2023-03-09 16:48:33 ET
Summary
- Repsol looks poised to capitalize on refining margins staying elevated into FY23.
- Following a bumper FY22, the expanded balance sheet capacity also allows for an accelerated energy transition path or for more capital returns.
- With the valuation screening favorably relative to the fundamentals, I like the risk/reward.
The slight stock price dip post-Q4 results for integrated oil & gas company Repsol ( REPYY ) was perhaps justified given the low-quality headline earnings beat and the sub-par underlying cash flow numbers. Yet, the guidance for another year of elevated refining margins supports the investment case for Repsol being a macro play via its outsized exposure to middle distillates (relative to the rest of the European 'Big Oil' group). Backed by ample balance sheet capacity, Repsol is also making headway in its energy transition goals – the combination of more renewables M&A and accretive decarbonization projects should drive long-term value creation beyond the core energy business. Yet, the business is being valued at a ~30% discount to book value vs. >20% ROE generation over the last year. Alongside an attractive high-teens percentage FCF yield and a clear path to stronger capital returns (dividends and buybacks) in the coming year, the risk/reward is compelling.
Marketscreener
Still a Play on Refining Tailwinds
As the Q4 update highlighted, Repsol remains a key beneficiary of the favorable refining backdrop, with margins staying elevated despite the macro challenges in H2. Leading indicators point to the Q4 strength extending into FY23, supporting management's guidance for a QoQ improvement in refining margins toward the Q2 2022 peak. Per management, refining margins rebounded post-December 2022 (likely driven by China reopening), supporting $18/bbl margins in early January. With the strength in diesel crack spreads likely to continue as well, all signs point to refining upside in Q1 2023.
Repsol
Also contributing to further tightness in European middle distillates is the Russian oil embargo , which came into force from February onward. Given Repsol's outsized exposure to refining margins vs. the rest of the European integrated sector, it should outperform in this environment. For context, Repsol's Spanish indicator refining margin averaged >$15/bbl in FY22 (vs. ~$2.4/bbl in FY21 and >$6/bbl over the last decade), so if the company can sustain margins anywhere near that, expect the refining-driven cash flow upside to more than adequately cover the group's overall cash needs.
Renewables M&A a Key Part of the ESG Push
Based on expectations for another year of solid refining margins, Repsol has also guided to >EUR5bn of capex spending in FY23. Of the headline capex amount, most of it will be allocated to upstream operations, ~23% to its industrial segment, and ~24% to renewables (note the unit spans wind, solar and hydro plants globally). Given the strength of the balance sheet, there's ample dry powder available to also execute acquisitions, particularly in renewables. So while the selldown of a 25% stake in its renewables unit (at a ~EUR4.4bn implied valuation) last year might have led to concerns about the company's commitment to its energy transition agenda, the latest capex guide validates the case for this division emerging as a key growth driver going forward.
Repsol
The recent acquisition of Asterion Energies for EUR560m could be a sign of things to come with regard to Repsol's energy transition goals. The deal grants access to a 7.7GW renewable asset portfolio; with a focus largely on development, management appears to favor a development-focused acquisition strategy that allows it to grow the acquired assets within the Repsol ecosystem. Elsewhere, Repsol also boasts a robust pipeline of decarbonization projects related to hydrogen and advanced biofuels that will be worth monitoring. With the mid-term capex guidance for low carbon businesses intact at ~35% of the overall EUR18bn capex through FY25, there remains ample room to further accelerate efforts from here.
Attractive Capital Return Prospects
From a financial perspective, Repsol is in a much better place following an exceptionally strong FY22. The company has used the incremental cash flow generation well, and even after the increased shareholder returns, the net debt has been cut in half. Adding to the balance sheet capacity is the pending receipt of $2.4bn of cash proceeds from the monetization of its upstream assets via a 25% stake sale , with proceeds expected sometime in Q1 2023. So relative to the ~EUR2.3bn net debt position in Q4 2022, expect a further strengthening of the balance sheet in the coming quarters.
Assuming no major acquisitions and that management delivers according to the capex guidance for the year, there is ample room for upside to Repsol's distribution. For one, the overall (dividends and buybacks) payout is low at >30% of operating cash flow. Even if management sticks with a 25-30% payout, one or two more strong quarters in refining and a balance sheet that looks poised to turn net cash over the next quarter or so should be more than sufficient for a one-off special dividend. Given the low valuation at ~0.7x P/Book, I wouldn't rule out an expanded buyback program either. Assuming a relatively modest >EUR1.0bn/year run-rate, for instance, would entail a significant high-single-digit EPS tailwind.
The Setup Remains Compelling Into 2023
Coming off the Q4 report, there are signs that Repsol's underlying cash flow and earnings momentum are slowing down. While the current refining tailwinds are unlikely to sustain for the long term, it is worth keeping in mind that margins are moderating from multi-year highs in 2022. And with leading indicators signaling continued strength into this year as well, Repsol, which maintains the highest exposure to middle distillates across the major European oil companies, should continue to sustain margins well in excess of historical averages. The cyclical cash flow boost has, in turn, supported balance sheet capacity and energy transition efforts, with Repsol well-positioned to unlock more value from low-carbon businesses via M&A. Yet, the stock trades at undemanding levels relative to its FCF generation and book value (vs. a ~25% ROE); investors willing to wait out a re-rating stand to be well-rewarded via increasing dividends and buybacks.
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Repsol: The Setup Remains Compelling Into 2023