Australia ranks 53rd globally in population size but 12th when it comes to consumption of petrol and 19th in consumption of diesel. If our economy continues to strengthen, our reliance on roads to move more goods will mean consumption of diesel products in particular will only go one way in the near term.
It’s a solid backdrop for the biggest proposed float of the year – Viva Energy, which offers potential exposure to petrol refining, distribution and retailing.
The prospectus for the Viva Energy IPO was released last week. The company is looking to raise between $2.4 billion and $3 billion. The retail offer opens on Thursday, with trading on the ASX scheduled to start on July 18.
Viva is hoping to join the other, larger downstream fuel distributor Caltex on the ASX with a market cap of around $5 billion.
Viva is not a household name because when it bought the Australian downstream assets of Shell in 2014, it also bought the exclusive right to continue marketing fuel under that name.
The other major brand name you will commonly see at Viva Energy-linked stations is Coles Express (part of Coles Group) which sub-leases sites and operates the pumps and convenience stores on most of Viva’s sites.
In return, Viva receives rental income and some royalty payments if sales exceed benchmarks.
This allows Viva to focus on its core capability of supplying petrol which it sources from Vitol, the world’s largest independent trader of fuels, which is expected to retain at least 40 per cent of Viva after the listing.
Viva is being marketed as a moderate growth business which has adopted a capital-light business model where it looks to control an asset without necessarily being the operator of that asset. Most of its earnings streams can be considered defensive.
Viva Energy doesn’t even own the majority of the underlying petrol station sites, with more than 400 spun off into a listed real estate trust (of which Viva owns 38 per cent) and leased back to Viva Energy.
Distribution of fuel through retail outlets drives just over half of earnings with another quarter coming from wholesale activities and another quarter from refining.
Viva owns the second-biggest refinery in Australia at Geelong. Refinery earnings are notoriously volatile given they are exposed to global oil markets and foreign exchange movements.
Viva’s key corporate relationships – for instance with Coles, Vitol and Shell – will determine the prospects of the group over the long term.
The quantity of petrol sold through retail outlets has actually fallen over the past two years by 3 per cent as Viva lifted the price of fuel supplied to the Coles Express outlets by about 3¢ per litre and this has been passed on to customers. It must have put a strain on the relationship between the two parties, with even one of the brokers promoting the float, Bank of America Merrill Lynch, noting that the alliance with Coles Express was not “operating optimally”.
At the end of 2029, Viva can take up the operations of the Coles Express sites.
As is the case for Caltex, growth for Viva Energy will come from new sites, (18 are expected in financial year 2018), convenience store sales growth and growth in demand for higher margin premium fuel.
Some investors have questioned whether the sector is attractive. They suggest that too many sites are located in key areas and, with the commoditised nature of fuel, consumers are price-sensitive.
But Mark McKenzie, the chief executive of the Australasian Convenience and Petroleum Marketers Association, which represents the interests of Australia’s fuel distributors and the majority of service stations, said the outlook for the industry was positive as it underwent a “convenience revolution”.
“As much money is being invested on the shop as on the forecourt, traditionally it would have gone on the forecourt,” he said.
Before 2012 about 80 per cent of the revenue and 60 per cent of the profit of a typical service station would have been generated by the sale of fuel, implying 20 per cent of sales and 40 per cent of profit was generated by convenience store, non-fuel sales.
However these days a typical service station might generate only 65 per cent of sales from fuel with 35 per cent of sales generated in the convenience store, with the profitability split evenly.
Mr McKenzie said the profitability of the end stream petroleum sector had improved over the past five years after a decade of intense competition caused by the entry of the major supermarkets into the sector.
The intervention of the ACCC against heavy discounting associated with shopper dockets by the supermarkets had allowed independent operators to reinvestment in their service station assets.
Former Caltex executive Wade Death founded the boutique Jack & Co Food Store chain six years ago. There are now five Jack & Co food stores, four of which also offer BP fuel, with more on the horizon.
Mr Death said it was not surprising to see a number of the big oil companies looking to lift their exposure to retail sales through the rollout of agency models rather than rely on the wholesale margin of selling fuel.
“For the big corporates, the prize is there but they have a huge amount of learning to go until they get it right. I’m absolutely confident that we are a number of years ahead of the rest and they don’t know what is in front of them.
“From the wholesale perspective they look at the retail margin and say we should have a crack at that but what comes with that is a lot of capital and a lot more operating risk as well.”
Endless comparisons to Caltex will be made by prospective investors in Viva. Supporters of Caltex will argue that it benefits from being a fully-integrated retailer and its refinery in Brisbane requires less capital expenditure.
But Viva will argue that its retail business should generate higher returns off a lower capital base and its refinery is better positioned.
Much has changed in the petrol game. The total number of petrol stations around Australia in 1970 was around 20,000. These days there are closer to 7000 outlets.
Over the past five years three refineries have closed, reducing Australia’s refining capacity by about 40 per cent.
Extracted from AFR