Z Energy : High oil price, intense price competition and lower margins

Half year financial result and dividend

Z Energy (NZX: ZEL) today announced its earnings and net profit for the six months to 30 September 2018.

Z reports its earnings on an historic cost as well as replacement costs basis. Statutory financial statements are reported on an historic cost basis in accordance with NZ-GAAP, however replacement cost accounting is the globally-used non-GAAP industry standard to measure financial performance.[1]

Replacement cost accounting is the financial measure that Z is valued at by the share market, that Z's debt covenants are calculated on, that management is incentivised by, and that the Government track in their weekly margin monitoring.

Historical cost net profit after tax (HC NPAT) was $139m, up 74% from $80m in the prior corresponding period (PCP). This result was driven by the sharp increase in the underlying oil price over the period and the decline of the New Zealand dollar against the US dollar.

Z reported replacement cost earnings before interest, depreciation and amortisation (RC EBITDAF) of $175m, down 21% from $221m in the first half of last financial year.

Z's replacement cost net profit after tax (RC NPAT) was $72m, down 31% from $105m in the PCP. Total marketing volume for the half year was 1,969 million litres, flat compared to the PCP. The above RC NPAT is equivalent to 3.7 cents per litre, down from 5.3 cents per litre in the first half of last financial year. Z's RC fuel unit margin[2] of 15.5 cents per litre was down on the PCP of 17.0 cents per litre.

The Board of Z has declared a fully imputed interim dividend of 12.5 cents per share, up 20% from 10.4 cents per share compared to the PCP. The interim dividend will be paid on 11 December 2018.

Drivers of the result and of full year RC EBITDAF guidance

Commenting on the results, Z Chief Executive Mike Bennetts said that the operating environment for the first half of FY19 was the most challenging experienced in the eight and a half years of Z.

'During this period, US dollar crude prices increased by 25%, the NZD/USD exchange rate depreciated by 9%, and fuel taxes nationally and regionally increased. Combined, these factors have led to record high prices at the pump. These sustained high prices have resulted in a decrease in retail demand,' said Mike.

Competition has intensified in both the North and South Island, particularly on price, as customers seek out bargains in the high price environment.

'Margins typically come under pressure when crude prices rise steeply, as prices at the pump lag behind the increases in the price of crude oil, and customers are sensitive to new, higher price points,' said Mike.

In addition, results were negatively impacted by the extended refinery shutdown resulting in lost gross refining margin (GRM). The purchase of unplanned product imports to cover for the extended shutdown also had a negative impact on fuel margin.

'Given the volatility in crude prices and exchange rates, we are taking a cautious view on the second half of the financial year and reducing our full year RC EBITDAF guidance to $400 million to $435 million,' continued Mike.

Commerce Commission market study

Record high fuel prices, driven by high crude oil prices, the weaker exchange rate and additional tax, have once again thrust our industry and Z, into the political and media spotlight.

Mike acknowledged the impact that fuel prices have on customers, from households to businesses.

'Because fuel has such a big impact on household budgets and many businesses, customers want to know that they are at least paying a fair price because the market is competitive. We welcome a Commerce Commission market study as we believe that it is the most sensible and transparent way to give customers the assurance they need. It's important to have an objective agency who can compel all industry participants to provide relevant data and have people with the skills and knowledge to interpret the data and investigate the market,' said Mike.

'Z cooperated fully with the MBIE led market study in 2017, and we will cooperate fully with any Commerce Commission market study. We will continue to point to the facts; our books are open and financial returns are not excessive given the complexity of the business and the capital employed, competition is intense and our returns are consistent with similar companies around the world,' said Mike.

Z's strategy of optimising the asset base and boosting operating efficiency continues to pay off

Z has made considerable progress in continuing to deliver operating efficiencies throughout the business.

'Despite the difficult operating environment, we have continued to make progress on our strategy for a more productive core business,' said Mike.

'In the first half we delivered on our refinery optimisation strategy, we brought back in-house operational control of the remaining five fuel storage terminals (three were completed at the end of FY18) and simplified our bulk fuel distribution into a new long-term contract with a haulage partner. These projects, plus others announced in our Strategy 3.0 program, are forecasted to contribute $16-18m of EBITDAF within the year.

On 1 September Z commenced fuel supply to the Foodstuffs Group, the co-operative for the New World and PAK'N SAVE stores.

Mike said that he was proud of the Z team for flawlessly executing a seamless transition.

'There are very few deals out there in the New Zealand market that represent such a structural shift in volumes. Z is now supplying approximately 150 million litres annually to the Foodstuffs Group supermarket service stations and is the redemption outlet for their fuel dockets. This will grow Z's supply chain volumes and further improve our economies of scale,' he said.

Investment in Flick Electric

On 1 September, Z invested $46m to acquire a 70% stake in Flick Electric. Flick is an electricity retailer and disruptor that allows its customers the choice between access to the spot price of the New Zealand wholesale electricity market or low fixed prices.

Commenting on the investment, Mike said that Flick fits into Z's long-term view of the New Zealand energy market, providing access to the retail electricity market, access to a new form of energy and strong digital capability.

'Although Z's ownership of Flick Electric is a majority, we intend for it to operate as a subsidiary company outside of Z's operations, so that it can keep doing what it does best. We will continue to support the Flick management team to grow the business towards EBITDAF profitability in FY21.'

Capital structure, debt reduction and returns to shareholders

Z remains committed to debt reduction and increasing returns to shareholders over the next decade. Z believes it is prudent to reduce its overall debt position and maintain a strong, investment-like grade balance sheet because of the uncertainty around the price of crude oil.

'At the end of last financial year, we had reduced our debt leverage, defined as debt to RC EBITDAF, to 2.1x. In the first half of FY19 debt to RC EBITDAF has increased to 2.4x through a combination of reduced earnings and the investment in Flick. Z remains committed to deleveraging to around 1.6x debt to RC EBITDAF by the end of FY21.

'This year sees the first implementation of our new dividend policy of 'better with you than us'. While we acknowledge the current challenging trading conditions have reduced the size of the dividend from original guidance, the change in dividend policy reinforces our commitment to efficiently return cash to shareholders.

Second half outlook and priorities

Given the volatility of the global commodity markets and the recent movements of the New Zealand dollar, Z is not depending on a drop in crude prices or improving FX rates to support our second half performance.

Commenting on the priorities for the rest of the year, Mike said:

'Our focus for the next six months is simple, we must increase momentum by prioritising business as usual activities and projects that directly improve customer experience and we will focus our productivity work on fewer, higher value actions that create more meaningful bang for buck.'

A conference call for media and investors will be held at 10am on Thursday 1 November 2018. Dial in details can be found at https://investor-centre.z.co.nz/investor-centre/assets/Uploads/20181009-NZX-results-date-announcement.pdf

[1] Z prepares its statutory financial statements on an historic cost basis in accordance with NZIFRS. Earnings prepared on this basis are subject to volatility due to changes in oil prices and exchange rates and is therefore not a dependable measure of business performance or profitability. Replacement cost earnings do not reflect this volatility to such an extent as the cost of the stock sold is accounted for as its replacement cost at the time of its sale. Z's management focuses on the industry standard replacement cost operating metrics, which it considers a better reflection of the underlying performance of the company.

[2] This is the margin on fuel sold before operating costs and corporate tax are accounted for.

Investors: Matt Hardwick 027 787 4688

Media: Sheena Thomas 027 551 2589