Major downstream player ARDOVA (“the company or the firm” from henceforth) released its unaudited financial result for H1-2021. It was evident to note, that the rebound in economic activities and improved margin efficiency drove double-digit y/y bottomline growth for the major petroleum product marketer. Revenue declined marginally by 0.6% y/y to N86.7bn in H1-2021, Cost margin improved to 91.5%, in H1-2021 from 94.9% in H1-2020, due to increased Lubricants sales and improved economies of scale. Furthermore, improved margin efficiency boosted Gross profit and Operating profit by 37.8% and 188.3% y/y to print at N7.4bn and N2.6bn, respectively. Overall, the company recorded a Profit before and after tax of N2.6bn and N1.7bn respectively (vs Profit before and after-tax of N1.1bn and N1.0bn respectively in H1-2020). Earnings per share (EPS) increased to N1.36 in H1-2021, from N0.78 in H1-2020. Below, we highlight key details of the downstream operator’s performance and our expectations for H2-2021 and beyond.

Improved margin efficiency propels bottomline : In H1-2021, ARDOVA’s total Revenue dropped marginally by 0.6% y/y to N86.7bn, due to supply shortages from Pipelines Product Marketing Company (PPMC) at the start of H1-2021, as volume sold dropped by 28.0% y/y in the period under review.  However, a price hike on PMS, as well as increased market share in its lubricants business cushioned the reduced supply of PMS products. 

Across product segments, Fuel revenue fell marginally by 6.0% y/y to N74.7bn in H1-2021. As highlighted earlier, the drop in Fuel sales, was a result of shortage in supply of PMS from PPMC, as disclosed by the firm’s management. In the Lubricants business, sales were up 43.8% y/y to N11.2bn, as the company’s market share grew, following a 14.0% y/y growth in volumes in H1-2021. ARDOVA’s drive to increase its market share in the lubricant market by signing an agreement with Shell lubricant appears to be yielding support.  Profit margin in the PMS segment remained low, as the firm does not hold any wholesaler privileges. Overall, the company’s lubricant segment remained its most profitable segment with Gross margins at 26.7% vs 6.7% in its Fuel segment. ARDOVA’s Renewable segment underwhelmed, as Revenue declined by 22.7% y/y to N5.7m. Liquefied Petroleum Gas (LPG) sales grew by 258.2% y/y to N11.3m in the period under review, solidifying expectations of increased LPG demand over the next decade. 

Cost efficiency supports margin expansion: Despite the decline in revenue, profitability and margins grew in H1-2021, driven by improved margin efficiency. Cost of Sales (COS) moderated by 3.1% y/y to N79.1bn in H1-2021, as the company maximised margins, due to earlier supply constraints experienced in the period under review.    Thus, due to the improved revenue mix and cost efficiency, margins expanded as Gross margin improved to 8.5% in H1-2021, from 6.1% in H1-2020. In addition, Gross profit grew 73.8% y/y to N7.3bn in H1-2021, from N5.3bn in H1-2020.

Controlled operating expenses drive positive operating performance: Operating profit up 188.1% to N2.6bn in H1-2021, vs a 10.3% y/y increase in operating expenses to N4.7bn in H1-2021. Accordingly, PBT and PAT were up 127.3% and 76.0% to N2.6bn and N1.7bn in the period under review. 

Balance sheet analysis: Increased receivables working capital position: In the period under review, ARDOVA’s total asset base grew by 10.5%, largely due to a 21.4% increase in trade receivables. We note the increase in trade receivables was not linked to deterioration in cash conversion or change in credit policy. To put in context, ARDOVA’s Inventory turnover and its credit policy, bar TOTAL, remained on par with its Major Oil Marketers Association Nigeria (MOMAN)   peers as ARDOVA’s days of sales outstanding and its receivables turnover was at 146 days and 2.5x vs MOMAN average of 142 days and 2.6x in H1-2021. However, in its most recent analyst call, the firm’s Management disclosed that increase in receivables was linked to an advance to suppliers as ARDOVA’s continued its CAPEX expansion drive, with its construction of its 20.0KMT LPG terminal in Ijora. That said, the increase in receivables ensured that the company’s net cash flow position worsened and was retained in the negative territory as the firm’s  

Outlook for ARDOVA is moderate despite uncertainty in the downstream oil and gas sector

Our outlook for ARDOVA remains moderate and influenced by the broad-based positive growth in the downstream oil and gas sector, following the rebound in economic activities and the low base for 2020. However currently ARDOVA high base in 2021,  we expect the firm’s cost improvement and efficiency management drive observed in recent quarters to continue to drive profitability in H2-2021.  

However, despite the FG’s recent reform initiatives, including the president’s assent to the Petroleum Industry Bill (PIA), which gives a clearer path toward deregulation in the downstream oil and gas industry, we note that there is still a lot of uncertainty around the adjustment of petrol prices.  It remains to be seen how quickly the government will begin to implement price recovery following anticipated backlash from organised labour.  

Notably, the NNPC disclosed that it currently incurs a cost of roughly N150.0/ litre to maintain the pump price of petrol at N162.0/litre. Although we applaud the recent passage of the PIB, persistent FX challenges and the continuation of the NNPC Direct Sale, Direct Purchase program (DSDP) indicate that the NNPC, through the PPMC, may remain the sole importer of PMS. Although the Central Bank of Nigeria (CBN) in recent weeks has made efforts to improve dollar availability, we remain sceptical about the capacity of the CBN to handle the FX needs of petroleum product importers. Until then, ARDOVA and other downstream players will continue to earn a retailer’s margin for PMS sales, dampening our outlook for the downstream sector. 

On PIA:  Industry players cautiously optimistic on full cost recovery as the PIA is signed

Despite the recent signing of the PIA into law, ARDOVA’s management expressed cautious optimism about the pricing of petrol, despite a provision in the act that allows for the price of petroleum to be fully recoverable.  The act highlights that any pricing tariff framework with regards to petroleum pricing shall be cost-reflective, in the foreign currency or naira equivalent in which the respective initial cost was incurred as applicable under the regulations. This essentially paves the way for a cost-reflective pricing regime for petroleum marketers. However, the government reserves the prerogative to intervene when it considers prices exploitative. 

Planned Enyo acquisition still in progress

Going forward, we expect ARDOVA’s planned acquisition of Enyo to still be in progress subject to Federal Competition and Consumer Protection Commission (FCCPC) approval. ARDOVA reiterated its plan to acquire Enyo retail with management restating the deal would be an acquisition and not a merger meaning ARDOVA, and Enyo will run separately under two different brands.

The deal would be financed through a Special Purpose Vehicle (SPV) that would be capitalized using equity and debt. ARDOVA’s Management at its most recent earnings call disclosed that the firm was currently in talks with its financial advisers to raise a N60.0bn bond issuance, in which part of the proceeds would be used to fund the transaction via the SPV. 

The Enyo acquisition fits nicely into ARDOVA’s expansion drive and would complement its retail base. ARDOVA currently has a network of about 450 or more stations. Enyo will add about 90 or more retail outlets in 15 Nigerian states. While we are unable to factor in the potential impact of the acquisition into our model estimates due to the non-availability of Enyo’s financial statements, we expect this to further bolster volumes and improve overall performance due to a potential benefit from economies of scale. Going forward, we are also cautiously optimistic with regards to the company’s LPG, and Renewables & Battery-as-a-service segments.  

Valuation: BUY rating retained with higher upside

In view of the foregoing, our expectations for the performance of ARDOVA in 2021 remain broadly moderate, as such, we retain our model assumption while awaiting details about the proposed acquisition. Nevertheless, adjusting our valuation estimates, we adjust our Target Price for ARDOVA to N23.4. Compared to the current market price of N15.5, this portends an upside of 50.3% thus we retain our BUY rating on the ticker.

 
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