Hellenic Petroleum — Low dependency on Russian crude

Russia’s invasion of Ukraine is affecting the oil price (the average price for March so far is $115/bbl, which is 35% above the average price in January of ($86/bbl), on the expectation that supply will further tighten due to restrictive sanctions on Russian energy. Since Russia started its invasion, the oil price has soared, touching a 14-year high intraday of over $139/bbl on 7 March as the United States and European allies discussed banning Russian oil imports. There is not enough capacity to compensate for the loss of the whole Russian supply (c 7m barrels a day), while OPEC+ (Organization of the Petroleum Exporting Countries and their allies, including Russia) decided not to increase supply.

The Energy Information Administration (EIA) lifted its brent price forecast in its March Short-Term Energy Outlook (STEO) for 2022 and 2023 to $105/bbl and $89/bbl from $83/bbl and $68/bbl, respectively. However, in the worst-case scenario, according to Rystad Energy, oil prices could hit $240/bbl this summer if Western countries roll out sanctions on Russia’s oil exports. If the high pricing environment continues, at some point it may affect fuel demand adversely, potentially accelerating the move towards non-fossil solutions. However, we note that raw material prices for renewables equipment, including electric vehicles, and gas prices have increased to unprecedented levels. Higher oil prices suggest crude feedstock costs may rise for European refiners, weighing on margins and limiting recovery from the pandemic’s effects.

Historically there is a negative correlation between oil prices and Hellenic’s refining margin until 2018, after which refining margins become more volatile, depending not only on crude price but also on demand for specific refinery products. As a result of Russia’s invasion of Ukraine there was a significant increase in refining margins in the first days of March, according to BP. However, as a result of sustained high oil prices, we expect this short-term increase to reverse followed by further downwards pressure on margins and possibly increased volatility.

For Hellenic, as with other refineries, earnings depend on changes in refining margins. Hellenic does not provide information on hedging and, notwithstanding this, as a price taker, it can do little to mitigate short-term volatility in margins. In the longer term it can further increase vertical integration, scale up its petrochemical business and diversify into renewable energy sources (RES).

Vertical integration of Hellenic’s refineries allows for outperformance versus benchmark refining margins, with an average margin improvement over benchmarks of $5.7/bbl (2015–21) (Exhibit 2). This is supported by overperformance in refining operations (density escalation, crude slate optimisation and synergies), commercial and wholesale trading premia (such as logistics premia due to costal locations with own port facilities), as well as propylene contribution (reported under Petchems).

Additionally, sanctions imposed on Russia may partially affect tourism arrivals in Greece, adversely affecting fuel demand. However, according to the president of the Greek Tourism Confederation (SETE) it is ‘too early to make any safe statements today over the consequences on tourism’. Russian tourism arrivals in Greece had peaked at 1.3 million in 2013 and started easing in 2014. In 2019 (pre-pandemic) there were 583,000 arrivals from Russia (versus c 31 million arrivals in total). In addition to the loss of Russian vacationers, Greece may also see declines of up to 10,000 in the number of Ukrainian travellers.

In Q421, Hellenic reported adjusted EBITDA of €138m versus €77m in Q420 and €125m in Q321, mainly driven by the recovery in oil demand and improved realised refining margins ($11.8/bbl in Q421 versus $6.6/bbl in Q420). This resulted in FY21 EBITDA of €401m, which is a 20% increase over FY20 (€333m). During Q421, performance was supported by operational improvement due to higher refinery availability (no turnaround versus Aspropyrgos turnaround in Q420) that outweighed the impact from contango from last year. Additionally, marketing operations were positively affected by the introduction of new premium products in Greece. However, that was partially offset by a significant increase in variable operating costs, owing to a sharp rise in international natural gas prices to multi-year highs (€97/MWh in Q421 vs €15/MWh in Q420 and €49/MWh in Q321), which affected electricity prices, along with a significant increase in the carbon price (average of €72/tonne in Q421, up c 150% y-o-y).

Refining margins recovered further in Q4 after reaching pre-pandemic levels in Q321. This increase was supported by higher demand for the main product cracks. Surging natural gas prices have been supportive for refined products, with substitution likely to lead to stronger demand. At the same time, we continue to see a recovery in oil demand as COVID-19 restrictions are eased. Refining benchmark margins improved further in February 2022, reaching $6.7/bbl (fluid catalytic cracking) and $8.4/bbl (hydrocracking). The two-month average (January–February) increase is shown in Exhibits 4 and 5. Higher benchmark margins along with an increase in sales (due to higher demand) should positively affect refining profitability in Q122, as the refining margins improve further from the low levels in 2021 driven by the pandemic.

In Q421, demand for Greek domestic market fuels rose 25% y-o-y to 1.9m metric tons (MT) (Exhibit 6), returning to 2019 levels. Aviation fuel consumption rose significantly year-on-year, supported by a recovery in tourism (195k MT versus 77k MT), and was only 9% lower than in Q419. As for bunker fuel, demand increased to 590k MT (+11% y-o-y), due to increased coastal shipping activity, but was still significantly lower than in Q419 (Exhibit 7).

As pandemic-related restrictions reduce, we expect domestic traffic and air travel trends to remain favourable, driving demand for road and jet fuel in Greece and its neighbouring countries. This should benefit Hellenic in 2022. A decline in tourism arrivals from Russia due to sanctions may be a small offset (c 2% of total arrivals in 2019).

The refining benchmark margin of $3.9/bbl in Q421 was in line with our expectations, while the realised margin of $11.80/bbl in Q421 was $2.0/bbl above our forecasts. We have increased our estimated Q122 refining margin to $4.7/bbl from $3.2/bbl on the back of favourable January and February margins (implying $4.6/bbl) and significant margin increase in the first days of March. However, as we expect natural gas and electricity prices to remain high, we have increased costs in Q122 by €10m versus our previous estimates. Additionally, we reflect the impact of higher carbon prices (in line with current Bloomberg forecasts for 2022–26), which increase carbon costs by €8m in Q122 and €35m in FY22. All this translates into a net 2% increase in our EBITDA refining forecasts for FY22 (Exhibit 8), as higher margins and demand together with a favourable exchange rate (stronger US dollar) should offset the cost increases. If sustained, the March 2022 oil price hikes could lead to pressure on refining margins and higher refining margin volatility. However, due to the uncertain environment and complexity of the moving parts, we make only minor tweaks to our quarterly (in FY22) refining margins forecasts at this stage. We will continue to monitor developments in the run up to Q1 results.

Our total FY22 EBITDA forecast has increased by 3% supported by marketing (improved demand and higher margin products), as well as a €10m increase from the RES business due to the recent acquisition of an operational wind farm (38MW) and a solar photovoltaic (PV) plant (16MW). The company has guided that the current portfolio of 285MW (Kozani plus acquired projects) should generate ‘certainly over €30m’ EBITDA on an annual basis.

The balance sheet at end-December showed net debt (excluding lease liabilities) of €1,938m, €265m higher than end-FY20 net debt of €1,673m. FY21 operating cash flow of €270m was negatively affected by increased inventories (€690m), due to higher oil prices. Furthermore, Hellenic invested €400m, with 60% directed to RES projects (EU taxonomy eligible investments): the Kozani project (construction completed in Q421) and the acquisition of the 38MW Evia wind farms for €85m (Q421). Based on a November 2019 Hellenic presentation, internal rates of return (IRRs) for such projects in Greece may vary in the range of 5–8% for acquisition projects and 8–10% for organic development projects. Based on technological advancements and current market dynamics, we expect IRRs may now be higher than this. The company now owns 0.3GW of operational RES projects. In December, Hellenic completed the hive-down of its refining, supply, trading and petrochemical businesses, and plans to rebrand the company before the annual general meeting (AGM), which is scheduled for June, with a new name, logo and corporate identity in line with its Vision 2025.

In FY22, we expect operating cash flow of €264m, slightly lower than FY21, due to a negative impact from increased working capital (c €300m) due to a higher oil price. We expect free cash flow to be negative (€159m), due to the ongoing investment programme along with higher maintenance capex (€40m) affected by turnarounds in Elefsina (H122) and Thessaloniki (H222). Our end-FY22 net debt (excluding lease liabilities) forecast is €2,097m (versus €1,558m previously). We expect a rebound in operating and free cash flow in FY23.

The company has proposed a €120m annual dividend for 2021 (€0.40/share) to be paid in two tranches, one in April (€0.30/share) and the remainder (€0.10) after the AGM, in June. This is €0.30/share above the dividend for FY20 of €0.10/share, which had been cut significantly from €0.50/share in FY19. Additionally, Hellenic expects the sale of DEPA Infrastructure (in which Hellenic owns a 35% share) to be completed in H122, subject to regulatory approvals (not yet included in our model). Management indicated that it plans to return 50% of the proceeds to shareholders in FY22, equating to c €130m or €0.42 per share. Combined with our forecast dividend for FY22 of €0.31 per share, this would give a total estimated dividend for FY22 of €0.73 per share, equating to a yield of c 10%.

Our forecasts and valuation are based on the company’s current state. We do not include future projects presented in Vision 2025, or any capital expenditure or returns associated with them. We await further information about this from the company, which should be presented with the rebranding at the AGM. However, we see potential for upside from the new strategy and plan to update our valuation once we have better visibility. Vision 2025 will support the growth of Hellenic’s clean energy activities, including investment of c €1.7bn on wind and solar projects, targeting 2GW by 2030. It also involves upgrading Hellenic’s core refining operations aimed at a significant reduction in CO2 (50% by 2030, including both a reduction in emissions and offset through RES).

We value Hellenic using a blend of DCF, leveraged and unleveraged EV/EBITDA, and P/E multiples, arriving at a valuation of 7.48/share, 8% above our last published estimate (€6.91/share), primarily on account of higher FY22 estimates.

Hellenic trades at FY22e multiples of 9.5x P/E and 6.5x EV/EBITDA, compared with the European peer group averages of 7.2x and 5.2x, respectively. Hellenic’s EV per complexity-adjusted barrel is $1,555bopd, which is higher than the European peer average of 1,190bopd. Hellenic has the most-indebted balance sheet and highest leverage ratio among peers.

Our DCF valuation is at €7.31/share versus €7.41/share previously, adversely affected by expected working capital movements in FY22 driven by high oil prices, while the higher carbon prices (in line with current Bloomberg forecasts for 2022–26) should be partially offset by higher refining margins in FY22. Due to the uncertain environment and complexity of factors, we keep margins beyond FY22 unchanged for now and continue to monitor developments in the run up to Q1 results. Our valuation is based on cash flows to 2035, using a 7% cost of capital. We incorporate a terminal value, which assumes the unwinding of working capital and 1% terminal growth.