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Caltex's (CTX) stock price declined sharply in June following the release of earnings guidance that fell short of the market's lofty expectations, in part due to the strengthening Aussie dollar. This week we look at the result and consider the likely impact of continued Aussie dollar strength on the company's future results.
For the six months to 30 June 2007, the company generated a net replacement cost of sales operating profit (RCOP) of $255 million, matching the six months to 31 December 2006. This replacement cost measure adjusts for the impact of fluctuating crude oil prices, thereby affording a more accurate appraisal of management's performance.
Caltex is comprised of two core divisions, Refining and Marketing. Marketing promotes and sells Caltex products through a network of around 2000 service stations and accounts for around 40 percent of gross earnings.
Although sales volumes increased to 6.7 billion litres from 6.5 billion in the same period last year, increased competition weighed on the division's profitability.
Meanwhile, the larger Refining division, which we will focus on in today's article, purchases crude oil and converts it at the company's two refineries into petrol, diesel, jet fuel and other speciality products.
During the period, Caltex's refineries produced 5.4 billion litres of various fuels. The result fell short of the 5.6 billion litres produced in the prior six months due to planned maintenance shutdowns. For the full year to 31 December 2007 however, the refineries are on target to expand production by 7.8 percent to 11 billion litres.
The extent to which production flows through to earnings is largely determined by the refiner margin. The refiner margin is the difference between the cost of importing a barrel of crude oil and the cost of importing the barrel's equivalent of refined product.
As the chart below shows, while the refiner margin exhibits considerable volatility, the 2004 - 2006 average (as shown by the red lines) has been rising. Although, the margin appears to have stabilised so far in 2007
Source: Caltex
During the six months to 30 June, the refiner margin averaged US$10.74 per barrel, compared to US$9.76 in the same period last year.
However, the margin is quoted in US dollars. As a result, the deteriorating US dollar reduces the benefits of an expanding margin to the Refining division's Australian dollar denominated earnings.
In fact, Caltex estimates that the stronger Aussie dollar negatively impacted the Refining division's contribution to group earnings by $30 million for the period. Given our expectation of continued US dollar weakness, should we be concerned over Caltex's future profitability?
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