the company’s earnings. A major risk to FO is the

devaluation of the Naira as gas prices are quoted in dollars whilst the company

receives payments for generated electricity in naira.. Naira devaluation will see

operating expenses rise for the power business.

Ana

Damilola La

Damilola.Lawal@cardinalstone

04 March 2016

HOLD TP: N29

Stock Data

Bloomberg Ticker:

Market Price (N)

Shares Outs (Mn)

Market cap (N’Bn)

Price

Performance FO

12-month (%) 32.4

3-month (%) 17.9

YTD (%) -11.1

Valuation 2015A 2016E

P/E (x) 63.8 39.1

P/BV (x) 8.0 7.1

Div. Yield (%) 1.0% 1.2%

0

0.5

1

1.5

2

- - -

J l - - -

ASI FO

YTD Price Performance (rebased)

Contact Information

research@cardinalston

+234 809 04

sales@cardinalston

+234 809 94


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Company Update


FY’15 Review – Tough operating environment deals blow to

revenue, but earnings delight

FO reported a 27% YoY revenue decline to N124.6 billion in FY’15. The decrease in

revenue reflects lower revenue from the company’s fuel and lubricants business

(down by 32% YoY) due to product distribution challenges which affected volumes

and a N10 price cut in the retail price of PMS. The other divisions, the productionchemicals, lubricants and power generation segments reported strong growth

numbers – up by 44% YoY, 9% YoY and 13% YoY to N3.9 billion, N6.2 billion and

N10.3 billion respectively. We saw considerable shift in focus towards the

production chemicals and lubricants segments given that they are margin accretive.

The uptick in the power generation segment was due to an increase in capacity

utilization to 33% from 30%.

Table 1: FY’15 Segment Breakdown (N’billion)

FY’15 FY’14 % Growth

Power 10.3 9.1 13.3%

Fuels 104.3 152.7 -31.7%

Production Chemicals 3.9 2.7 44.2%

Lubricants 6.2 5.7 9.1%

Source: CardinalStone Research, Company Financials

FO reported FY’15 EPS growth of 87% to N4.11, boosted by an exceptional rise in

other income – up by 190% to N4.1 billion. Other income increased by 190% due toincome from investment in securities held to maturity, freight income from the 100

trucks acquired the previous financial year and sale of investment property. FO’s

Board of Directors proposed a DPS of N3.45 (FY’14: N2.50), representing a payout

ratio of 84%.

Price performance: Is there any gas left?

Relative to the All Share Index (-14.01%), and Nigeria’s Oil & Gas index (-6.81%), FO

(+32.41%) has outperformed over the last 12 months. The market has reacted

positively to news about FO; - 1) the award of a crude oil lifting contract by the

NNPC; 2) planned upgrade to the installed capacity of the Geregu Power Plant; and

3) release of FY’15 results. Other news such as the increase in downstream

marketer’s margin to N5.00 per litre and the introduction of price modulation

template was justifiably acknowledged by the market. We believe FO’s market

valuation is stretched at current level. However, illiquidity and trading sentiments

may continue to support FO’s share price.


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Company Update


2016 themes - Higher fuel margins, increase in Geregu’s

installed capacity, oil l ifting contracts, a plus for 2016 earnings

Along with the review of the PMS pricing template, the margin for retailers has been

increased from N4.60 per litre to N5.00 per litre after a long period of fixed margins

– technically an 8.7% increase in margin per litre. We also expect that supply

disruptions that plagued much of last year will ease as the de-risking of the “subsidy

burden” should help improve volumes. Secondly, the fall in crude oil prices has ledto a corresponding fall in base oil prices which should be supportive of lubricants

segment margin; we recall that this category accounted for 5% of sales last year. We

see contribution from that business segment rising to 6% in 2016. Other areas that

could help improve FO’s earnings is the ongoing upgrade to the Geregu Power Plant

which will lift installed capacity to 435 megawatts and the award of the crude oil

lifting contract. At 55% capacity utilisation (CSP’s 2016 estimate), that business

segment will account for 11% of revenues. This could rise much further if capacity

utilisation reaches management’s target of between 70 - 85%. FO was awarded a

one-year contract by the NNPC to lift crude oil (c.45,000 barrels per day) from the

various crude and condensate production arrangements. In our view, its partnershipwith Mercuria helped the company qualify for the contract which brings in higher

margins than petroleum marketing. Details are sketchy as the contract is yet to

commence but we are optimistic that this will boost revenues and earnings further

as crude oil trading brings in higher margins than petroleum marketing. This entails

the swapping of crude oil in the international market for refined petrol, which is

then imported into the country. This could also help reduce the strain of sourcing FX

to import refined fuel.

100

150

200

250

300

350

400

Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-

FO

Source: CardinalStone Research, Bloomb

Figure 1: Event Tracker

1. FO announces FY’14 dividend of N2.50 (February 03)

2. FO signs $83 million contract with Siemens (June 30)

3. FO sells 17% stake to Mercuria (September 27)

4. FO wins NNPC lifting contract (December 18)

5.

FY’15 earnings release accompanied by DPS of N3.45 (Jan 29)


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Company Update


Nonetheless, devaluation concerns rise to the fore

In our view, FX volatility provides the biggest challenge to operations this year and

could likely offset or limit most of the positives highlighted earlier. Devaluation

would prove to be a “double whammy” on the company’s operation. Firstly,

devaluation of the naira will increase the landing cost of petroleum products.

Accordingly, this will increase the subsidy the government will have to pay on

regulated products such as petrol – if subsidies are retained. For these products,

devaluation will have no impact on the marketers as the government bears the

exchange rate risk. However, for bills of laden executed before the devaluation, the

subsidy repayment will be based on the pre-devaluation exchange rate and only bills

executed after the devaluation will be refunded using the devalued exchange rate.

As such, the company will be forced to bear the loss of devaluation. Asides that, for

non-regulated products such as diesel and kerosene, the company may have to bear

or transfer the total cost implication to the consumers or split the cost between

themselves and consumers. Either of these alternatives would pull margin

downwards. Secondly, the company pays for gas priced in dollars and receives

payments for generated electricity in naira. Hence, cost of sales will rise if

devaluation occurs. A devaluation would increase Forte’s operating expenses in the

power segment. Though, MYTO allows for an upward adjustment in electricity tariffs

in the event of devaluation, the difficulty in implementing tariff increases lately will

be a hindrance.

Valuation

We value FO using a five-year discounted cashflow model. We increase our TP for

FO to N297.69 (Previous: N183.61) after adjusting for higher margins in the

downstream sector and improved outlook for earnings from the power division.

This implies a 2% upside potential from current share price levels and therefore

revise our recommendation to a HOLD. However, given the sketchy details around

the crude oil lifting contract, we have excluded its impact from our valuation.


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Company Update


Operational report of Geregu’s plant visit

A Brief History

Amperion Power Distribution Co Ltd, a power generation company and a subsidiary

of Forte Oil Plc, acquired the Geregu Power Plant located in Ajaokuta, Kogi State,

under the government-led privatization program in the power sector, for a purchase

consideration of $132 million in 2013. The total installed capacity of the gas-fired

power plant is 414 MW. The transaction implies a deal value of $0.32 million per

MW. While it may seem expensive relative to other acquisitions in the sector

(average of $0.25 million per megawatt), we highlight the fact that the Geregu

Power Station is the newest of the power stations that were either sold or

concessioned. The gas-fired power plant was commissioned in 2007 with three

Siemens V94.2 open cycle gas turbine power generation units totaling 414MW of

installed capacity. The three operational units namely GT11, GT12, and GT13 have

an installed capacity of 138 MW each.

Good ramp up expected

Forte Oil signed an $83 million contract with Siemens AG to upgrade the capacity of

the power plant to 435 MW. The company has made a down payment of $62.25

million for the work and construction work should be completed by H1’16.

According to the Siemens representatives, repair and replacement works have

commenced and work is progressing according to schedule. GT11 and GT12 have

been shut-down for the necessary repairs whilst work will commence on GT13 when

repairs have been completed on GT11 and GT12. Following the completion of repair

works, the plant should be able to function at close to c.100% capacity but due totransmission losses, management expects capacity utilisation to vary between 70% -

85% but still well above the 33% capacity utilisation recorded in 2015.

The energy risk is contained

The Geregu Plant is gas-fired with feedstock currently supplied by Seplat Petroleum

Development Corporation through a 24-inch natural gas pipeline which feeds from

Seplat Oben gas processing plant in Edo State. Seplat currently supplies about

80mmscf/d though negotiations are ongoing to increase supply by an additional

10mmscf/d. We understand that gas supply is relatively stable except when there

are incidences of pipeline vandalisation which then reduces gas pressure. Efforts areunderway to mitigate this as discussions are ongoing with the Nigerian Gas

Company to supply additional gas as back-up. Power has a considerable impact on

the company’s valuation contributing 40% to EBITDA in 2015; however margins

could come under pressure in the event of devaluation of the Naira. The company

pays for gas in dollars at the interbank rate and from our analysis, a 50% devaluation

of the official rate could see gross margins for the power division drop by 25%.


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Company Update


Photo Gallery of Geregu Power Plant, Ajaokuta, Kogi State

Pi e-link from Oben Gas Plant Ste -U Transformer

Welcome to Gere u GT11 GT12 and GT13

Generators Stri ed-Out Gas Turbine


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Company Update


Sector Analysis in 2016

Overall, we expect a much smoother operating environment in

the downstream sector

The downstream sector was fraught with negative events last year. For lengthyperiods of time, persistent queues rocked fuel stations across Nigeria. A

combination of factors precipitated this event. 1) There were continued delays in

the reimbursement of oil subsidies by the federal government; 2) poor product

evacuation infrastructure at the Apapa Ports, including road networks; and 3) higher

risk aversion by banks to the sector which limited credit to petroleum marketers. In

addition to these, FX volatility was not supportive. In 2016, we expect smoother

operations given that delays in subsidy reimbursements are likely to be less of an

issue. Crude oil price outlook remains bearish and as such, the expected market

price for premium motor spirit (PMS) is set to hover around the FG’s set N87.00 per

litre pump price, possibly below, for an extended length of time. Secondly, the roadnetwork in Apapa is expected to improve given concerted efforts by the Federal and

State Government to ease bottlenecks. Recently, Dangote Construction Limited

announced plans to reconstruct the Apapa Road as part of its corporate social

responsibility. With the de-risking of the subsidy burden, we think that lenders will

be more comfortable lending to petroleum marketers.

Power - Can gas supply catch up with estimated electricity

demand?

NERC’s electricity generation projections for 2015-2024 under the Multi Year Tariff

Order (MYTO 2) estimates a 15% Compounded Annual Growth Rate (CAGR) in load

projection with gas-fired (thermal) power plants generating an average 88% over

the period. Thermal power generation is expected to rise from 4,853 MW in 2016 to

13,170 MW by 2024. From our calculations, the industry would require a significant

boost in gas supply to achieve this feat. We calculate that a doubling of gas-to-

power supply from the 722.0 mmscf/d recorded in December 2015 to 1,444

mmscf/d is required in order to meet 2016 load projection of 4,853 MW. By 2024,

4,181 mmscf/d of gas will be required to meet load projection of 13,170 MW. Whilst

current and forecast gas production can bridge this gap, gas producers will need to

significantly reduce gas flaring which at an average 743 mmscf/d is higher than the

average supply of 696.7 mmscf/d supplied to the power industry in the whole of

2015. Commercializing flared gas would require huge investments which gas

producers are cautious of making in view of huge debts owed by the power industry.


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Company Update


Financial Statements and Key Ratios – Forte Oil Plc

Income Statement 2014A 2015A 2016E 2017F 2014A 2015A 2016E 2017F(N'Mn) (US$'Mn)

Revenue 170,128 124,617 181,946 197,405 1,030 626 910 940

Cost of Sales (151,663) (106,256) (147,163) (156,825) (918) (533) (736) (747)

Gross Profit 18,465 18,361 34,783 40,579 112 92 174 193

Distri. And Admin Expenses (11,726) (13,724) (21,834) (23,689) (71) (69) (109) (113)EBITDA 6,739 4,637 12,950 16,891 41 23 65 80

Other Income 1,398 4,051 1,398 1,426 8 20 7 7

EBIT/Operating profit 8,137 8,688 14,348 18,317 49 44 72 87

Interest Expense/Income (2,130) (1,676) (2,898) (1,201) (13) (8) (14) (6)

Pre-tax earnings 6,006 7,012 11,449 17,116 36 35 57 82

Taxation (1,550) (1,218) (1,989) (3,081) (9) (6) (10) (15)

Profit after tax 4,457 5,794 9,460 14,035 27 29 47 67

Statement of Financial Position 2014A 2015A 2016E 2017F 2014A 2015A 2016E 2017FAssets

Property, Plant and Equipment 54,253 62,420 66,370 68,722 329 315 332 327

Investment Property 1,935 1,832 1,832 1,832 12 9 9 9

Intangible Assets 476 286 286 286 3 1 1 1

Deferred Tax Assets 121 131 131 131 1 1 1 1

Long-Term Employee Benefits 16 42 42 42 0 0 0 0Inventories 12,202 10,060 13,933 14,848 74 51 70 71

Other Assets 573 390 540 575 3 2 3 3

Trade and Other Receivables 53,600 34,897 24,924 27,042 325 176 125 129

Cash and Bank Equivalents 16,062 11,701 18,938 18,202 97 59 95 87

Total Assets 139,238 121,758 126,995 131,679 845 614 635 627

Liabilities

Loans and Borrowings 12,289 13,758 12,094 6,815 75 69 60 32

Bank Overdraft 16,496 10,268 8,268 6,268 100 52 41 30

Current Income Tax Liabilities 846 968 1,406 2,083 5 5 7 10

Deferred Fair Value Gain on Loan - 441 441 441 - 2 2 2

Trade and Other Payables 52,515 34,183 47,344 50,452 319 172 237 240

Deferred Taxation 82 74 74 74 0 0 0 0

Loans & Borrowings 12,254 13,952 3,522 1,985 74 70 18 9

Non- Curr. Deferred Fair Val Gain on Loan - 1,433 1,433 1,433 - 7 7 7Non-Current Trade and Other Payables 422 400 400 400 3 2 2 2

Total Liabilities 94,904 75,477 74,982 69,952 576 380 375 333

Capital and Reserves

Share Capital 546 546 546 546 3 3 3 3

Share Premium 8,181 8,181 8,181 8,181 50 41 41 39

Foreign Exchange Reserve (248) (258) (258) (258) (2) (1) (1) (1)

Revenue Reserve 3,959 6,002 10,789 19,099 24 30 54 91

Treasury Stock - (1,389) (1,389) (1,389) - (7) (7) (7)

Non Controlling Interest 31,897 33,198 34,144 35,548 194 167 171 169

Shareholders' funds 44,335 46,281 52,014 61,728 269 233 260 294

Total liabilities and equity 139,238 121,758 126,995 131,679 845 614 635 627

Key Ratios 2014A 2015A 2016E 2017F 2014A 2015A 2016E 2017F

Profitability

Return on Average Equity 10.3% 12.8% 19.2% 24.7% 10.3% 8.2% 5.6% 6.6%

EBITDA Margin 4.0% 3.7% 7.1% 8.6% 4.0% 3.7% 7.1% 8.6%

EBIT Margin 4.8% 7.0% 7.9% 9.3% 4.8% 7.0% 7.9% 9.3%

Pretax Profit Margin 3.5% 5.6% 6.3% 8.7% 3.5% 5.6% 6.3% 8.7%

Net Profit Margin 2.6% 4.6% 5.2% 7.1% 2.6% 4.6% 5.2% 7.1%

Valuation Multiples

P/E (x) 82.9 63.8 39.1 26.3 82.9 63.8 39.1 26.3

P/B (x) 8.3 8.0 7.1 6.0 8.3 8.0 7.1 6.0

Dividend Yield (%) 0.7% 1.0% 1.2% 1.5% 0.7% 1.0% 1.2% 1.5%


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Company Update


Disclosure

Analyst Certification

The research analyst(s) denoted by an “*” on the cover of this report certifies (or, where multiple research analysts are primarily responsible for

this report, the research analysts denoted by an “*” on the cover or within the document individually certifies, with respect to each security or

issuer that the research analyst(s) cover in this research) that: (1) all of the views expressed in this report accurately articulate the research

analyst(s) independent views/opinions, based on public information regarding the companies, securities, industries or markets discussed in this

report. (2) The research analyst(s) compensation or remuneration is in no way connected (either directly or indirectly) to the specific

recommendations, estimates or opinions expressed in this report.

Analysts’ Compensation: The research analyst(s) responsible for the preparation of this report receive compensation based upon various factors,

including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from,

among other business units, Investment Banking and Asset Management.

Investment Ratings

CardinalStone employs a 3-step rating system for equities under coverage: Buy, Hold, and Sell.

Buy ≥ +15.00% expected share price performance

Hold +0.00% to +14.99% expected share price performance

Sell < 0.00% expected share price performance

A BUY rating is given to equities with strong fundamentals, which have the potential to rise by at least +15.00% between the current price and the

analyst’s target price

An HOLD rating is given to equities with good fundamentals, which have upside potential within a range of +0.00% and +14.99%,

A SELL rating is given to equities that are highly overvalued or with weak fundamentals, where potential returns of less than 0.00% is expected,

between the current price and analyst’s target price.

A NEGATIVE WATCH is given to equities whose fundamentals may deteriorate significantly over the next six (6) months, in our view.

CardinalStone Research distribution of ratings/Investment banking relationships as of December 31, 2015

Rating Buy Sell Hold Negative Watch

% of total recommendations 57% 17% 23% 3%

% with investment banking

relationships

33% 0% 50% 17%

Valuation and Risks: Please see the most recent company-specific research report for an analysis of valuation methodology and risks on any

security recommended herein. You can contact the analyst named on the front of this note for further details.

Frequency of Next Update: An update of our view on the company (ies) would be provided when next there are substantial

developments/financial news on the company.

Conflict of Interest: It is the policy of CardinalStone Partners Limited and its subsidiaries and affiliates (individually and collectively referred to as

“CardinalStone”) that research analysts may not be involved in activities that suggest that they are representing the interests of Cardinal Stone in

a way likely to appear to be inconsistent with providing independent investment research. In addition, research analysts’ reporting lines are

structured to avoid any conflict of interests. For example, research analysts are not subject to the supervision or control of anyone in

CardinalStone’s Investment Banking or Sales and Trading departments.


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Company Update


However, such sales and trading departments may trade, as principal, based on the research analyst’s published research. Therefore, the

proprietary interests of those Sales and Trading departments may conflict with your interests.

Company Disclosure:

CardinalStone may have financial or beneficial interest in securities or related investments discussed in this report, which could, unintentionally,

affect the objectivity of this report. Material interests, which CardinalStone has with companies or in securities discussed in this report, are

disclosed hereunder:

Company Disclosure

Forte Oil Plc j

a. The analyst holds personal positions (directly or indirectly) in a class of the common equity securities of the company

b. The analyst responsible for this report as indicated on the front page is a board member, officer or director of the Company

c. CardinalStone is a market maker in the publicly traded equities of the Company

d. CardinalStone has been lead arranger or co-lead arranger over the past 12 months of any publicly disclosed offer of securities of

the Company

e. CardinalStone beneficially own 1% or more of the equity securities of the Company

f. CardinalStone holds a major interest in the debt of the Companyg. CardinalStone has received compensation for investment banking activities from the Company within the last 12 months

h. CardinalStone intends to seek, or anticipates to receive compensation for investment banking services from the Company in the

next 3 months

i. The content of this research report has been communicated with the Company, following which this research report has been

materially amended before its distribution

j. The Company is a client of CardinalStone

k. The Company owns more than 5% of the issued share capital of CardinalStone

l. CardinalStone has other financial or other material interest in the Company

Important Regional Disclosures

The analyst(s) involved in the preparation of this report may not have visited the material operations of the subject Company (ies) within the past

12 months. To the extent this is a report authored in whole or in part by a Non-U.S. analyst and is made available in the U.S., the following areimportant disclosures regarding any Non-U.S. analyst contributors: The Non-U.S. research analysts (denoted by an * in the report) are not

registered/qualified as research analysts with FINRA; and therefore, may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on

communications with a subject company, public appearances and trading securities held by a research analyst account. Each analyst (denoted by

an *) is a Non-U.S. Analyst and is currently employed by Cardinal Stone.

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CardinalStone Research - Forte Oil Plc_Higher Fuel Margins, Geregu Upgrade, A Plus for 2016 Earnings

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