THE REAL OIL?
FUEL RETAILER Z ENERGY COMES TO MARKET
COME BONUS season it’s a fair bet there will big cheques in the envelopes at investment company Infratil. There may even be some baubles in store at the straitlaced Super Fund.
After all, these people will have pulled off a piece of exceptional business. In April 2010 they bought Shell’s downstream fuel operation for $696.5 million and this year they will sell half of it, renamed Z Energy, for about the same amount, effectively doubling their money.
Smart work, especially when you consider they have done it with a low-margin business in a low-growth industry.
There is some wariness around the market about buying something at such a mark-up from a shrewd player like Infratil, but professional investors I have spoken to say the lower end of the asking price range – $3.25 to $3.75 a share – looks reasonable.
So what sort of investment would Z Energy be?
Z’s owners, Infratil and the Super Fund, are selling down their stake to between 40 and 50 per cent. This will involve the sale of 200 million to 240 million shares to institutions and private investors, generating proceeds of $650m-$900m at the indicative price range.
When the offer is complete, Z will have 400 million shares and a market capitalisation of $1.3 billion-$1.5 billion.
The company’s core business is fuel retailing, whether petrol, diesel, aviation fuel or marine fuel. It has 213 service stations, 94 truck stops, fuel storage facilities around the country and a 17 per cent stake in the Marsden Point oil refinery.
Z buys its crude oil through a contract with Shell which runs until 2016 and gets its refined imports from South Korea.
The combination of assets means Z has all the necessary infrastructure for selling fuel, but it is the only one of the four main fuel suppliers in New Zealand – the others are BP, Caltex and Mobil – which does not have a global production and distribution business.
Z regards this as an advantage, arguing that it can therefore make business decisions based solely on local priorities. On the evidence so far it looks like Z is right, with profit margins rising under local ownership.
According to the prospectus (and investors using it should be aware of Z’s different ways of stating its fuel costs) the gross fuel margin was 12 cents a litre in 2011, 13c in 2012 and 15.3c this year. It projects a margin of 16.5c in the year to March 2014.
It says the gains are the result of investment in service stations, better deals on fuel purchasing, ditching low-margin commercial customers, more commercial deals with rivals on shared storage and more sales to competitors because of Z’s ability to hold more stock.
Although data on industry margins suggests all the big fuel retailers have lifted margins over the past two years, Z’s work is seen as exemplary.
‘‘It’s clear the current management team and [chief executive] Mike Bennetts have done a superb job of improving margins,’’ said Andrew Bascand of Harbour Asset Management.
Bascand said Z had pulled off a most successful rebranding, so a lot of the risks Infratil and Super Fund faced when they took over the Shell assets have dissipated.
Phil Anderson of Devon Funds Management said the main thing to look at with Z was the margin per litre of fuel.
Z makes all its profits from that fuel margin – as opposed to Caltex, BP and Mobil, which earn a lot more of the end price of $2.20 a litre, he said. Z is therefore focused on keeping pricing of that last bit of margin rational.
‘‘Shell was probably not that price-sensitive on the last bit of margin,’’ Anderson said.
At forecast levels of profitability, which is pretty much the same as this year’s, Z expects to pay a dividend of $88m in the coming year.
That’s equivalent to 22c a share, or a net yield of 5.9-6.8 per cent. Taking into account imputation credits, that amounts to a gross yield of 8.1-9.4 per cent.
It is this dividend yield that provides the main attraction for investors. Analyst Paul Gardner of Logic Funds Management said the growth opportunity in Z was being enjoyed by Infratil and the Super Fund.
‘‘As incoming investors, we are highly unlikely to benefit from much revenue growth at all. Z Energy will therefore be viewed as a yield stock and will sit well in most balanced or conservative income portfolios.’’
Gardner viewed the top end of the price range as expensive. Unfortunately for retail investors, not much can be done about that because the price will be set after the closure of the broker firm offer on August 15. Retail buyers in the IPO will just have to hope for the best. Is this unsatisfactory? Absolutely. But the only way to get more certainty on price is to wait until the shares hit the market, which is swapping one kind of risk for another.
Anderson said the price range ‘‘looks appropriate’’ and the yield ‘‘looks pretty attractive relative to Vector and Mighty River and Contact’’.
There are couple of caveats, though.
One is that as a yield stock Z’s share price could be negatively affected if, or when, interest rates start to rise. The other is the long-term future of fossil fuels.
‘‘You only have to go google [electric car maker] Tesla,’’ said Bascand.
‘‘Distributing petrol is not a growth industry in the long term . . . One would expect this offering ought to be priced within a range that reflects those long-term issues.’’