Is Petron Malaysia one of the better Bursa Malaysia stocks?

Value Investing Case Study 05-3: I first covered Petron Malaysia in Oct 2020. This is an update taking into account the financials for FYE 2020 and the Q2 2021 results.
 
Is Petron Malaysia one of the better Bursa Malaysia stocks

On 1st Oct 2020, Petron Malaysia Refining and Marketing Berhad (Petron M or the Group) was trading at RM 3.26 (1 Oct 2020). At that juncture, I estimated its NTA to be RM 5.93 (as of 30 June 2020). 

I had presented my rationale then for why Petron M was not a value trap.

The price has since increased to RM 4.44 per share as of 28 Sep 2021. At the same time, the NTA has also increased to RM 6.93 per share (as of 30 Jun 2021). Yes, the market price has increased by 36 % since then. Have you missed the boat?

In 2020, the Group incurred a loss due to the measures taken to control the Covid-19 pandemic. But there were also Covid-19 measures over the past 6 months.

Were there significant changes to the long-term business prospects of the Group since then? Or was the market behaving irrationally last year?

Join me as I argued why Petron M is still one of the better Bursa Malaysia stocks to invest in. If you are not familiar with the Group, please refer to the following articles as this post assumed some background knowledge.
At the current price, it is still not a value trap. It means that there is still an investment opportunity.

Should you go and buy it? Well, read my Disclaimer.

Contents

  • Investment thesis
  • Rationale
  • Valuation
  • Why is Petron M one of the better Bursa Malaysia stocks?
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Investment Thesis

As of 28 Sep 2021, Petron M was trading below its NTA. The NTA did not include the revaluation surplus from the Investment Properties that was estimated to be at least RM 1.05 per share. The Asset value is a good indicator of the intrinsic value.

Petron M valuation
Chart 1: Valuation

The EPV and the Earning Value with growth were estimated based on the historical performance. In other words, I had assumed that the future is similar to the past. Given Petron M's business plans, this is a conservative valuation approach. 

Petron M is a company with strong fundamentals. As such it is not a value trap.

The Malaysian stock market is still reflecting the pandemic effects. I expect this to be a catalyst for re-rating once the Covid-19 pandemic is brought under control. Secondly, crude oil prices are trending higher compared to the average prices in 2020. This could be another catalyst for re-rating.

Rationale

  • Petron M is financially sound with net Debt Equity of 0.33. 
  • While it incurred losses in 2020 due to the Covid-19 pandemic, it has managed to be profitable in the first half of 2021. This was despite the 2021 Covid-19 pandemic restrictions.
  • Its 2021 performance has been boosted by higher crude oil prices compared to 2020. As long as crude oil prices stay well below USD 100 per barrel, Petron M should have good gross profit margins.
  • The composition of the Board and Management Committee remained the same as last year. Management still has good operations and capital allocation track record. It also had a good record for creating shareholders' value.
  • There is less risk today to invest in Petron M compared to last year.
  • There are margins of safety based on the Asset Value, EPV, and Earning Value with growth.

The supporting details are presented in the following sections.

Financial strengths

As of the end of June 2021, the Group had a Total Capital Employed (TCE) of RM 2.6 billion. 71 % of this was funded by Shareholders’ Equity with the balance from Debt (including leases)

About 94 % of the TCE was used for the operations. Of the balance, RM 159 m was in cash, equal to about RM 0.59 per share. 

Because of this cash, the Group has a net Debt Equity ratio of 0.33. The Debt level has gone up compared to last year. However, this is still manageable as this is equal to 12 times the interest coverage ratio based on the past 9 years' average EBIT.  In the first few years when Petron Corp of the Philippines first took over the Group, the Debt-Equity ratio was about 3 times higher.

Petron M Capital structure and its deployment
Chart 2: Sources and Uses of Funds

In 2020, despite the losses, the Group generated positive cash flow from operations. From 2012 to 2020, the Group generated RM 2.5 billion cash flow from operations. This was more than sufficient to cover the total cash used for investments of RM 1.6 billion for the same period.

Current performance

As of the end of Jun 2021, the Group had revenue of RM 4.0 billion compared to RM 3.3 billion for the same period last year.  It achieved a YTD PAT of RM 145 million compared to a loss of RM 153 million for the YTD of last year.

Management had attributed the better performance to recovering oil prices. Sales volume for the first half of 2021 was lower at 13.1 million barrels compared to 14.1 million barrels for the same period last year. Effectively this meant that the average unit selling prices were 33 % higher compared to the average unit selling prices last year.

2021 will likely reverse the declining PAT trend as illustrated in the chart below. The chart illustrated that the PAT was relatively more volatile compared to the revenue. 

As can be seen, 2020 was not the only year that the Group suffered a loss under Petron's leadership. The Group also incurred losses in 2013 and 2015. However, the Group managed to achieve an average PAT of RM 136 million per year from 2012 to 2020. 

Link to crude oil prices

Oil prices have been cyclical and the current prices appear to have recovered from the 2020 lows. The current price of Brent crude oil as of 20 September 2021 was $73.59 per barrel and appeared to be going higher. 

According to Statista, Brent crude oil is forecast to have an average annual price of 68.61 U.S. dollars per barrel in 2021. This is expected to decline to 66.04 U.S. dollars per barrel in 2022. While these prices would be above the drop seen in 2020 as a result of the Covid-19 pandemic, they are also above the pre-pandemic levels.

Brent crude oil prices
Chart 3: Brend Crude Oil Prices.  Source: MacroTrends

As an oil & gas company, you may think that the performance of the Group would be linked to the global oil prices.  However, the link is not so clear partly because Petron M is a refinery where the margins are generally squeezed as crude oil prices increases. 

The other reason why the linkage between profits and crude oil price is not so clear is that petrol prices in Malaysia are regulated.

The chart below illustrated how Petron M experienced low gross profit margins when crude oil prices were in the USD 100 per barrel price range. Its gross profit margins improved when crude oil prices were in the USD 60 range.

etron M GP margin vs crude oil price
Chart 4: Petron Malaysia Gross Profit Margin vs Brent Crude Oil Price

Of course, the profits of the Group would be also be affected by the physical volume of sales. Excluding the pandemic year, the sales volume had been growing. 

The chart below shows that while Petron M sales in Ringgit had some link to oil prices, the sales volume in terms of barrels of oil did not show any linkage. 

Petron M sales index vs crude oil price index
Chart 5: Link between Petron Malaysia sales and Crude Oil Prices

In my 2020 article, I had concluded that while the RM revenue had not grown, the sales in the barrel of oil had grown by 24% from 2012 to 2019. The decline in the per-unit value of products had masked the 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 M product prices would have declined correspondingly. 
  • While there is no equal overall index for Petron M product price, I deduced that it must have declined by 24 % for the RM revenue to be “constant”.

Last year, I had concluded that we should have RM sales growth when the price of global oil rises. This is because I attributed the lack of growth in the RM sales to the decline in the global oil price.  It remains to be seen whether this conclusion is valid. 

What does this all mean for Petron M going forward?

For the first half of 2021, sales volume was lower compared to that of last year. This was because of the 2021 Covid-19 pandemic measures. As the measures get lifted, there ought to be an increase in sales volume.  

In the longer term, I would expect a continuation of the growth that was experienced from 2012 to 2019. This would be supported by the growth in the number of service stations.

Secondly, the RM sales would also improve with the recovery of crude oil prices. Historically, if the crude oil prices stayed around USD 60 per barrel, we ought to see good gross profit margins. The Group had incurred losses when the crude oil price was around USD 100 per barrel. 

Management

There was no change in the composition of the Board of Directors or Management Committee. The members featured in the 2020 Annual Report were the same as those in the 2019 Annual Report.

In 2020, I benchmarked Petron M's performance against that of Petronas Dagangan. The latest comparison showed that:
  • Revenue for Petron M in 2020 declined by 43 % compared to 38 % for Petronas Dagangan. But, Petron M would have higher revenue growth in 2021 based on the first-half revenue of 2021.
  • In 2020, Petron M's gross profit margins declined compared to that for 2019. Petronas Dagangan's gross profit margins actually improved.
  • Petron M had a negative ROE for 2020 whereas Petronas Dagangan managed to have a positive ROE in 2020. But Petron M ROE for the first half of 2021 seemed to recover better than that for Petronas Dagangan.

I would conclude that Petron M suffered more in 2020 compared to Petronas Dagangan. But it bounced back better in the first half of 2021.

Petron M performance c/w Petronas Dagangan
Chart 6: Petron Malaysia performance c/w Petronas Dagangan performance

When it came to capital allocation, the Group still followed through on its expansion efforts.  This was despite the unfavorable business environment. 
  • The number of service stations under the Petron brand was increased from 700 in 2019 to 720 in 2020. Note that these included those owned by its sister companies. There was no information on how many of the 20 were owned by Petron M itself.
  • The Diesel Hydrotreater and Marine Import Facility 2, were two of Petron M's biggest projects yet in the Port Dickson Refinery. These continued despite experiencing some delays during the Covid-19 Movement Control Order.

I would conclude that this was a good sign of the Group's plan to grow the business.

Shareholders’ value creation

I looked at the following metrics from 2012 to 2020 when assessing shareholders’ value creation.
  • Comparing returns with the cost of funds.
  • Comparing the gains by an investor who bought a share at the end of 2008 and held it till the end of 2020. The gain was compared with the cost of equity.
  • The Q Rating

Overall, the returns were better than the respective cost of funds. Furthermore, the Q Rating was better than the average of the panels.  I would conclude that shareholders’ value was created during the past 9 years.

Petron M shareholders' value creation
Chart 7: Petron Malaysia shareholders' value creation
Notes
(a) Based on average EBIT/TCE from 2012 to 2020 assuming 24 % tax rate compared with WACC

(b) This looked at how the SHF at the end of 2012 would have grown by the end of 2020 assuming that no Dividends were paid. I compared it with the cost of equity

(c) Computed assuming that an investor bought 1 share at the end of 2012 and held onto it till the end of 2020. His gain would be 10.8 % CAGR as shown below.

Petron Shareholders' gain


Petron M had an overall Q Rating of 0.50. This placed it just below the 67 % position among the panel companies. It was better than average. Its position was pulled down by the low financial score although it did well on the growth score.

Petron Q Rating
Chart 8: Petron Q Rating

Risks

In my 2020 analysis, I stated that the 2 main risks that you have to be aware of when investing in Petron M were:
  • Privatization risk.
  • Disruption to the service station model.

I had concluded that it was possible for San Miguel (the ultimate holding company of Petron M) to privatize Petron M. 

In its General Offer in 2012 following the purchase of Petron M from ExxonMobile, San Miguel has stated that it did not intend to main the listing status if there was a shortfall in the public spread.  Note that the offer price then was RM 3.59.

Since there was no privatization exercise last year when the stock was trading at RM 3.26 per share, the privatization risk has been reduced. Today it would cost about 36 % more to privatize it. I do not think it makes sense to privatize it at a higher price. 

As for the disruption to the service station model, there is no change in my view. I had stated in 2020 that the challenge is whether Petron M would be able to reinvent itself when the times come.  

I had taken a positive view that Petron M would be able to do this because of its reinvestment track record and its sales and its marketing mindset. Furthermore, Petronas as the dominant player in Malaysia will also have to address this issue.  This may buy Petron Malaysia time to re-invent itself. 

My view of Petron M was reinforced with its decision to continue with the refinery project and service stations expansion. This was despite the challenging 2020.

There is less risk today to invest in Petron M. 

Valuation

I determined the intrinsic value of the Group based on the following:
  • Asset value. This is broken down into the NTA and Book Value.
  • Earning value. This is broken down into Non-Operating Assets and Earnings Power Value (EPV) and Earning Value with growth

You can see from the charts that there are margins of safety from both the Asset Value and Earning value.

Petron M valuation
Chart 9: Petron Malaysia valuation


Petron M valuation metrics
Chart 10: Petron Malaysia valuation metrics

In deriving the Earning value, I assumed that the future will be similar to the past 12 years' performance. This was a conservative approach given the Group's expansion plans. If you believe that the future is better, then you would ascribe a higher value than that derived and vice versa.

The Earning Value with growth was based on the following:
  • I had used the fundamental growth equation of growth = return X reinvestment rate. This had a growth rate of about 5%.  From 2012 to 2019, the NTA of the Group had grown at a CAGR of about 9% while PAT had grown by 5 % CAGR. In other words, the assumed growth rate did not seem unrealistic.
  • I used the average of the discounted Free Cash Flow and Residual Income to derive the Earning Value of RM 6.56. Actually, the estimate from the Residual Income model was RM 7.11 per share providing a much higher margin of safety. 

As can be seen from the table and chart, the NTA, EPV, and Earning Value with growth are all above the market price. 

Furthermore, the NTA and Book Value did not reflect the market value of the assets. According to the Notes to the 2020 Accounts, the fair value of its investment properties was RM 937 million compared to its book value of RM 654 million. This meant that the NTA and Book Value was understated by about RM 1.05 per share. There is an even larger margin of safety for the Asset Value. 

Over the past 9 years, Petron M had declared an average dividend of RM 0.16 per share. At the current price of RM 4.44, this is equal to a dividend yield of 3.6 %.  This is about double the current bank fixed deposit rate. 


Case Notes

As you see, the estimated intrinsic value will depend on the valuation models as well as the assumptions you make about the future. Projecting the future performance is very challenging.

To get around it, my base approach is to determine the value based on the historical performance. This is probably the most "accurate" value as there was certainty about the inputs.

I then gauge whether the future is going to be better or worse than the past. A good company analysis would help you answer this question. Once you can determine the future prospects relative to the past, you can then use the "historical valuation" in a relative manner.
  • If the future looks better, then the intrinsic value based on the future outlook would be better than the historical valuation. 
  • If the future is worst, then the historical value would have overvalued the company.

The crux of the matter is whether you have the business experience to judge whether the future is going to be better. If you do not have a business background, you may find this a bit challenging. If you face such a situation, one way is to rely on third-party analysis and valuation.  

There are several financial advisers who provide such analyses. 

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 tap into their business analysis and valuation.




Why is Petron M one of the better Bursa Malaysia stocks?

The above analysis had shown that Petron M is fundamentally strong. Leaving aside the pandemic year, it had been able to grow its sales volume. As stated in my 2020 report, it had taken market share from its competitors. The Group continues to grow the number of service stations in 2020.

At the same time, Debt is at a manageable level. From 2012 to 2020, the Group generated RM 2.5 billion cash flow from operations. This was more than sufficient to cover the total cash required for investments of RM 1.6 billion incurred for the same period. This looked like a cash-generating business.

Management has a good track record as an operator and capital allocator. It had been able to create shareholders’ value over the past 9 years.

The is a sufficient margin of safety at the current price. At the same time, its historical dividend compared to the current market price would result in a dividend yield of 3.6 %. So, while waiting for the market to re-rate, the dividends will provide a return that is much better than keeping your money with a bank.

What are the catalysts for re-rating? I expect sales to recover once the economy opens. Secondly, the higher crude oil prices over the next few months or so would provide some short-term boosts to the bottom line. 

For these reasons, I consider Petron M one of the better stocks in Bursa Malaysia to invest in.



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Disclaimer & Disclosure
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 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.

This blog is reader-supported. When you buy through links in the post, the blog will earn a small commission. The payment comes from the retailer and not from you.





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