11 October 2018 : Analysts upgrade their FVE on Total Nigeria Plc ( TOTAL ) to N244.28, as analysts now model a 24% hike in domestic petrol price to N180 per litre and increase in finance income in 2019 - following robust subsidy receivables as at H1 18. However, to adjust for the regulatory risk in the Nigerian downstream sector, analysts raised their equity risk premium on the stock to 8%. From a valuation perspective, Total is trading at a FY 19 P/E of 3.8x which is at a discount to its domestic peers of 8.1x.

Still the preferred of the pack

Contrary to pressured margins experienced by other players in the downstream sector over H1 18, Total reported a gross margin expansion of 290bps YoY to 13.6%. Accordingly, margins expanded across its business reporting segments - network1 at 14.1% (+272bps), General Trade2 at 13.2% (+254bps) and Aviation at 10.7% (+10.3ppts). While analysts were unable to get clarifications from the management, analysts perceive the margin expansion stemmed from the use of older stock for lubricants, as inventory declined by 5.31% YTD to N25.3 billion as at H1 18. 

Also, analysts perceive better pricing in the aviation segment further supported the increase in their margins, as it reported YoY revenue growth 75.7%. Overall, aggregate revenue rose 2.2% YoY to N156.3 billion while cost of sales declined by a modest 1.2% YoY to N135 billion. Further down, Total booked a lower effective tax rate of 34% (H1 17: 37%), which in addition to the improved margin drove a 23.2% YoY growth in PAT to N5.7 billion, translating to an EPS of N16.71 over H1 18.

Moderation in input cost underpins core earnings

In terms of their outlook for 2018, analysts project a flattish revenue of N288.1 billion, as analysts expect the volume driven decline in petroleum products and lubricant sales at the network segment (- 5% YoY to N203.0 billion) to offset higher price and volume driven sales at the general trade (+7% YoY to N61.6 billion) and aviation sector (+40% YoY to N23.5 billion) segments.

On cost, given the use of older inventory in H1 18, particularly for lubricants, analysts expect cost of sales for FY 18 to print at 86.9% (FY 17: 89.8%) necessitating their forecast of a decline in COGS (-3.3% YoY to N251 billion). For clarity, analysts expect the company’s cost to increase in the second half in a bid to replace its used inventory3 which should instill pressures on its cost given the sustained increase in the price of base oil. Consequently, analysts forecast gross margin to expand 290bps to 13.1%. Elsewhere, operating expense is expected to grow by 7.7% YoY to N22.6 billion, hinged on the increase in staff cost. Coalescing growth in OPEX with gross earnings expansion and other operating income of N1.5 billion translates to an EBIT of N16.7 billion (+36.2% YoY) with respective margin at 5.80% (FY 17: 4.26%).

Higher operating profit offset the jump in net finance cost

Elsewhere, analysts expect a five-fold increase in the company’s net finance cost to N3.3 billion (FY 17: N474 million), resulting from the decline in finance income due to the absence of any subsidy payment in their model and the significant jump in trade finance (+ 55.7% YTD to N5.5 billion) during the year. Irrespective, analysts expect gains from higher operating profit to offset the increase in net finance cost, translating to a profit before tax of N13.4 billion (+13.6% YoY) and FY18E EPS of N25.66 (+17.2 YoY).

Price hike to change the story in 2019

Beyond 2018, given that the fixed nature of retail domestic PMS price relative to the rising importation cost has pressured margins for the downstream players, analysts believe there is possibility of a price hike in 2019, particularly post-election. For us, applying their 2018E average crude price of $70 per barrel4 to the PPPRA pricing template, analysts think the domestic crude oil price could increase by 24% to N180 per litre, which analysts expect to bolster revenue. Accordingly, analysts expect a pick-up in the revenue with a 4- year CAGR of 5.6% between 2019 and 2022.

The attendant impact of analyst's modelled price hike post-election in 2019 results in gross margin improvement, with their 4-year forecast average of 14.6% (vs 12.7% between 2014 and 2017). Also, another upside for the company is the increase in finance income via the payment of its outstanding PSF receivables (N3.2 billion) which analysts now expect to come in from 2019. Net impact of these adjustments necessitated their FVE of N244.28 which offers an upside of 33.5%, translating to a STRONG BUY on the stock.

Downside risk to analyst's forecast is if the domestic retail price is left unchanged, leaving margins at current level.

Reporting for EasyKobo on Thursday ,  11 October 2018 in Lagos, Nigeria

Source: Olamide Adeboboye  from ARM Securities Limited

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