Caltex reported a 13% decline in first-half 2013 replacement cost net profit to AUD 171 million, in line with expectations. Revenue fell 2.5% to AUD 23.6 billion due to lower sales volumes and lower average prices. Marketing and distribution earnings before interest and tax, or EBIT, was in line with the record first-half 2012 result of AUD 367 million, as lower sales were favourably offset by lower production costs.

However, refining and supply was negatively impacted by the weaker Australian dollar (AUD 39 million), unplanned outages (AUD 29 million) and higher depreciation (AUD 27 million). Group net operating cash flow improved from AUD 67 million to AUD 244 million, comfortably ahead of levels anticipated. Positive free cash flow of AUD 70 million allowed a modest decline in net debt to AUD 730 million, net debt to equity falling to 32% from 34% at end December.

All in all a solid result, particularly at the important cash level. We are yet to complete a full evaluation of implications for earnings and fair value but don’t expect material changes at this stage. At AUD 18.85 per share Caltex remains materially overvalued on the basis of our most recent AUD 16.50 per share fair value estimate.

The market, remains overly optimistic on the potential for improved cash flows and dividends, although we agree improvement is coming. The conversion of Kurnell refinery to an import terminal is progressing to schedule and budget, and will expunge a major draw on capital upon completion in 2014. The positive implication for free cash flow is a major plank in the investment thesis for Caltex, but only at the right price.

Caltex’s extensive network and comprehensive product offering are modest competitive advantages. A very efficient supply chain makes Caltex an effective competitor but we don’t see this as sufficient to justify a moat rating. Potential risks include: volatility in the global crude oil price and the U.S. dollar/Australian dollar exchange rate; lightheavy crude spreads; and regional refiner margins. Caltex declared a AUD 17 cent interim dividend, less than our AUD 19 cent forecast.