Is Petron Malaysia a value trap? (Part 1 of 2)

Case Study 05-1:  Fundamental analysis and valuation of Petron Malaysia. This post focuses on its current situation, how it got to where it is today, and its future prospects

Petron Malaysia Refining and Marketing Berhad (Petron Malaysia) is a downstream oil and gas company.

With its current price of RM 3.26 (1 Oct 2020) compared to its NTA of RM 5.93 (as of 30 June 2020), you may wonder why is the market giving you such a bargain.

No doubt the oil and gas industry is going through a challenging period due to the Covid-19 pandemic as well as the global excess supply. 

Is the share price at such a level because the company has poor prospects?  Are its assets going to be impaired?

If these answers are yes, then it is a value trap.  But if it is not, then it is a bargain

Join me in a 2-parts series as I present my rationale why Petron Malaysia is not a value trap.

I will show that it still has a good future and that its assets are not going to be impaired.  Its intrinsic value is still intact. 

Part 1 will be presented here while Part 2 will be published on 25 Oct 2020


Contents

  • What is so unique about Petron Malaysia?
  • Has it used its Funds in the Best Way?
  • Can you describe the Current Performance as Outstanding?
  • Is there a Rich and Unique History?
  • Is there a Great Future?
  • Pulling it all together


Petron Malaysia - value trap or bargain?


Valuation Date

1 Oct 2020

Company Name

Petron Malaysia Refining and Marketing Berhad

Stock Name in Bursa Malaysia

PETRONM

Company’s Bursa Co

3042

Bursa Malaysia Sector

Energy

Listing Date on Bursa Malaysia

1963

Financial Year End

Dec

Latest Quarterly Results

2nd Quarter 2020, 30 June 2020

Shareholders’ Equity

RM 1,601 million (30 June 2020)

Market Capitalization

RM 880 million (1 Oct 2020)

Corporate Website

https://www.petron.com.my/

Table 1: Company Info

What is so unique about Petron Malaysia?

Petron Malaysia is part of Petron Corporation (Petron Corp) of the Philippines. 

Petron Corp is the largest integrated oil refining and marketing company in the Philippines. 

In March 2012 Petron Corp acquired ExxonMobil’s downstream businesses in Malaysia.

Petron Corp’s subsidiaries in Malaysia today comprises:
  • Petron Fuel International Sdn. Bhd. that offers retail and commercial fuels and serves customers worldwide.
  • Petron Oil (M) Sdn. Bhd. The Company's business includes the wholesale distribution of petroleum and petroleum products.
  • Petron Malaysia that is listed on Bursa Malaysia

Petron Malaysia traces its rich heritage to 1893 when it was first established as the Standard Vacuum Oil Company. 
  • It opened its first service station in Malaysia in 1921
  • Construction of the Port Dickson refinery was started in 1961 and commenced operations in 1963.

Along the way, Petron Malaysia experienced many significant changes.  These included mergers and acquisitions, shaping it into part of ExxonMobil and finally into part of Petron Corp.

Today Petron Malaysia and its sisters’ facilities include:
  • The Petron Port Dickson Refinery (PDR) which has a rated capacity of 88,000 barrels per day. It produces a wide range of petroleum products eg gasoline, diesel, liquefied petroleum gas (LPG), and aviation fuel. 
  • Eleven strategically-located depots and terminals 
  • 700 service stations throughout Malaysia. 

About 90% of its revenue is generated from domestic sales with the balance exported.

In Malaysia, its main market segments are
  • Transportation - served by the service stations network
  • Households with its LPG
  • Commercial with its industrial fuel products


Case Notes

Before 2012, Petron Malaysia (then known as Esso Malaysian Berhad) was part of the ExxonMobil Group.

In 2012, the San Miguel Corporation of Philippines acquired all ExxonMobil Group’s interests in Esso Malaysia Berhad
  • San Miguel nominated its subsidiary Petron Corp to be the registered owner of the shares in Esso Malaysia Berhad. 
  • Esso Malaysia Berhad was renamed Petron Malaysia Refining and Marketing Berhad. 

Because of the changes, I have analyzed the historical performance of Petron Malaysia from 2012 onwards.

Some of Petron Malaysia’s products are marketed through its sister companies in Malaysia and while the Management Discussion and Analysis in the Annual Reports do not always make the distinction between what is sold by the listed entity and those by the sister companies, the financial statements of Petron Malaysia reflect the financials of the listed entity.

Where appropriate, in the descriptive part of my case study, I have pointed out those contributed by the sister companies. 


Has it used its Funds in the Best Way?

Petron Malaysia’s SHF accounted for about 81% the total capital employed (TCE) of RM 2.1 billion as of the end of June 2020. 

About 88% of the TCE is deployed for its operations with the majority of the balance held as cash. 


Items

Ref

RM million

Shareholders’ Equity

SHF

1,601

Minority Interests

MI

0

Total Debt/Lease  

Debt

544

TCE

 

2,145


Items

Ref

RM million

Net Operating Assets

Net OA

1,883

Net Financial Assets

Net FA

262

Non-Operating Assets

Non OA

0

Total

 

2,145

Table 2: Sources and Uses of Funds (2nd Quarter, 30 June 2020)



Petron Malaysia Sources and Uses of Funds
Chart 1: Petron Malaysia Sources and Uses of Funds

Can you describe the Current Performance as Outstanding?

Petron Malaysia reported a YTD Loss after tax of RM 153 million for Q2 2020, compared to a PAT of RM 114 million for the same period last year. 

The current year performance has been impacted by 
  • The drop in demand due to the Movement Control Order (MCO) that was put in place to control the transmission of Covid-19
  • The plunge in global oil price and the sluggish domestic demand due to the MCO leading to an inventory holding loss of RM 68 million.

Petron Malaysia Performance Index
Chart 2: Petron Malaysia Performance Index

In spite of the current oil glut and Covid-19 issues, the performance of Petron Malaysia over the past 8 years can be described as “standstill”:
  • The revenue in 2019 is about the same as that in 2012 and over the past 8 years, the revenue was below that 2012 level most of the time
  • During the past 8 years, the annual profits were above the 2012 level for 5 years.  Petron Malaysia sustained losses in 2013 and 2014.
  • There was no discernible gross profitability trend.  This is actually a good sign as the gross profit as a % of the total assets has remained steady.  This is in spite of the variation in profits and the decline in the price of crude oil since 2012. 
  • From 2012 to 2014 the average ROE was (2) %, but for the past 3 years, it averaged 17 %.  

Petron Malaysia Past 3 years Performance
Chart 3: Petron Malaysia Past 3 years Performance

While there was negligible topline growth over the past 8 years, returns improved due to better operating margins.

Is there a Rich and Unique History?

Petron Malaysia core business activities involve
  • The refining of petroleum products in its PDR
  • The marketing of these products through Petron’s fuel retail network and commercial businesses. 

In 2012, the company transitioned from being part of the ExxonMobil to being part of Petron Corp.   With this, Petron Malaysia shifted its focus from refinery to marketing of petroleum products.

A good example of this shift is the message to shareholders in the Annual Reports
  • Before 2012, refinery operations were reported first.  This was followed by the reports on the retailing and commercial businesses.
  • From 2012, the marketing and sales of petroleum products were reported first.  At the same time, there were more discussions on these compared to the refinery operations.

Today Petron Malaysia is in the retailing and wholesaling of petroleum products rather than in the refinery business. 

This is an important change in the business direction.  The refinery now becomes a “manufacturing facility” for its retailing and wholesaling business.

This is illustrated by the chart below that showed the changes after 2012
  • Domestic sales became a larger part of the total revenue
  • Sales to related party became a smaller part of the total revenue

Another clue to this change in business direction is that less than 1% of the current revenue is for processing third party crude. 

Petron Malaysia Revenue Source
Chart 4: Petron Malaysia Revenue Source

Over the past 8 years, revenue has not shown any growth. 

While the Annual Reports do not provide any breakdown of the revenue or profits, its 2015 Annual Report had the following:

“Improved volumes were driven by growth in key sectors such as retail gasoline and commercial trade.”

How do you reconcile this with the stagnant revenue?

There are other irreconcilable activities:
  • The number of Petron service stations has grown from about 550 (former Esso and Mobil stations) in 2012 to 700 in 2019. Not all these are fully owned by Petron Malaysia. Some were owned by Petron Fuel International and some by Petron Oil (M).  
  • The main point is that today there are about 25 % more service stations retailing the Petron brand of gasoline compared to 2012. Yet this is not reflected in Petron Malaysia's revenue.
  • In 2013, Petron Malaysia acquired the LPG business from its sister company Petrol Fuel International Sdn Bhd.   The goal was to consolidate and grow the business in Peninsular Malaysia.  By 2014 it had 1.6 million Gasul branded cylinders in the market. Today Petron Malaysia supplies LPG to households and restaurants. It was the first to introduce the selling of gas cylinders in service stations. 
  • The Treats stores at major Petron service stations were introduced in 2012 and there were 200 stores by the end of 2013.   By 2018, there were 470 Treats convenience stores and P Kedai marts. Of these, 240 were owned by Petron Malaysia. 
  • The number of loyalty cardholders (formerly ExxonMoble Smile cardholders) increased from 1.3 million in 2013 to 2 million by 2014.  By 2018, there were 3 million members.
  • The Petron Fleet card was introduced in 2013 and served 4000 corporate customers in 2014.  In 2016, 3000 new cards were added to the base.

Petron Malaysia Revenue Profile
Chart 5: Petron Malaysia Revenue Profile

One way to account for this anomaly is to compare the growth in RM sales and barrels of oils. 

You can see from the chart below that while the RM revenue has not grown, sales in the number of barrels of oil have grown by 24%. The decline in the per-unit value of products has masked physical growth.
  • In 2012, Brent crude was trading at about USD 104 per barrel whereas in 2019 it was trading at USD 62, a decline of 40%.  
  • Petron Malaysia's product prices would have declined correspondingly. 
  • While there is no equivalent overall index for Petron Malaysia product price, I deduced that it must have declined by 24 % for the RM revenue to be “constant”.
Petron Malaysia Revenue Index
Chart 6: Petron Malaysia RM Sales vs No of barrels of oil Sales

If you attribute the lack of growth in the RM sales to the decline in the global oil price, then when the global oil price rises, we should have the RM sales growth.


Is there a Great Future?

Petron Malaysia's vision is to be the leading provider of total customer solutions in the oil sector and its allied businesses.  It does not see itself in the refinery business but rather as a consumer and commercial sales and marketing company.

This business direction meant that its growth can be independent of its refinery capacity as the supply could be out-sourced. 

Its future is tied to the demand for its products in Malaysia.  This growth would have to come from either
  • Secular growth in demand
  • Taking market share from its competitors

Over the past 8 years, Petron Malaysia has grown its sales of physical products by about 24% equal to a 3.1 % compounded annual growth rate.

At this pace of growth, it is likely that this has to be at the expense of taking some market share from its competitors because 

1. The consumption of oil in Malaysia grew from about 759,000 barrels per day in 2012 to 838,000 barrels per day in 2019, equivalent to a compounded annual growth of 1.4%. Petron Malaysia's market share increased from 10.5 % in 2012 to 11.8 % in 2019. 

2. About half of the oil in Malaysia is consumed as gasoline/petrol. The consumption of gasoline/petrol grew by about 2.4 % per annum during this period.  Compare this with Petron Malaysia's overall growth rate of 3.1 %.  

Although Petron Malaysia does not provide market or product segment information, I can draw the following conclusions
  • The shift from the refinery to sales and marketing is correct given that there will be excess refining capacity in the country in the coming years
  • We are unlikely to see double digits revenue growth given that the growth in the underlying demand is in low single digits.  Furthermore, part of the growth would be at the expense of its competitors
  • Future revenue and profit growth will be dependent on an increase in crude oil prices. 
  • Petron Malaysia has spent considerable efforts to improve its distribution and logistics facilities and this will have long term benefits.  

Petron Malaysia's future is likely to be slow and steady growth and not some quantum leap.

Details of the estimates to derive these conclusions are presented below.

Oil consumption

Malaysia Oil Consumption
Chart 7: Malaysia Oil Consumption
Source: Statista

According to the Malaysian Energy Commission, the oil is consumed as follows: 
  • About half is petrol
  • Diesel accounted for 1/3 
  • LPG accounted for about 7%

Breakdown of Petroleum Products
Chart 8: Malaysian Petroleum Products Consumption
Source: Malaysia Energy Commission Jun 2019


Gasoline 

Global Economy.com estimated that in 2017 Malaysia consumed 300,000 barrels of gasoline per day. 

This has grown from about 191,000 barrels in 2012. However, as the chart below has shown, after a “leap” in 2013, the growth from 2015 to 2017 was only about 2.4 %.  

There is nothing to suggest that the consumption from 2017 to 2019 would be significantly different. 

Again, the data suggests that Petron Malaysia grew at the expense of its competitors.

Malaysia Gasoline consumption
Chart 9: Malaysia Gasoline Consumption
Source: The Global Economy.com

Automatic Pricing Mechanism (APM)

In Malaysia, petrol and diesel are “controlled goods” where their prices are regulated by the government. 

In place since the 80s, the APM is the Malaysian government’s formula to regulate the petrol and diesel prices.

The initial APM formula had a sales tax or fuel subsidy component that was sort of set at the discretion of the government.

APM Formula = MOPS + Operation Costs + Profit Margin Oil Companies + Profit Margin Petrol Dealers + Alpha + Sales tax or fuel subsidy
  • MOPS = Mean of Singapore’s Platt oil prices.  The formula meant that the refinery costs are already included and indexed in the MOPS.
  • The operations cost, profit margin, and Alpha are intended to cover the sales, marketing, and distribution portion. 

In 2010, the subsidy for the premium grade of petrol was removed. 

In 2014, a managed float system was introduced following the removal of the sales tax/fuel subsidy in the light of the reduction in crude oil prices. Initially, this was reviewed monthly but was later changed to weekly. 

With the removal of the sales tax/fuel subsidy, the government “lost” one way to regulate the retail prices via the APM.  However other measures were adopted
  • In the weeks leading up to the 2018 Malaysian election, the retail prices were frozen. 
  • In 2019, the new government decided to bring back the APM while at the same time revising upwards the dealers’ margins.  According to the then Finance Ministry, there will also be a cap. 
  • In Feb 2020, the cap on the retail fuel prices for RON95 and diesel was revised downwards based on the APM.
 
The APM appears to provide “base profits” for the oil and gas companies.  If they could reduce their actual sales, marketing, and distribution costs to be below those in the formula there is a possibility of generating better profits.  

Note that the refinery costs have been covered in the MOPS.  If the actual refinery cost could be lower than that “imputed” in MOPS, there could be extra margins. 

For Petron Malaysia, it is likely that Malaysia will continue to have a regulated petrol and diesel price environment.  There are benefits to be more cost-effective than its competitors. 

Pulling it all together

A stock is a value trap when 
  • It appears to be cheap looking mainly from the historical multiple perspectives
  • But is actually cheap because of insurmountable underlying problems.

These underlying problems will eventually cause the intrinsic value to deteriorate.

If there are no such underlying problems, then the intrinsic value would be intact and the stock is actually a bargain.

While we have yet to value Petron Malaysia, are there any signs that it faces insurmountable underlying problems?
  • Its business in terms of sales of barrels of oil has been growing. 
  • It has been able to maintain its margins and controlled its SGA expenses while growing

I would conclude that its physical assets and customer relationships are intact.  They are not going to be impaired.

Petron Malaysia is not a value trap.  

Now whether this is a huge bargain would depend on the analysis in Part 2. 


End of Part of 1of 2

Part 2 will be published on Sun 25 Oct 2020


Notes
1) Gross profitability = gross profit margin / total assets

Reading guide
If you are a first-time visitor to this blog, you may not be familiar with some of the concepts that I have used in my analysis and valuation.  I suggest that you check up the Foundations series - Fundamentals 01,  Fundamentals 02, and Fundamentals 03.   I also have a Definitions page in case you are not familiar with the terms I have used. 




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Disclaimer
I am not an investment adviser, security analyst, or stockbroker.  The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies.   Investments or strategies mentioned in this website may not be suitable to you and you should have your own independent decision regarding them. 

The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such. 

I may have equity interests in some of the companies featured.




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