Total Nigeria Plc, in line with the new SEC regulation, recently released its interim Q4’19 and FY’19 financial statements. According to the report released, revenue declined by 6% year-on-year to N290.88bn in FY’19 from N307.89bn in FY’18. The 6% revenue decline was majorly induced by a 21% revenue decline in the ‘General Trade’ business segment to N61.09bn in FY’19 from N76.99bn in FY’18. The General Trade business segment (24% of total revenue) consists of sales to corporate customers excluding customers in the aviation industry. We suggest that the revenue decline in the segment resulted from increased competition and lower demand by corporate during the period.
Similarly, revenue declined by 6% in the ‘Aviation’ business segment. During the period, revenue declined from N27.72bn in FY’18 to N26.18bn in FY’19. We also attribute the decline to lower demand of fuel products by the Company’s aviation customers due to the weak demand for services of the Company’s customers. The Aviation business segment generates an average of 9% of the Company’s total revenue.
On the other hand, revenue from ‘Network’ (sales to service stations), which contributes c.67% of the Company’s total revenue, remained flat at N203.62bn in FY’19 (FY’18: N203.27bn).
Consequently, resulting from the pressure that came from the ‘General Trade’ and ‘Aviation’ business segments, total revenue declined by 6% year-on-year to N290.88bn in FY’19 from N307.99bn in FY’18.
Cost Margin Declines as fewer Volumes are Sold
The cost of sales, in the same direction with revenue, declined by 6% year-on-year to N257.06bn in FY’19, from N273.20bn in FY’18. However, the cost margin improved by 100 basis points from 89% in FY’19 to 88% in FY’18. It is also interesting to note that the improved cost margin of 88% in FY’19 was largely driven by a lower cost margin in Q4’19 (87%) relative to the cost margin (of 95%) in Q4’18. Consequently, gross profit declined at a slower rate of 3% year-on-year (compared to a 6% revenue decline) to N33.83bn in FY’19 from N34.79bn in FY’18.
Surge in “Other Income” Suggests a Strategic Move
We note the challenges in the downstream sector of the oil and gas industry, typically characterized by low margins and inconsistent cash flows. The prospects and potentials of the downstream sector are capped with bottlenecks not limited to poor regulation, lack of free market, excessive price control, and poor government policies. As a result, we have begun to see a likely strategic shift and increased efforts on diversification by some players in the downstream sector of the oil and gas industry, in a bid to support weak margins and maintain profitability.
The ‘Other Income’ line consists of net income and gains on the disposal of assets. Network income (Bonjour shop, rent, vendor management fees, and other miscellaneous income) rose by 524% to N1.54bn in FY’19 from N247.93mn in FY’18; while the gain on disposal of assets rose by 130% to N2.76bn in FY’19 from N1.20bn in FY’18. The Company also earned a net foreign exchange gain of N291.11mn.
We note the 524% increase in net income earned by the company. The sharp increase, in our view, suggests that the Company might be on course to focus on other means of generating income to support margins amid the challenging environment of its core operational activities. Recently, a competitor of the Company – 11 Plc announced its acquisition of Lagos Continental Hotel, to diversify her interests given the current challenging environment in the downstream sector of the oil and gas industry. Therefore, we believe that the diversification effort might gradually become an industry trend.
Technical Management Fee Gulps all the Cash
The Company incurred an operating expense of N27.68bn in FY’19 – 10% higher than N25.10bn incurred in the previous year. Breaking down the operating expenses components, the major line items that drove operating expenses higher were rent expenses (+90% from N775.28mn to N1.48bn), and technical assistance and management fee of N2.08bn (an expense that was not incurred in the previous year). Technical assistance and management fee relates to fees paid to Total Raffinage Marketing (parent company) for general assistance recorded for Research and Development. The expenses are generally charged to the income statement when the Company obtains approval from the National Office for Technology Acquisition and Promotion (NOTAP) with respect to the transactions.
Nonetheless, operating profit rose by 6% year-on-year to N10.36bn in FY’19 from N9.81bn in FY’18.
Working Capital Deficiency Underpins Industry Challenges
But for delayed payments to creditors and suppliers in Q4’19, the Company could have reported a significantly lower operating cash flow. The Company, as of 9M’19 ended September 2019, had a negative operating cash flow of N7.38bn. Combining a cash outflow of N2.94bn on investing activities, and additional cash outflow of N17.07bn on financing activities, the Company drew down an overdraft facility of c. N23.83bn as working capital financing to support operations. This resulted in higher finance costs across Q1’19. Q2’19, Q3’19, and Q4’19. Finance cost rose by 179% in Q1’19 (from N686.47mn to N1.91bn), 102% in Q2’19 (from N1.01bn to N2.03bn), 65% in Q3’19 (from N1.44bn to N1.71bn). On an annual basis, finance cost increased by 76% year-on-year from N4.46bn in FY’18 to N7.86bn in FY’19.
On the other hand, finance income declined by 83% year-on-year from N6.75bn in FY’18 to N1.15bn in FY’19. The decline in finance income was largely resulting from a high-base effect. In FY’18, the Company earned N5.99bn from the Petroleum Support Fund (PSF). In FY’19, the Company only earned N739.14mn, thus resulting in the shrinkage of finance income in FY’19.
PBT Falls Despite a Strong Q4’19 Performance
Profit before tax declined by 70% year-on-year to N3.65bn from N12.09bn in FY’18. However, profit before tax in Q4’19 stood at N3.76bn (the highest since Q2’17). This implies that as at 9M’19, the Company reported a loss before tax of N117mn, resulting from high operating costs and high finance cost. Meanwhile, in Q4’19, the significant net income and proceeds from the disposal of assets boosted the bottom-line.
Profit after tax also declined by 70% year-on-year to N2.42bn in FY’19 from N7.96bn in FY’18. The performance of the Company in FY’19 was the worst in the last 10 financial years. Return on Equity (ROE) stood at 8% in FY’19 (FY’18: 27%; 5-year average: 33%; 10-year: 36%).
Our outlook for the downstream sector of the oil and gas sector industry remains negative. This is due to the bottlenecks to growth such as inconsistent government policies, high cost of doing business, infrastructural deficits, and high regulation, we believe that revenue will be relatively unchanged in FY’2020 at N291.47bn.
We project an operating profit of N9.29bn for FY’2020, which comes at a 10% decline to FY’19 levels. The projected decline in operating profit is based on expected lower ‘other income’ in FY’2020. We project an ‘other income’ of N1.49bn (FY’19 actual: N4.59bn). In our analysis above, we explained the spike in ‘network income’ and ‘gain on disposal of assets’. Although we suspect a possible shift in the strategy of the Company, we yet remain conservative in our assumptions until we get clarity and full disclosure on that line.
However, we believe that the Company will incur lower finance costs. Although we expect total borrowings to increase by 6% in FY’2020, we posit that the Company would take advantage of the current low-yield environment by refinancing costly debt. Hence, we forecast that finance costs will be 18% lower in FY’2020.
We adopted a blend of the Free Cash Flow Valuation Method and the Dividend Discounted Model Valuation Method to arrive at our fair value. Our risk-free rate estimate stood at 11.36%, reflecting the market yield of the 10-year government bond. Using an equity risk premium of 6% and an adjusted beta of 0.47, we arrived at a cost of equity of 14%. Thus, we discounted our projected future cash flows (free cash flows and dividends) by our estimated cost of equity to arrive at a fair value of N50.47.
Based on our fair value estimate, we have an earnings yield of 13%. We projected a dividend payout 72% in FY’2020 and expect N5 to be paid as a dividend in FY’2020. Thus, our estimated dividend yield stands at 10%. The justified PE of the stock, based on our valuation, stands at 7.08x. At our fair value estimate of N50.47, relative to the market price of N107.00, the upside potential is -53%. Hence, we recommend a SELL rating on the stock.
PS: Our estimates and forecasts are based on the released interim results. Although we do not expect material change between the released interim results and the yet-to-be-released audited result, our estimates could be revised upon the release of the audited financial statements for the year ended December 31, 2019.
WSTC Securities Limited (WSTC)