What is Caltex Worth?
For some reason over the last few weeks I have received an influx of requests for a valuation on Caltex. I guess it must have something to do with the share price declines.
Let me start by saying, you are on a hiding to nothing, trying to value this company. Like any business, the true value of Caltex has nothing to do with its share price and is instead determined by its equity and the profitability of that equity. As you are probably already aware profitability (return on equity) is going to be heavily impacted by input costs and revenues which for Caltex are fast changing. To better understand Caltex profits, have a look at what goes into the price of a litre of petrol that it sells.
To determine an Australian refiners’ profits you must start with the Singapore refiners’ price for petrol. This is because Australia’s local oil refineries compete with imported petroleum products from refineries in Asia, regardless of the cost of importing and refining crude oil. Consequently, the price of petrol at Australian refineries is based on international petrol prices. If local prices were higher than international prices, imports of petrol would displace local production. The result is “import parity pricing” – in other words, what it would cost to land fuel from Singapore refineries into Australian terminals. In turn, this price includes the Singapore benchmark price for refined petrol or diesel, the addition of an Australian “quality premium” (dubious but said to take into account Australia’s “high fuel standards”), plus shipping costs and cargo insurance. The result is then converted from US dollars per barrel into Australian cents per litre (1 Barrel = 159 litres).
So, starting with the Singapore petrol price (which is itself prone to wild swings),we have to add shipping (variable), quality premium, shipping insurance (variable), covert to Aud (variable), then add port costs (relatively stable), then add wholesale and retail margins (variable) and freight (variable) and then after GST and the Governments fuel excise we have a retail price for petrol.
You can see that there are many factors that are out of Caltex’s control and will determine its profitability and I haven’t addressed the factors that will influence the Singapore refiner’s margin, although the cost of crude oil has the most impact in the long term.
Feel like a break yet?
The result is that Caltex’s profitability is volatile and this is evident in the numbers. In 2001 Caltex’s return on equity was -20%, while it was 40% in 2004. Based on some of the research I have seen, return on equity is expected to be around 10% for the next three years. Really? Who knows? How could you know? It will depend on the price of oil. In the 2007 year (Caltex has a December year end) oil prices traded between US$49.90 and US$99.29 and Caltex’s return on equity was 24%. n 2008 the oil price began at US$96, rallied to US$147 and fell to US$32.40. Caltex’s return on equity that year was 1.3%.
If we assume that the analysts are right with their forecasts of a 10 percent return on equity, then the value of Caltex is somewhere between $8 and $9. My valuation actually comes in at $8.74 but for the reasons I described above, I would not even consider a purchase unless the shares were at a very substantial discount to this valuation.
You should be aware that if you are trying to value Caltex, you are punting and making a plain old bet. Its a bet you might get right, but it is speculating not investing. Perhaps if you can buy Caltex at a 50% discount to a conservative estimate of intrinsic value it would be a safer bet but even then it is still a bet.
Posted by Roger Montgomery, 10 December 2009
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
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rogermontgomeryinsights
:
In terms of business economic performance, WPL stands out as vastly superior to STO. I appreciate its a short answer and I could write a book and half but for now, its worth using the comparison to help guide you in your search for the desirable characteristics.
Roger
Dom
:
Hi Roger,
I came accross this blog after your comments tonight in relation to Caltex on your money your call program. I must say, as a novice in investing you are great to listen to and make a lot of sense especially in terms of valuing a business and as such come accross really well on TV unlike some other guests.
I have been caught up in the hype of this stock and probably should close out of the postion based on your comments.
What I would be grateful to find out though is, what alternate stock in the energy sector that I could buy into that has good future maintainable earnings and is easy to value. In particular, what do you think of Santos and Woodside as an alternative investment.
Thank you very much for your comments if you get a chance to reply to this comment.
Regards,
Dom
rogermontgomeryinsights
:
John’s right Tim (I hope you are well by the way Tim).
Hedging, forward supply agreements and the like do reduce the exposure to fast changing commodity prices as do long term stablisers like legislated contractual arrangements (utilities) and where these exist it can make the trick of estimating future rates of return on equity easier. But then, once you have found the stable earners in the resource sector, you are faced with the difficulty of predicting capital expenditure and maintenance and then you have to deal with capitalised expenses and various accounting shenanigans. Its easier to buy businesses like JB Hi-Fi whose valuation rises steadily year after year (of course it will eventually end) than BHP whose value (based on actual historical performance) can oscillate wildly from $80 to $10 and back again inside a fifteen year observation period. Perhaps most important are John’s comments about pricing power. The best businesses to own are those with a sustainable competitive advantage (CA) and the most valuable CA is the one that allows the business to raise its prices. Resources companies in general cannot do this and where they can, it is usually for a short period (iron ore at present).
John
:
A possible answer to Tim Clare’s question: this is not true of all commodity businesses. For example, LNG producers (almost?) always tie their production to long-term supply contracts with customers to de-risk the huge capital costs required to bring production online and organise the transport infrastructure. This makes valuation a much more predictable proposition. It often leads to different producers selling at difference prices to possibly even the same customer. This means some producers may offer better value vs their market cap against others.
Also note where the pricing power lies. For example, iron-ore producers today prefer spot prices rather than yearly agreements with customers on pricing because the demand far exceeds the supply and output is concentrated in the hands of only a few producers (whose likelihood of cooperation rather than undercutting seems proportionate to their market share).
Caltex does not enjoy pricing power in the least – I believe that is Roger’s point. Consumers can freely switch between imported and domestic production. I guess if Singaporean refiner output should experience heavy, long-term disruption for whatever reason, then it becomes a different proposition?
Hope I’m not out on a limb here.
tim clare
:
Hi Roger,
Would this not be true of all commodity businesses? In the short-term you may be able to purchase them at a significant discount to valuation for a quick turn-around profit (if price rises to reflect value) but as a long-term proposition, they are too much at the mercy of commodity prices to make a fair assessment of future performance and therefore value.