Caltex under scrutiny

Viva Energy, which operates Shell-branded petrol stations along with refineries and infrastructure around the country, is seeking an IPO later this year and is currently being scrutinised by institutional investors.

We've been scrutinising its most direct peer, Caltex. Like Viva, Caltex operates petrol stations, a refinery and vital infrastructure around the continent. And like Viva, Caltex is fighting relentlessly lower fuel volumes.

We've been buyers of Caltex in the past and have considered buying again. On a valuation basis, it doesn't look dear, boasting a price-earnings ratio of just 12 and an enterprise value to earnings before interest and tax multiple of about 8. Yet lower volumes through a fixed cost asset base could be disastrous if left unchecked.

Fortunately, Caltex has managed to offset volume falls with higher margins and is now investing into a promising retail offering. Is that enough to offset the volume problem? We can't say.

We made our first foray into Caltex because the value of its retail business was being obscured by its refining business. We now wonder whether risk in the fuel business is being adequately counted.

The investment case for Caltex is no longer about recognising the value of a previously obscured segment; it now depends on changing the business into a fully-fledged retailer.

To be clear, we like the strategy and the execution has, to date, been sensible and cautious. Yet the range of possible outcomes is wide and the variables we must consider have expanded dramatically.

Caltex, for example, is considering splitting its retail and infrastructure operations; it is rolling out a brand-new store format into an internalised retail operation and it is grappling with the loss of its largest supply customer, Woolworths. That's a lot of balls in the air.

Our response is to lower our Buy price to $25 and our Sell price to $40. Perhaps margin increases will continue to offset volume falls and perhaps the retail rollout will work a treat. ‘Perhaps' – that word is the problem. With higher risk must come greater caution. HOLD.

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