Hellenic Petroleum — A flexible refiner in a turbulent time

Hellenic Petroleum operates three refineries in Greece with a total capacity of 344kbd and has sizeable marketing (domestic and international) and petrochemicals divisions. Two of the refineries (Aspropyrgos and Εlefsina) are complex, integrated and provide significant flexibility of feedstocks/throughput. The third, Thessaloniki, is small and simple but houses Hellenic’s petrochemicals units, which have significant Greek and Mediterranean sales, and complements Hellenic’s refining system. In addition to refining and petrochemicals, Hellenic is active in the fuels marketing, power and gas sectors. It is looking to build out its renewable power generation capacity over the course of the next five years, and on 17 February 2020 it announced it has signed a sales and purchase agreement (SPA) for the acquisition of 204MW PV portfolio in Northern Greece.

Edison’s valuation of Hellenic is based on a blend of three approaches: DCF, FY20 P/E multiple and FY20 EV/EBITDA multiple. Hellenic trades at an FY20e P/E of 7.4x relative to European peers on 5.7x, and 5.4x FY20e EV/EBITDA relative to the peers on 3.6x. The refining industry has seen a c 40% decline in market value since January 2020 on concerns regarding the impact of coronavirus on global energy demand. According to EIA, global oil liquids consumption has already declined in Q120 from an average of 101.4mmbopd in Q419 to 99.1mmbopd and is currently estimated to pick up only in Q420. The current uncertainty in terms of the magnitude and duration of the impact of coronavirus on the global economy has a direct effect on our blended valuation as it reflects the current market valuation of Hellenic and its peers. We have also reduced our DCF valuation to account for the reported FY19 results and potential impact of coronavirus (see page 9 for details).

Although we expect the reduction in global oil and gas demand to affect Hellenic’s results in FY20, our revised estimates still suggest that Hellenic will be significantly free cash flow (FCF) generative, with FY20 FCF of €437m and FY21 FCF of €413m. Excess cash generation offers the ability to de-leverage and fund opportunities to maximise margins through the optimisation of existing installed capacity as macro conditions evolve. We also expect the company to invest in renewable activities. These may provide a new area of growth for Hellenic but there are execution risks, particularly if it considers growing by acquisition; in addition, in our view, returns for renewable projects are likely to remain under pressure due to significant competition. Hellenic targets competitive returns on equity from renewable investments and where the company can see potential synergies with the rest of the business.

The main sources of potential risks are developments in the global economy and their impact on the performance of the European refining industry, including price fluctuations in crude oil and final products as well as the exchange rate of the Euro/US dollar. The outbreak of coronavirus and the efforts to contain it are already affecting the global economy and as a result the demand for oil products and crude oil, as well as the supply of products, particularly from Pacific Asia. These developments might have a negative impact on refining and petrochemical margins at least in Q120 and Q220, although it is difficult to quantify the effect and its duration.

Hellenic operates three refineries that together account for 344kbd of capacity and 65% of the Greek refinery output. A composite Nelson complexity index of 9.3 gives an indication of the complex’s flexibility and ability to produce a high percentage of light products from every barrel. The refineries are linked, allowing better integration to best take advantage of their strengths of location, size, storage and complexity.

Hellenic’s refinery complex has a high degree of flexibility; since 2014 it has been able to flex its gasoline yield between 20% and 24%, while middle distillates have been between 50% and 58% of yield (working at full capacity). Fuel oil yields are fairly low (below 5%) and there are no plans to undertake large projects to add further units to the complex at this time. The company has a large storage capacity (41.8mmbbl) and can take advantage of trading opportunities.

Hellenic’s low fuel oil yield and complexity should ensure the group is well placed for IMO 2020 and the anticipated switch in demand from HSFO 3.5% to ULSFO 0.5% and MGO 0.5%. Hellenic had minimal changes to crude processing at Elefsina and Thessaloniki ahead of IMO 2020 as neither refinery produces HSFO. However, Aspropyrgos presented an opportunity to reduce high sulphur feed and replaced this with lower sulphur crudes.

Aspropyrgos is the largest refinery in Hellenic’s portfolio and is one of the most modern refineries in Europe (it was built in 1958). Significant upgrades were completed in 1986 (residue conversion project, FCC, mild hydrocracker, visbreaker and CCR units), 1999 (capacity increased to 148kbd) and 2004 (upgrade of conversion units). From 2014, heat and power have been supplied by natural gas (rather than fuel oil), reducing costs and increasing flexibility. The result is a refinery able to produce high levels of gasoline. It is connected to Elefsina via pipeline.

Elefsina is Hellenic’s most complex refinery and has a refining capacity of 106kbd. A €1.4bn upgrade in 2012 added a 39kbd hydrocracker, a 20kbd thermal cracking unit (flexicoker, which gasifies coke for internal heat and power generation and reduces the need to export/sell coke produced elsewhere in the refinery) and a vacuum distillation unit, increasing the Nelson complexity to 12. Its large storage capacity (20.7mmbbl), coastal location and connections (to Aspropyrgos refinery and crude terminals at Pachi and Megara) make it a good trading and logistics hub. The refinery can take heavy, high-sulphur crudes and products. As a result, its middle distillate yield is over 75%.

Thessaloniki is the smallest and simplest refinery (hydroskimming) type and has a storage capacity of 8.8mmbbl. It is the only refinery in Northern Greece (Aspropyrgos and Elefsina make up a southern Greek hub) and supplies both the domestic market and neighbouring countries. A 2011 upgrade renovated distillation units, increased storage capacity and added a 15kbd CCR unit. Thessaloniki also provides feedstock (including residues) to the Southern hub and reforms naphtha from Elefsina (to gasoline).

Hellenic’s refineries are at the smaller end in comparison to European refinery capacities, but we note that the combination of Hellenic’s two more complex refineries (integrated through pipeline connection) would equate to a combined capacity towards the top end of the group. This complexity and integration means that Hellenic’s refining margin compares well to its European listed peers, especially after the Elefsina 2012 upgrades.

In 2019, the refinery utilisation rate was negatively affected by the end of run performance for the Aspropyrgos and Elefsina refineries and the full turnaround at Elefsina, which was safely completed in Q419. However, as a result, production and sales were equally affected. The refining system observed the lowest benchmark margins since Q313, as HSFO cracks collapsed ahead of IMO implementation. However, due to the current volatility in oil products supply and demand it is difficult to draw conclusions as to the actual impact of IMO 2020 on demand. In 2019, benchmark margins for Mediterranean refineries were significantly weaker. Key drivers were supply/demand balances of products and Urals crude pricing. The Mediterranean benchmark cracking margin averaged US$1.7/bbl in 2019, US$2.9/bbl lower y-o-y and the Mediterranean benchmark hydroskimming margin averaged US$0.3/bbl, reduced by US$3/bbl compared to 2018. In Q419 refining margins were at negative levels on the back of very low fuel oil cracks. We have adjusted our refining margins for Hellenic to reflect the current market conditions (see page 11 for more details).

The weaker refining environment in 2019 had a negative impact on the company’s 2019 financial performance with adjusted EBITDA of €572m versus €730m in 2018. This was partly offset by an improved trading performance and a stronger US$ vs the euro. As a result of lower capacity availability, production and sales were 8% and 11% lower, respectively.

Since the beginning of the year, the market caps of Hellenic and its peers have decreased by an average of c 40%. Concerns about lower global demand for oil and petrochemicals have had an impact on global refining systems. Lower demand is already being observed in Q120, especially in China, with oil liquids consumption decreasing from 15.2mmbopd in December 2019 to 13.1mmbopd in February 2020 and is expected in Q220. With falling demand, refiners have seen realised prices decrease, which affected refining margins for the first two months of the year. March saw a pick-up in refining margins as a consequence of low oil prices. However, with falling global demand for oil products, these margins will tend to shrink. The key question now is how long the lower global oil demand will persist and how quickly the global economy will recover. In addition to the coronavirus outbreak the oil price war between Saudi Arabia and Russia broke out on 9 March 2020. The Opec+ ramp-up in production will come just as demand has significantly reduced as a result of the coronavirus. According to press reports, as OPEC members gathered last week, Saudi Arabia was signalling it would cut production to maintain oil prices. However, when Russia decided it was unwilling to accept its proposed share cut of 0.2–0.3mmbopd, Saudi Arabia cut its selling prices, triggering the oil price crash. Lower oil prices tend to be positive for refiners, but with current low margins and rising crude oil inventories no upside is expected until global oil demand picks up. Nonetheless, compared to its European peers, Hellenic benefits from proximity to Middle East oil suppliers, taking advantage of crude spreads, especially on increasing freight rates.

For 2020, Hellenic’s strategy is to further strength its competitive position within the refining sector, in particular through the optimisation of its operational performance and synergies among the group’s refineries. Hellenic intends to improve the performance of conversion units and the energy efficiency of its refineries, and explore opportunities for operational optimisation in the context of the group’s digital transformation programme. At the same time, the company remains focused on finding high return investment opportunities both within the refining business unit as well as in the renewables space. Hellenic recently announced the acquisition of a 204MW PV project, which is at the final permitting stage, from German developer JUWI. On completion, it will be the largest renewable energy system (RES) plant in Greece. The total estimated investment, including the construction cost, is approximately €130m, and management currently expects a stable annual EBITDA at c €15–17m from 2022. Management announced the transaction is expected to be closed in Q220 with a construction period estimated at c 16 months. However, due to the current disruptions in economic activities and supply chains, some delays might be expected.

In February 2020, Hellenic also reached an agreement with the Hellenic Republic Asset Development Fund (HRADF) for a joint sale process of DEPA Infrastructure and Hellenic’s participation in DEPA Commercial sales process. The existing DEPA Group operates in the wholesale, trading, transmission, distribution and supply of natural gas and is 35% owned by Hellenic whereas the remaining 65% are owned by HRADF.

Since the beginning of the year global markets have been experiencing increased volatility, which has had a significant effect on the oil and gas and refining industries. Geopolitical events and the outbreak of coronavirus have negatively affected supply/demand and increased earnings uncertainty. Having said that, on our updated estimates that provisionally take into account the depressed market conditions, we expect Hellenic to remain an excess cash and FCF-generating business with a revised FCF forecast of c €437m in FY20 (vs our previous estimate of €528m). We believe Hellenic’s excess cash and FCF will be predominantly used to reduce debt. As such, net debt should continue to fall steadily in the absence of any major investment over and above maintenance capex, with net debt/EBITDA remaining below 3.0x in 2020 and declining to c 1.9x in FY21. Considering the current markets volatility, we expect Hellenic to increase its capital discipline and therefore we do not see additional capex being employed until the global economy stabilises.

Other uses of FCF include increasing investment in improving the core business and its growth, and the development of the company’s renewables business. Current guidance is for combined growth capex spend of c €700m over the next five years. Our net debt forecasts, as per Exhibit 8, include this spend, but conservatively we do not include a material margin contribution from renewables given the construction timelines for greenfield renewable projects. Renewable investments are likely to span the wind, solar and biofuel sectors, while margins and returns on investment have the potential to be robust based on renewable peers in Greece. Wind and solar projects in Greece offer the potential for stable, long-term cash flows based on a combination of feed-in tariffs and power purchase agreements. We expect management to provide more details on this aspect of the business in due course. At the time of FY19 results, management expected growth capex alongside competitiveness improvement strategies would provide the basis for the company to generate adjusted EBITDA in excess of €1bn pa (excluding IFRS 16 impacts) from 2025. Our current estimates are more conservative with an FY20e EBITDA of €600m versus our previous estimate of €645m.

Chairman Ioannis Papathanasiou holds a degree in electrical engineering from the National Technical University of Athens. Until 2002, he was chairman and managing director of J.D. Papathanassiou, a company engaged in the trading of technological equipment for buildings.

Ioannis Papathanasiou was first elected as a member of the Greek Parliament in 2000, with the New Democracy party. He was re-elected in 2004, 2007, 2009 and in May 2012 and served in several posts: From 2004 to 2007, was the deputy minister of development for commerce and consumers’ issues, while in 2005 he was also assigned the research and technology issues of the ministry. From 2007 to 2009 he served as the deputy minister of finance and economy for investments and development, and in 2009 he was minister of finance and economy. Ioannis Papathanasiou chaired the board of directors of Hellenic Petroleum between 2014 and 2015.

CEO Andreas Shiamishis holds an economics degree specialising in econometrics from the University of Essex in England and is a fellow (FCA) member of the Institute of Chartered Accountants in England and Wales.

Andreas Shiamishis began his career in 1989 in the banking and financial services practice of KPMG in London. From 1993 to 1998 he worked initially as executive and subsequently as the finance and customer services director in ΜΕΤΑΧΑ, a member of the Diageo International Group of food and beverages. In 1998 he took over as regional finance and business development director, with the responsibility for the areas of the Middle East and North Africa, of Pillsbury (Diageo Group). Between 2000 and 2002 he worked as CFO in a listed company associated with the Leventis Group interests, while in 2003 he was hired as chief financial and IT officer at Petrola Hellas.

After the merger of Petrola Hellas with Hellenic Petroleum in 2004, Andreas Shiamishis took over as CFO of the group and became a member of the group’s executive committee. He was deputy CEO of the group during the period 2014–15 and 2017 to August 2019, when he became the CEO of the group.

Refining margins: along with all refineries, the major risk to earnings is volatility of refining margins. As a price taker, Hellenic can do little to mitigate this in the short term. In the long term, improvements to refineries are capital intensive and take many years. However, Hellenic will also benefit from increases in refinery margins.

Concentration risk: the bulk of Hellenic’s earnings are generated at the three refineries. Any incident that stops the refineries from operating (such as an unplanned outage) could have a material effect on cash flows. This is mitigated to some extent by the three separate sites and the other material businesses.

Commodity markets: oil price fluctuations have a significant impact on the refining industry. While the recent drop in oil prices and the anticipated increase in oil supply could be positive for the refiners, the reduced demand due to coronavirus is likely to continue to have a negative effect on refining margins in the near term.

Greek risk: Hellenic has significant export businesses and its production is entirely fungible for international markets. Greek country risk is a factor when considering cost of capital and domestic product demand.

Equally, we note that the Greek economy has a lot of potential to grow, and Hellenic Petroleum would be well placed to benefit from increased economic activity through the marketing, power and chemicals divisions. Greek bonds have been on a declining mode in 2019, reaching historic lows, as fundamentals and confidence improved further, with 10-year Greek bonds decreasing at a faster rate than other Eurozone periphery government bond yields. Increased tourism would help the refining and trading segment.

FX rates: refining is a US dollar business (margins are quoted in US dollars) while Hellenic’s costs are predominantly in euros so the lower euro versus the US dollar has benefited earnings (and cushioned the poor refining environment in 2011–14). While we do not forecast currency swings, fluctuating exchange rates will have an impact on earnings.

We value Hellenic using a blend of DCF, leveraged and unleveraged multiples arriving at a valuation of €7.33/share, down from our last published estimate of €9.30/share, driven by the reduction in sector multiples and lower estimates on the back of the anticipated reduction in oil products demand in 2020. Changes to our forecasts are shown in Exhibit 16.

Hellenic trades on FY20 multiples of 5.4x EV/EBITDA and 7.4x P/E compared to the European group trading on 3.6x and 5.7x, respectively. Hellenic’s FCF yield is higher than the peers at 27.5% in FY20e and its EV per complexity adjusted barrel is lower than the peers at $1,183/bbld. Our DCF is based on discounted cash flows to 2025, using a 7% cost of capital. We incorporate a terminal value, which assumes the unwinding of working capital and a negative 1% terminal growth. The DCF reflects lower refining margins in the first half of 2020 when compared to 2019 and an anticipated pick-up in the second half of the year as the global economy recovers and the lower oil prices persist.

In the current market conditions, Hellenic trades at premium to the peer group on our updated estimates, which are highly sensitive to underlying refining margin and over-performance assumptions. On a complexity adjusted basis, Hellenic trades at a discount despite the flexibility offered by its current refining configuration.

An overview of the key changes to our forecasts is provided below. Key impacts include the weak industry environment in Q419 and the fall in demand for oil products in Q120 and Q220 due to the outbreak of coronavirus. As a consequence, we have lowered our refining margin estimates to reflect realised margins in January and February 2020: Aspropyrgos averaged US$2.8/bbl, Thessloniki -US$2.3/bbl and Elefsina US$4.2bbl, resulting in a refining margin implied by benchmarks of c US$2.17bbl versus US$3.74/bbl in our previous estimates. We expect margins to remain at these relatively depressed levels for the next at least six months with the subsequent improvements in Q420 as the global economy recovers from coronavirus and oil prices potentially remain at subdued levels. All in all, our FY20e total EBITDA is 26% lower compared to our previous estimate.

As our FY20 EBITDA estimate is 15% below consensus, we believe the latter is yet to fully reflect current market conditions. For FY21, our estimates remain in line with consensus as we expect demand to recover and stabilise, and realisations to normalise.