A stake in Africa’s oil-fueled future?
Does downstream petroleum business Vivo Energy provide an undervalued opportunity for investors?
By Adi Mishra
3rd May 2021, 12:56 GMT
Current Market Position
Vivo Energy is a British downstream petroleum business that serves both retail and commercial customers in 23 African countries. Vivo Energy’s exclusive service to emerging markets presents an opportunity to exploit a huge growth opportunity.
Since being established in 2011, Vivo distributes petrol under the Shell-brand to retail customers through petrol stations in 15 African countries. Since May 2019, Vivo has expanded into 8 new markets under the Engen-brand. The combination of these 2 retail operations is an EBITDA of $228 million, accounting for roughly 57% of Vivo's total EBITDA.
Vivo’s second-largest business area is their commercial service, at 30% of total EBITDA. Vivo Energy’s commercial business includes supplying fuel to mining, construction, transport, power and industrial companies. In addition to this, Vivo also supplies aviation fuel and ‘bunkering’ for marine traders and shipping companies.
13% of Vivo’s business can be attributed to its lubricants business, which serves both commercial and retail customers. Unlike Vivo’s other areas, Vivo’s lubricants business covers everything from manufacturing to distribution and marketing.
In Vivo’s original countries, it retains a 23% market share, displaying a strong control over its market, while in the newly entered 8 other countries Vivo has achieved an 11% market share so far. 90% of Vivo Energy’s volumes are in markets where they are placed either no.1 or no.2 in terms of market share.
This strong grip over these markets sets Vivo up to take advantage of the rapidly expanding demand for fuel in African countries; while demand in the US and Europe has stayed roughly flat over the past 20 years, demand in Vivo’s markets has risen by over 80%.
This trend of increasing demand for fuel in Africa is likely to continue with rapid urbanisation and population growth, combined with high GDP growth of 5.1% and a wholly unsaturated vehicle market growing at 5-7% a year.
Financial Position & Performance
Vivo has a healthy but not excessive cash position; it holds about $515m in cash, meaning it can cover current debt nearly twice over and has enough cash to cover operating expenses for at least 1 year.
Vivo produces free cash flows of about $300-400m per year, meaning it yields a whopping 22.5% on market cap. This suggests two things, (1) Vivo could be selling at a discount to what it is actually worth, (2) Vivo is a high-quality business.
This high cash flow is what enables it to pay out a dividend yield of about 2.5%.
Vivo’s cash flow in 2020 was damaged by the pandemic, falling from $300m to $100m. Vivo’s commercial segment was the worst hit, suffering a 32% YoY decrease in adj. EBITDA. However, despite the short term hit to cash flows, Vivo was able to continue its expansion by opening an additional 104 new retail stations, building its market share in its new markets.
The management at Vivo Energy places an emphasis on capital allocation, with an internal rate of return hurdle for all retail projects being set at 20%, and commercial projects at 25%. This has resulted in a very strong ROACE, which has consistently been above 20%.
Vivo Energy also benefits from a strong, negative working capital structure, with retail payments typically coming in 6 days after delivery, while credit payments are often on a very long term basis. The company’s efforts to improve working capital has proved beneficial, and can partly explain the high cash flow generated.
Future Cash Flows
We can try to get some sense of the growth in cash flows Vivo Energy may experience by calculating their potential benefit from certain macro trends within their existing markets.
As of 2015, there are 66 vehicles per 1000 people in Vivo’s markets. There are currently about 252 million people living in Vivo Energy’s previous markets, and roughly 153 million in their new markets. This means that we can estimate there to be about 19 million vehicles in the previous markets, and about 10 million in their new countries. The growth in vehicles is about 5% per year and Vivo has market shares of 23% and 11% in their previous and new markets respectively. We can therefore estimate (assuming they retain market share) that they will see an estimated expansion of their retail customer base in their more established markets of 220,000 people per year averaged out over a 10 year period. In their newer markets, this figure is about 56,000 per year.
In developing economies, income spent on petrol/gasoline is typically between 1% and 2% of GDP/Capita. The average GDP/Capita in established markets is about $39,000 and is $31,000 in newer markets. A conservative approximation would leave us at $390 and $310 as a yearly spend on petrol by consumers. This would mean that an extremely rough estimate of the combined yearly increase in cash flows would be above $80,000,000 per year, averaged over a 10 year period.
Since this is a very rough estimate, we can use a 30% margin of safety, giving us $56 million. This would imply a 17% yearly growth rate (compared to pre-covid cash flow).
Vivo Energy has about $515 million in cash and about $2.5 billion in liabilities. Considering this, and discounting future cash flows of $200 million using a discount rate of 8%, a cf growth rate of 12.5% and a yearly decline in this growth rate of 2%, Vivo energy is worth at least $3.8 billion. At a current market cap of ~$1.75 billion, Vivo Energy could therefore present a great value opportunity for investors.
Note: Any views expressed in this article are that of the author alone and are not to be taken as financial or investment advice; please do your own research or consult your financial advisor.