Recent Initial Public Offerings (IPOs) have been a mixed bag. For every Medibank Private Ltd (ASX: MPL), investors have to sift through half a dozen Guveras, Dick Smiths and other basket cases.
The latest IPO to flash across my screen was the Viva Energy Ltd (ASX: VVR) IPO, courtesy of Nabtrade – no doubt many other readers will have received the same offer. There's often a lack of coverage on IPOs, which can make decisions more difficult for the average investor. Here's my take on the company:
What is it?
Viva Energy is the exclusive licensee for Shell products in Australia. The Viva Energy REIT (Real Estate Investment Trust) owns 425 service stations which it will lease to Viva Energy, who is its tenant.
The leases are 'triple net' meaning that Viva Energy (the tenant, not the REIT that shareholders will own) is responsible for all taxes, insurance, and maintenance. The tenant also agrees to indemnify/remediate the REIT in certain circumstances in respect to contamination of a site. This reduces the risk and costs for shareholders significantly. Although Viva Energy is the tenant, the service stations are operated by Wesfarmers Ltd's (ASX: WES) Coles Express.
The Manager of the REIT portfolio is a member of Viva Energy group (the tenant), so the commercial relationship appears to be closer than arm's length. The risk is reduced for shareholders as a result of extremely long lease periods, with a Weighted Average Lease Expiry (WALE) of 15.9 years, and contracted rent increases of 3% per annum. The company expects to pay a dividend yield of approximately 5.9% per annum at debut prices.
Who runs it?
The board of the company will be composed of an independent chairman, two independent non-executive directors, and two representatives from Viva Energy. These five do not own any shares but will purchase a combined total of 275,000 shares during the IPO process.
Viva Energy expects to retain an approximately 40% holding in the Viva Energy REIT, which it considers a strategically significant investment.
What's its financial situation?
Management expenses are expected to be around 0.32% of asset value per annum, or around $6.8 million in Financial Year 2017. Given that the business of the REIT can be forecast with some certainty due to its contracts, management's earnings predictions should be reliable.
Viva Energy REIT is expected to earn $155 million in revenue in its first full year of operation (Financial Year 2017), of which $31 million is finance costs, another $6.7 million are management costs, and the remaining $118 million is profit. The company earns enough to cover its interest payments 4.1 times over, which is acceptable.
The Viva Energy REIT will have cash of $7 million and debt of $730 million after the completion of the offer.
Key Risks
Since Viva Energy is the only tenant of the Viva REIT, if that company's business (Shell licensee/ petrol retailing in Australia) started to struggle it would be bad news for shareholders. There is a discussion of Viva Group's finances on page 37 that is required reading for would-be shareholders. There are the other risks including the significant share ownership by Viva Group, which will give it significant influence on management and in any votes.
Management is bound to act in the interest of shareholders with regards to further acquisitions, but given the biggest (although still minority) shareholder will be Viva Group, it looks as though the company has created a vehicle to make further petrol station acquisitions. Fortunately, the company's acquisition activity is limited by a bank-imposed gearing cap of 50% – gearing will be 35% at the time of launch.
Well, should I buy it?
I've run over the limit already and there's much more to discuss, like the 5.9% dividend yield, the group's gearing and debt covenants (page 139) as well as the dynamics of the Australian petrol market – readers should do further research on the topic for themselves. The Viva Energy REIT also has a limited operating history, while its main tenant is not a public customer. This creates transparency issues.
Based on what I've seen I believe the Viva Energy REIT looks solid, with great lease expiry lengths and guaranteed increases in rent per annum that are above the rate of inflation – for now. The company is launching at a 10% premium to the value of its Net Tangible Assets, which is not expensive compared to a number of other businesses out there.
The minimum subscription is $5,000 so there are portfolio size issues to consider, but if something like Viva Energy is what you're looking for I haven't seen anything to scare you off. That said, there's no need to race out and buy a business that grows at 3% per annum, so why not wait a while?
Over to you.
