July 28, 2020/United Capital Report

Recently, Total Nigeria Plc (TOTAL) published its unaudited H1-2020 result. According to the report, Revenue sharply declined by 29.3% y/y to N106.7bn, as the measures taken to contain the spread of the COVID-19 pandemic in Q2-2020, bit deeply into the company’s numbers. Overall, the company recorded a Loss before and after tax of N523.9mn and N537.2mn respectively (vs. Profit before and after-tax of N202.1mn and N130.0mn respectively in H1-2019). Below, we highlight key details of the downstream operator’s performance, as well as our expectations for H2-2020.

Weak fuel demand hampers margins: For the period under review, the downstream player recorded an underwhelming performance of its top-line number, as Revenue dropped 29.3% y/y to N106.7bn in H1-2020. While we note that Revenue in Q1-2020 declined by 9.3% y/y, its performance in Q2-2020 was highly alarming, tumbling 50.3% y/y to N36.5bn. Undoubtedly, the weaker economic activities triggered by the COVID-19 pandemic, which sparked series of strict measures on movement of people in Q2-2020 accounted for the woeful performance. Clearly, economic lockdown, cancellation of international and local flights, shutdown of businesses and other public centres, as well as a ban on interstate travel, weighed heavily on the demand for petroleum products, which constitutes about 78.5% of TOTAL’s Revenue. Further buttressing our point of a harsh operating environment, across its major operating segments, its Network segment (sales to service stations), which makes 71.0% percent of revenue, declined by 28.2% y/y to N75.8bn. Also, its General trade segment (sales to corporate customers excluding aviation), which accounts for 24.0%, fell by 19.2% y/y to N25.6bn. Lastly, its Aviation segment (about 5.0% of Revenue) recorded the worst performance, declining by 60.7% to N5.3bn.

Apart from the COVID-19 induced-lower demand, we note another challenge that might have hampered TOTAL’s operations. In the company’s 2019 annual report, it noted that the NNPC, the sole importer of PMS, implemented a policy of immediate settlement for coastal and inland purchases. Given the company’s weak cash position (which we will highlight in other segments), we believe this new credit policy would have impacted the volumes purchased from the NNPC by TOTAL.

Elsewhere, Cost of Sales, which remained relatively large compared to revenue, declined at a higher rate of 29.7% y/y, to N94.3bn. As a result, Gross margin improved mildly to 11.6% in H1-2020 from 11.1% in H1-2019. However, a negative mix of a weaker Other Income (down 27.3% y/y) and total Operating Expenses which remained sticky upwards at N13.9bn (fuelled by higher admin expenses and a net foreign exchange loss), led TOTAL to record an Operating Loss of N716.8mn, vs an Operating profit of N3.9bn in H1-2019.

Notably, the bottom-line number received some support from a Net Finance Income position of N192.9mn, as the company recorded a N2.0bn inflow from the Petroleum Subsidy Fund, while interest on bank overdrafts declined by 72.7%, to N1.1bn. In all, TOTAL recorded a Loss before and after tax of N523.9mn and N537.2mn respectively (vs. Profit before and after-tax of N202.1mn and N130.0mn respectively in H1-2019).

Working capital Management – The devil is in the details: In terms of working capital management, a couple of highlights gave us a cause for concern. While we note that Revenue declined on the back of reasons highlighted earlier, TOTAL’s inventory was depleted by 45.0% y/y, to N18.5bn. Also, the company’s cash balances declined by 40.5% y/y to N4.9bn. Meanwhile, Trade and Other Receivables (short-term) increased by 24.4% y/y to N56.5bn, compared to the increase in Trade and Other Payables, which grew by 10.3% y/y, to N63.1bn. We believe the deterioration in both the company’s cash positions and working capital could be traced to the new credit policy implemented by the NNPC. Elsewhere, we note that the company generated net cash from operating activities worth N12.1bn. This was due to a significant drop in inventories, given the fact that the lower  fuel demand during the period, did not spur the company to purchase more inventory. However, we believe the significant drop in inventory may not be a constant trend going forward, as normal business activities resume and demand for fuel rebounds. Also, the N2.0bn recorded from the Petroleum Subsidy Fund, is a one-off item which may not recur next year considering recent stance of the regulatory agency. 

Finally, the company’s leverage position (using debt/equity) improved in H1-2020 to 121.7% from 140.8% in FY-2019. We note that the company repaid about N7.1bn on ‘other loans and borrowings’ and recorded a N1.7bn decreased in bank overdrafts. Earlier in the year, we highlighted that the overkill of expensive short-term borrowing was detrimental to TOTAL’s profitability. However, we note that the company was able to drop the average interest rate on bank overdrafts for H1-2020 to approximately 9.59% p.a., vs 14.75% p.a. in FY-2019.

What does the future hold for the downstream player? Looking ahead, we expect the demand for petroleum products to improve given the lifting of restrictions on interstate travels  and domestic flights. This should support TOTAL’S H2-2020 numbers as volumes sold across its three main segments: Network, General trade, and Aviation, improves. However, we believe the new credit policy will put a significant strain on its ability to buy and push out more volumes, given its constrained cash capacity.

Also, the activation of the monthly market-based price regime remains the biggest elephant in the room, as uncertainty remains as to whether a policy back flip will occur, when oil prices get to pre-pandemic levels and how it will affect TOTAL’s operations. However, with NNPC being the sole importer, the company remains bound to earning just a distributors’ margin and is unable to capitalise on the movement in price, unless it significantly invests in import capacity. Apart from the regulatory uncertainty in price determination, other challenges to importation remain the equal but controlled access to the foreign exchange and recent liquidity concerns in the forex market. On a more company-specific level, we opine that cutting down high operating costs and continued reduction in finance costs will improve profitability going forward. Also, given the better cash positions of its competitors, especially MOBIL, TOTAL may further lose market share, as the new credit policy favours other better-placed competitors. In summary, we expect the company’s margins to be pressured in the near term.

TOTAL rated a SELL at current price: Incorporating all our views into our DCF valuation methodology (Dividend Discount Methodology), we review our year-end target price for TOTAL downwards to N84.82 per share, with a downside of -13.0%, from its current price of N97.5 per share. Also, we issue a SELL rating on the ticker.

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