A key objective for the Contango Income Generator is to deliver a sustainable yet attractive income stream by investing in mid-cap companies with stable cash flows and consistent dividends.

In this mid-monthly update, I would like to present a stock in the portfolio that reflects these investment objectives, Viva Energy.

Viva Energy (ASX:VEA) is a major energy producer and supplier in the Australian market. VEA operates the Geelong refinery as well as a network of service stations across Australia, mainly under the Shell brand. Although the business has existed for over 100 years, its listed life is quite short. Global energy trading company, Vitol, acquired the business in 2014 and in 2018 the business was floated on the ASX.

CIE participated in the initial offer and since listing has purchased more shares on market at prices below the $2.50 initial offer price. CIE’s weighted-average entry price is $2.35. At 31 March 2019 CIE had a 2.3% position in VEA.

Viva Energy Group Limited share price since listing

Source: Bloomberg

VEA is considered an attractive investment for CIE for several reasons. Firstly, it is a stable business with a staple product which has very consistent underlying demand throughout the economic cycle. Volume growth in petrol is quite flat, but diesel and jet fuel have shown some growth.

The balance sheet is also relatively strong. When the company was under Vitol control, the service station freeholds were floated as a listed company called Viva Energy REIT (VVR). VEA holds over 30% of VVR and leases the service stations back from VVR. We adjust for this lease liability in our calculations of debt. Despite putting these liabilities back onto the balance sheet, the company still has adequate gearing.

The industry is known for its competition at the petrol pump, but the business is profitable and quite stable. The major competitors are BP and Caltex which follow a premium service model. Competitors such as 7-Eleven and United are discounters but lack the integrated infrastructure of the larger players.

Coles partnership

VEA has an attractive alliance with Coles through the Coles Express business. The alliance has been extended to 2029, which we consider a good outcome for VEA. Recently the alliance was changed with VEA gaining control over the fuel pricing decisions at the service stations. This allows VEA to tactically respond to market pricing. We view the changes as positive for VEA.

Source: Viva Energy

The refinery at Geelong is an important piece in the infrastructure and logistics network. Although it does expose the company to volatility in the refining margin, the refinery is quite profitable and is a relatively small part of the mix.

Source: Viva Energy

Viva has a market capitalisation of A$3.3bn, so is reasonably large. Market expectations are for a dividend of around 5% fully franked for the current fiscal year. Cashflow is good and capital requirements should be quite easily managed, leaving room for the company to acquire more service station sites and grow market share.

Source: Viva Energy

In summary, VEA is a stable, profitable business with some growth options. The balance sheet and cashflow are good and recent changes are considered a positive.