The return of Caltex

There is nothing more satisfying than dabbling – and succeeding – in the forbidden arts. We would never recommend timing your buys and sells to capture peaks and troughs because it is impossible to do so. We don't believe pretty charts tell us anything about the future and we believe the mere pursuit of precision gives the false impression that it can be attained. Even trying to time the market while knowing it can't be done is dangerous.

We know all of this. Yet it still feels great to get timing right. Caltex is a fine example.

There was nothing accidental about our original buy call. In Caltex: A fuel's errand (Buy - $18.68), we argued that Caltex was morphing into a better quality business and the closure of its refining business would highlight this. Obscured earnings would be illuminated and Caltex would be a stable, profitable fuel retailer. That case worked our beautifully and we sold in Caltex: Time to sell (Sell - $37.83).

Selling is a more mysterious art than buying and we admit to some luck with the timing of our sell call. Since then, the share price has fallen around 18%. What should investors do now?

There was a strong case for selling at $37 but, at the current share price, that case is weaker. If we maintain our EBIT target of $890m, the current share price implies an EBIT multiple of just under 10 times and a likely PER of 15 times. That's far more attractive than the 12 times EBIT implied by our previous sell price.

Around $26 would deliver an ideal entry, implying an EBIT multiple of 8 times. That might sound low for a business we've dubbed as decent, but there are reasons for the caution.

Unrepeatable

Most of Caltex's earnings growth has come from the expansion of retail petrol margins which have doubled over a decade, driven by less competition and a structural shift to higher profit premium fuels. Those conditions won't be replicated.

Margins won't double again and industry consolidation is just about complete. There are few options for expansion and we expect growth from the business to be fairly modest, perhaps 2-3% a year. Little growth means there is little margin for error. This is now a decent business but we could still lose by paying too much for it.  

There are structural threats to fuel retailing. Fuel volumes are falling, retail margins are high and the impact of electric cars won't be a good thing for the business. Then there is the risk of management using its newfound cash to buy growth, which has already been suggested by the chief executive.

We're comfortable moving Caltex to a Hold at current prices but demand slightly cheaper prices before dipping in again. This is now more like a utility than a turnaround and should be priced as such. HOLD.