This is a guest contribution from Simon Maina.
KenolKobil is a leading oil distributor and marketer of petroleum and other associated products (e.g. petrol stations) in East Africa. Of late, it has also extended its footprint into Southern Africa with Zambia being its most recent investment.
I find shares of the company particularly attractive because it:
- stands to benefit directly from the region’s economic growth,
- has a strong brand,
- and, under the current managing director, has cut down risk-exposures that previously bedeviled it.
This third point, I believe, will be the key catalyst behind improved performance over the short to medium term.
What’s Driving KenolKobil’s Turnaround?
The last time there was a significant decline in oil prices (in 2012), KenolKobil and other distributors posted significant losses. International crude oil prices declined sharply from around $127 to lows of around $77 per barrel. The Energy Regulatory Commission reduced fuel prices, which left distributors holding huge amounts of high-cost inventory.
Meanwhile, the shilling dropped sharply and interest rates nearly doubled. Thus, the company, which had borrowed to fund its oil purchases, was forced to sell fuel and other products at a loss in order to fund working capital. Falling demand compounded the problem as its corporate customers were forced to scale back due to high borrowing costs.
Oil prices have experienced an even greater decline in recent months than what was experienced in 2012. Will today’s low oil prices cause a similar decline in KenolKobil’s earnings?
I believe that’s highly unlikely even with a weakening shilling.
In fact, my view is that the decline in oil prices will have a positive impact on the company. Why?
- The lower amounts required to purchase similar volumes of oil mean a reduction in debt required to finance purchases. This cuts down financing costs and help increase the level of equity in the company.
- According to the company, they have no material commodity risk at the moment.
- The drop in the oil price this time, unlike during 2012, is happening in a favorable economic environment. Interest rates are stable, the exchange rate decline against the dollar is fairly gradual and marginal, and the economy is sound.
- East African governments’ infrastructure spending is likely to boost real household and business income. This is likely to reflect on demand. Lower oil prices also mean higher disposable income, and although the rise in oil consumption might lag a bit (as people drop their expectations of a reversal in oil prices), we could start seeing the effects after a few months.
- Vehicle imports have increased, partly as a result of a rise in middle class population. This means higher demand for oil, which has been rising at an average pace of around 6% per year.
- Given KenolKobil’s recent trend in earnings and debt reduction, the company is likely to be offered lower borrowing rates in future, which will increase both equity and earnings.
New Strategy Firing On All Cylinders
The company has been cutting down on loss making operations since 2012’s huge losses. Management now concentrates expansion in countries where returns on investment are disproportionately high and where the regulatory environment is favorable.
As a result of changes made, the company recorded an increase in gross profit by 18% and an increase in profit after tax of 95%. Financing costs declined by 22% and there was significant reduction in dollar denominated debt.
At today’s price of 8.85, the company has a PE of 11.95 and price to book ratio of 1.8.
An Attractive Target
Since Puma Energy’s failed acquisition attempt in 2012, KenolKobil has been the subject of a number of takeover rumors, with the most recent one suggesting interest from a Bahrain-based oil company.
The company’s distribution network and brand name makes it an especially good target for oil companies looking to make an entry into local markets. However the company had specified that it would only be interested in an acquisition that would support its strategic plans. Their preferred suitor would be able to offer, at a minimum, operational leverage such as competitive product pricing in international markets and access to shipping and storage facilities.
The Bottom Line
My view is that KenolKobil is poised for good growth as East Africa’s economy grows. It presents a good buying opportunity into the Ksh7.00 – 8.00 levels for investors with a long-term view.
I will be monitoring how the company copes with rising competition from new and existing distributors and risks associated with expansion in other markets, although, at the moment, the bulk of its revenues comes from Kenya.
I welcome your thoughts for or against my investment thesis in the comment section below.