Power generation segment reaping fruits of capacity expansion
· Challenging quarter for fuel segment, gross profit down 40% q/q
· Diversified energy model to shield earnings further
· Valuation revised lower amidst more cautious outlook on fuel segment
Power generation segment continues to spur earnings growth
Despite posting a 20% y/y drop in 9M’17 revenue to ₦96.9 billion, FO reported a 23% y/y growth in 9M’17 EBIT to ₦9.7 billion, lagging our estimate by 22%. The y/y growth came amidst mixed performances across FO’s four business lines. Performance of the company’s flagship Fuel Retailing segment (63% of revenue) remained subdued on persistent product sourcing challenges within the Nigerian petroleum downstream sector, dragging the segment’s revenue and gross profit 41% y/y and 40% y/y lower to ₦60.8 billion and ₦6.2 billion respectively.
Gross profit from the Lubricant & Grease segment (9% of revenue, 3rd largest) was also down 40% y/y to ₦1.3 billion despite an increase in the segment’s turnover (11% y/y to ₦9.1 billion) as the relatively weaker naira kept import cost of main raw material (base oil) on the high side (Gross margin – 9M’17: 15% vs. 9M’16: 27%). On the other hand, Gross Income from the Production Chemical segment (2% of revenue, smallest segment) rose 54% y/y to ₦0.7 billion, with growth supported by a low 2016 base.
Performance of the Power Generation segment (27% of revenue) however remained the brightest spot within the Group, buoyed by increased capacity of its Geregu Power Plant (GPP) – following the complete overhaul in Q4’16. The segment’s gross profit rose 247% y/y to ₦8.7 billion (amidst a 221% y/y growth in revenue to ₦25.5 billion), accounting for over half of the group’s gross profit and providing the biggest boost to the 23% y/y EBIT growth.
As expected, net financing cost (up 84% y/y to ₦4.1 billion) remained a key pressure point over the period amidst ramp up in borrowings before the start of FY’17 year. Overall, PAT over the 9-month period rose 81% y/y to ₦5.1 billion but lagged our ₦7.1 billion estimate.
Worrying Q3 performance from fuel segment
Notwithstanding the decent y/y bottom-line growth, we highlight that standalone Q3 performance was very weak, particularly for the Fuel Retailing business. Given that PMS importation by independent fuel marketers remained uneconomic for most part in Q3’17 amidst stronger crude oil prices in the current no-subsidy reimbursement era, we had expected FO to remain dependent on NNPC for its supply – at regulated thin margin.
The 9M’17 results however showed that the segment’s margin came in much steeper than we had anticipated (down to 5% in Q3 vs 10% expectation) despite weaker than expected volumes. The dismal numbers in our view must have been impacted by lower diesel prices within the quarter which fell 10% in the first two months of the quarter. Be that as it may, the outlook of the segment appears much dimmer as the dependence on NNPC for PMS supply is expected to persist in the short to medium term. Strong oil price (above $50/bbl) and weak currency will keep PMS importation uneconomic for marketers over the near term.
Diversified energy portfolio to shield earnings further
Just as we highlighted in our initiation of coverage report “Forte Oil PLC: Powering an integrated energy model” (published: 5th October, 2017), FO’s diversified energy portfolio will be extremely crucial given the inherent challenges to the Fuel Marketing segment. Our outlook for the non-fuel segments is more positive. The performance of the Power Generation segment is expected to remain robust as GPP ramps up capacity further. Also, we expect the recent FG intervention (₦701 billion Power Assurance Guarantee fund “PAG”) to continue to improve liquidity in the Power sector.
Although disruption to gas supply remains a risk, we are cautiously optimistic that the current halt in pipeline attacks will continue following peace agreements in the Niger Delta. We are equally positive on the Lubes segment, as we expect the gradual economic recovery to spur demand from transportation, marine operations and industrial activities. The relative improvement in FX liquidity since Q2’17 and the resulting stability in the currency market, should moderate the cost pressure on base oil and consequently support segment’s margins going forward.
With a cautious outlook on the Fuel segment, we cut our estimates across most line items through our forecast period. We revise our FY’17 revenue estimate to ₦133.7 billion (Previous: ₦145.4 billion) and revise our gross margin to 16.8% (Previous: 18.5%). Consequently, our revised FY’17E EBIT falls sharply to ₦12.5 billion (Previous: ₦17.5 billion), and our FY’17E PAT down to ₦6.2 billion (₦10.2 billion) but still implies a potential 114% y/y bottom-line growth to be driven by contribution from non-fuel segment. After updating our model, we revise our target price to ₦84.43 (Previous: ₦92.01) but maintain our BUY rating.