Is Petron Malaysia a value trap? (Part 2 of 2)
Petroleum products are commodities.
To win in this environment, Petron Malaysia has spent considerable efforts to
- Improve its refining operations,
- Expand its distribution and logistics infrastructure,
- Expand its service station network,
- Establish its Petron brand.
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 the market is not recognizing these efforts.
Has the market overswung on its way down or are there management issues and other risks that the market has inferred into the price?
In Part 1, I have shown that despite the Malaysian economic environment and the excess capacity in the global oil market, Petron Malaysia has managed to grow its physical sales volume.
In Part 2, I will argue that Petron Malaysia has the financial resources and track record for long-term profitability. It is not a value trap. Rather it is a bargain.
There is now an update that was published on 10 Oct 2021.
Now as to whether you should go and buy - see my Disclaimer.
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Contents
- How well did Top Management Seize Opportunities?
- Is there a great Buying Opportunity?
- Will Shareholders’ Value continue to be created?
- How to minimize risk and secure your Investments
- How to Gain from the Case Study
How well did Top Management Seize Opportunities?
- There are 3 executive directors who have been seconded from Petron Corp
- There are 5 independent directors. 4 of these were appointed after the entry of Petron Corp
- One is a non-independent non-executive director who is currently the CFO, Treasurer, and CIO of San Miguel Corporation
The 3 executive directors have been with Petron Malaysia since the acquisition by Petron Corp.
I would classify Petron Malaysia as an owner-managed group as:
- San Miguel/Petron Corp owns about 73% of Petron Malaysia
- The 3 executive directors are from Petron Corp
The CEO and an additional 7 executives were featured as members of the Management Committee in the 2019 Annual Report.
- The CEO and the CFO are from Petron Corp
- The 6 other members are Malaysians who have been with the company before the entry of Petron.
The executive directors and management committee have Malaysian refining and marketing experience.
What have they achieved?
- Petron Malaysia has managed to reduce its SGA expenses from 3.3% of revenue in 2012 to 2.4 % in 2019 while expanding its sales and distribution network.
- While the crude oil price has remained depressed, it has managed to improve its gross margins. This could be because of lower unit costs due to either the increased volume or the investments in the distribution and logistics infrastructure.
- In terms of branding, it won the Putra Brand Silver Awards five times over the past 8 years
Currently, there are two Bursa listed company involved in the marketing, sales, and distribution of petroleum products
- Petronas Dagangan Berhad which operates in same the market segments as Petron Malaysia.
- Boustead Holdings Berhad which operates the BHP petroleum retail network. However, Boustead is reported to be seeking buyers for its BHP petroleum retail business.
Boustead Holdings do not provide a separate report for its BHP operations. Rather it is reported as part of the trading segment operations which included building materials.
As such, I only benchmarked Petron Malaysia’s performance against that of Petronas Dagangan.
- In 2013, Petron Malaysia’s revenue was 34.3 % of that of Petronas Dagangan, the industry leader in Malaysia. By 2019, Petron Malaysia has grown its revenue to be 38.0 % of Petronas Dagangan
- I estimated that from 2012 to 2019, Petron Malaysia sales volume increased by about 24%. In comparison, Petronas Dagangan's sales volume increased by about 4% during the same period.
- However, Petron Malaysia’s gross profit margins and ROE are lower than those of Petronas Dagangan
Chart 1: Petron Malaysia vs Petronas Dagangan Performance |
- In 2013, there were 532 Petron service stations in the country. This grew to 700 by 2019. In contrast, the number of service stations under the Petronas brand remained about the same of over 1,000 during this period.
- RM 378 million was paid out as dividends
- RM 1,428 million was invested into Property, Plant, Equipment, and Long-Term Asset
- At the same time, its loan was reduced from RM 900 million in 2012 to RM 130 million in 2019.
- In 2012, it acquired a controlling stake in Petron Malaysia from ExxonMobil for RM 598 million
- From 2012 to 2019, RM 1,428 million was reinvested into the operations. Considering its 73% stake in Petron Malaysia, its share of the reinvestment is more than what it paid to acquire its controlling stake
- I think it demonstrates the “owner-operator” commitment to the business.
Is there a great Buying Opportunity?
- The Earnings value is greater than the Asset value. This is not surprising as the return on capital employed is greater than its cost of capital.
- Over the past 5 years, there have been instances when Petron Malaysia’s share price has been higher than both the Asset value and Earning value.
Chart 3: Petron Malaysia Valuation |
Chart 4: Petron Malaysia comparative values |
- If you believe that the future is better, then Petron Malaysia’s Earnings Power value will be higher than RM 6.87 per share
- However, if you think that it will be worst, then the RM 6.87 per share is over-estimated
Will Shareholders’ Value continue to be created?
- Over the period from 2012 to 2019, if you assume that no dividend has been distributed, the shareholders’ funds would have increased by a compounded annual growth rate of 12%
- I estimate that Petron Malaysia’s weighted average cost of capital (WACC) to be 9%.
- With the growth in shareholders’ funds higher than the WACC, the shareholder value would grow as the business expands.
Chart 5: Petron Malaysia Q Rating |
How to minimize risk and secure your Investments
- Privatization risk
- Disruption in the fuel retail industry
Privatization
- The offered prices are definitely above the market prices,
- But they would be below the intrinsic values.
- In its General Offer in 2012 following the purchase of Petron Malaysia from ExxonMobile, San Miguel has stated that it does not intend to main the listing status if there is a shortfall in the public spread. Note that the offer price then was RM 3.59.
- It would cost San Miguel/Petron Corp about RM 238 million to acquire the remaining 27% of the shares it does not own at RM 3.26 per share.
- This is a small sum for the parent company. Recall the amount that has been reinvested into the business. Also, over the last 8 years, the parent company has received about RM 276 million for its share of dividends declared.
Disruption of the fuel retail industry
- A significant portion of the fuel retail network in some markets could be unprofitable by 2035
- In a market environment in which electric vehicles (EVs), autonomous vehicles, and new mobility models take off rapidly, up to 80% of the fuel-retail network as currently constituted may be unprofitable in about 15 years.
- Increased demand for grab-and-go eating
- A shift in the mobility energy mix
- Demand for eco-friendly outlets
- Hyper-connected customers
- Quest for easier living
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Chart 6: Malaysia vehicular traffic Source: CEICDATA.com |
- The first is the “traditional” industry being in a secular decline. This is what is happening to the media and taxi sectors in Malaysia
- The second is for the existing players to re-invent themselves. A good example of this is the Malaysian food retailers that has adopted online ordering with delivery via Grab
- Move from a vehicle-centric business model to a customer-centric one to capture new product and service opportunities
- Transform the service stations network eg changing formats in some locations and divesting locations that will not be profitable
- Develop new capabilities including digital expertise and, in some cases, capabilities related to entirely new areas such as last-mile logistics or real estate.
- It will have to reinvest. Given its reinvestment track record, this should not be an issue
- It sees itself as a sales and marketing company. This mindset may give it a first-mover advantage to re-invent the fuel retail network
- Petronas is the dominant player in Malaysia and like the taxi industry, there will be political-economic forces to delay the effects of the disruption. This may buy Petron Malaysia time to re-invent itself
- You will have to consider the risk of privatization in determining your entry price
- Any disruption will be seen/felt in the developed countries first and this may provide some window to plan your exit
Case Notes There are 3 basic skills that you need to develop to be a successful long-term value investor
Many investment courses only cover the last item superficially. Warren Buffett has said that risks come from not knowing what you are doing. That is why I believe that case studies are an important part of the learning process as they illustrate the analytical and valuation issues encountered in real life. At the same time, I also looked at the investment and business risk as part of the fundamental analysis. However, you should learn about risk separately and I have provided various risk-related topics in other posts. You must read them, I am of course assuming that you are interested to learn how to analyze and value companies. What would you do if you are not interested in doing your own analysis and valuation but still want to be a value investor? One way is to rely on other experts to assess and value companies for you. Those who do this well include people like Seeking Alpha.* Click the link for some free stock advice. If you subscribe to their services, you can then just read their analysis and assessment. |
How to Gain from the Case Study
- Commodity in a mature market
- Cyclical
- Regulated market (for petroleum and diesel prices)
What is our investment thesis?
- Petron Malaysia is financially strong with a 0.34 debt-equity ratio (as of 30 June 2020) and RM 262 million cash. It would be able to weather a longer downturn if this happens.
- It has a strong track record of growing shareholders value during the past 8 years which covered a period of declining and low oil prices
- It has paid an average of RM 0.175 dividend per share over the past 8 years. At the current price of RM 3.26 per share, it is equivalent to about a 5.4 % annual dividend yield. A reasonable recurring income while waiting for the capital gain.
- Privatization
- Disruption to the fuel retail sector
Is Petron Malaysia a value trap?
- The assets are intact and are not going to be impaired due to under-utilization
- Its business is expanding
- It has been able to generate returns that are more than its cost of capital
Reading guideIf 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 & DisclosureI 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 on this website may not be suitable for 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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