OKTA SKOPJE INVESTMENT DEEP DIVE
A special situation in energy sector with high margin of safety
"Heads I win; Tails I don't lose much" Mohnish Pabrai
Okta Skopje (MKOKTA101017) is the dominant importer and wholesaler of oil derivates on the North Macedonian market. A pending decision for reopening of the pipeline from Thessaloniki to the Okta facility in Skopje, can soon unlock its full earning potential and boost the stock price. Energy crisis in Europe is an additional tailwind for the company's earnings in the medium term.
At the price of 3.700 den, the stock is currently trading at 8 p/e multiple on the 2021 earnings, p/e of 4.7 on the trailing twelve months earnings (due to record Q1 2022 earnings) and very high Free Cash Flow yield of over 30%.
The company has a rock-solid balance sheet, without any long-term liabilities and huge pile of cash of 4.169 den per share. This makes Okta a “net-net” company with more cash that its market cap and negative enterprise value of 7.8 mil eur. Because it's an asset light business (not a producer, but oil derivates importer and wholesaler), Okta generates high Return on Invested Capital (26% in 2021).
Our conservatively estimated valuation of the company is between 8.000-9.000 den per share, which means an upside of approx. 230-250% and very limited downside from the current price.
INVESTMENT THESIS
After changing its business model in 2014, from oil refinery into oil derivates importer and wholesaler, Okta has become a much “leaner” operation with high Return on Invested Capital and Free Cash Flow due to decreasing operating costs and minimal CAPEX.
However, two factors have negatively influenced the earning and the share price in the last 24 months. First trigger was the collapse of oil demand and oil prices during Covid lockdown in 2020, while the second was a significant non-operating cost recognised in the 2020 and 2021 results (reservations for liabilities towards Customs administration, in the total of 975 mil den). As a result, Okta’s stock price has dropped from 4.500-5.000 den in 2019 and continued to hover around 3.500-3.700 den in the last 2 years.
But recently, several positive catalysts have emerged which can significantly influence the price in the next 6 to 12 months:
- The annual results for 2021, show historically record profit of 446 den per share, record EBIDTA of 839 den per share and FCF of 1.254 den per share. The oil prices have climbed back well above pre-pandemic levels.
- Q1 2022 earnings are record 508 den per share, driven by Ukraine crisis, resulting in higher oil prices and higher valuation of oil inventories that Okta holds.
- After 9 years of negotiations between Okta's majority owner Hellenic Petroleum and the Government of North Macedonia, there are concrete signs for issuing the licence the reopening of 213km (diesel) pipeline from Thessaloniki to the Okta facilities (Hellenic Petroleum Annual Financial Report on page 56 states the reopening for October 2022
The opening of the pipeline is likely a "bargaining chip" in the negotiations regarding 32 mil eur in damages that Hellenic claims from the Government. Once it happens, opening of the pipeline should considerably lower the diesel transportation costs (currently done by trucks) and unlock increase in the operating margin and profitability for Okta. It will also mean beginning of the process of Okta becoming regional distribution hub for Hellenic for all neighbouring countries. Such positive news should also bring this inefficiently priced stock, back into investor’s focus.
Negative factors can be summarised as following:
- Potential decrease of international oil prices in the future, could negatively influence the earnings and decrease the value of company’s oil inventories (due to Ukraine crisis, this development is less likely in the medium term).
- Opening of the pipeline has been postponed several times in the past, there’s in no firm guarantee this could not happen again.
- Customs administration issued additional tax liabilities of 194 mil den in 2021, above already reserved 781 mil den in 2020, for a total of 975 mil den, negatively impacting the net earnings for 2021 (on the positive side, the maximum amount of potential tax liabilities estimated by the company is 1.120 mil den).
- Dividend yield below 2% is very low, unless there’s change in dividend policy.
- The stock has very low liquidity, so it's suitable only for small and very patient retail investors.
Our conclusion is that due to several negative factors the stock price has been depressed, with negative sentiment among investors, making it significantly undervalued.
We consider that the negative effects have already been priced in, while the potential upside is considerably bigger. Meanwhile, crisis in Ukraine and Europe’s decoupling from Russian oil and gas has, additionally boosted the long-term prospects of the company.
For a price of 3.700 den, the investor gets a stock with 4.169 den of cash per share, while he acquires for free the entire (profitable) business, as well as all Okta assets.
This means very low downside and high margin of safety.
In the addition, in the next 6 to 12 months, there are several important catalysts that, if realised, can drive the stock price significantly higher.
As a result, the upside vs downside potential of the stock at this moment is highly favourable.
After the Okta refinery has stopped production in 2013 (burdened by old technology and uncompetitive production price per unit), Okta has changed its business model and instead of slow industrial company it has become asset light trading company – from 2014, it imports, stores and distributes oil derivatives.
Okta is the largest importer and wholesaler of oil derivates in MK with 69% of total imports, 90.3% of total exports and a dominant share of total trade in 2021.
Source: Energy regulatory Commission Annual Report 2021
Source: Energy regulatory Commission Annual Report 2021
Approximately 98% of costs are purchases of oil derivates from the majority shareholder
Hellenic Petroleum. Approx 25% of revenues are exports to the Kosovo market where Okta has 24% market share in 2021. Its biggest customer is Makpetrol.
Since mid 2019 the company started receiving a fee from the state, for storing big part of national oil reserves (estimated fee is 2-3 mil eur per year).
SHAREHOLDER STRUCTURE
Okta has 846.360 common stock issued. Majority owner is Hellenic Petroleum with 81,51%, while second biggest shareholder is Pucko Petrol with 10,87%. The rest of 7,6% of shares belong to a large number of very small shareholders. The distribution of 1329 small shareholders as of Nov. 2021, is the following:
From 1000 to 1.500 shares – 3 shareholders
From 500 to 1.000 shares – 6
From 250 to 500 shares – 13
From 100 to 250 shares – 38
From 50 to 100 shares – approx 400
Under 50 shares – approx 850
LIQUIDITY
Who is on the other side of the trade?
The trading volume of the stock is very low, with only around 4000 stocks traded in the last year (less than 0.5% of total shares and app 6% of free float), making it suitable only for small, longterm retail investors (who are willing to take the risk of being "locked" in the stock). Majority of domestic investors are dividend oriented, so they are not interested in the stock and have negative sentiment towards it. The sellers are the very small individual shareholders (mainly current and former employees). There are no bigger buyers.
Hence, the share price is highly inefficient – for example, the stock is trading at the same price of around 3.600-3.700 den after announcing a loss of 521 mil den in 2020 and after announcing a record profit of 378 mil den for 2021, with oil prices at record levels.
Since changing the business model in 2014 Okta has been working profitably. During this period, we notice several one-time, non-operating costs, which negatively influenced the earnings in a significant way. We would not expect those to repeat in the future.
**Out of which 129 mil is write down of the value of old equipment (when commencing the sales of catalytic convertor from the old refinery).
***Reservation for tax liabilities from Customs administration for additional taxes.
We see that the biggest influence on the net earnings (in addition to international oil price fluctuations), is caused by the one off, non-operating costs – such as severance payments in 2014 and 2018 write-off in the value of catalytic convertor from the old refinery before it was being sold (the convertor contained valuable platinum) – this has resulted in negative accounting cost, while in fact the company has received extraordinary income and cashflow totalling approx 3 mil eur from the sales of the platinum in 2019, 2020 and 2021.
In 2020 and 2021 Okta reserved 781 mil den and 194 mil den respectively, upon the decision from Customs administration to charge the company with additional taxes. Part of these taxes have already been paid in 2020 and 2021, but the company is contesting this decision in court. Quote from the 2021 annual report:
"In 2019, the customs authorities in North Macedonia, conducted an audit in OKTA, with regards to excise duties of eurodiesel imports, for the fiscal years 2014 - 2018. They are of the opinion that, excise duties related to these imports, were not correctly calculated and they issued relevant decisions for the fiscal year 2014, imposing additional amounts of 23.4 million MKD or EUR 380 k, which were paid in 2020. The Company filed lawsuits within 2019, initiating administrative disputes, seeking full annulment, on grounds of substantial violations of procedural rules from the customs authorities’ side, their failure to completely and correctly establish the facts of the case and to correctly apply substantive laws. As of December 2021, the authorities issued new decisions for the fiscal years 2015, 2016 2017 and 2018, imposing additional amounts of 830 million MKD. As at 31 December 2021 the company recognised a provision of 954 million MKD representing the company’s best estimate of potential future cash outflows. The Company retains its position that it has acted in full compliance with all relevant laws, also as per expert’s opinions received and intents to contest such decision to the ultimate judicial authority including if possible to international jurisdictional forums."
Update: On 16.11.2021, the Higher Administrative Court (Виш Управен Суд) has rejected Okta’s appeal and confirmed the initial Administrative Court ruling, confirming that Custom’s decision was lawful. We are not aware if Okta has other legal instances, domestically or internationally to further appeal the decision.
In conclusion, after analysing the results, we see that Okta is consistently generating operating profit and when excluding the one-time, non-operating expenses, it achieves average EBIDTA of 500 to 600 mil den (with EBIDTA of over 800 mil den in 2021).
This can be explained by the new, much leaner business model (wholesale trade), which requires significantly less capital, investments, and employees.
The table below shows that while Okta has been able to grow the revenues over time, it is continually decreasing the fix assets (by depreciation and sell off), as well as lowering the number of employees - the number of employees from 2014 to 2021, has decreased from 458 to 268, while the cost for gross salaries decreased from 387 mil in 2014 to 332 mil in 2015 and 259 mil in 2020.
Equally important, while the company books relatively high levels of amortisation, it has very small CAPEX – less than 100 mil den per year – invested mainly in maintenance of its storage facilities.
This results in very high return on invested capital (ROIC) of 26% and FCF yield 33% for 2021.
For example, in 2021:
- EBIDTA: 839 mil den
- CAPEX: -99 mil den
- Tax: – 75 mil den
- Amortisation: 155 mil den
FCF (2021) = 839 - 99 - 75 + 155 = 820 mil den, or 969 den per share (1.254 den including changes in Working capital)
FCF (2020) = 630 - 88 – 33 + 176 = 685 mil den, or 809 den per share (excl. changes in WC)
FCF (2019) = 554 -74 – 39 + 250 = 692 mil den, or 817 den per share. (excl. changes in WC)
As the result of strong FCF, the company has high FCF Yield of 22% to 26% in the last 3 years (excluding changes in WC) and keeps accumulating cash. As of 31.12. 2021, it has a huge stash of 3.527 mil den of cash, or 4.169 den per share.
VALUATION
In our valuation model, for calculating Weighted Average Cost of Capital (WACC), or the discount rate, we use data from Aswath Damodaran. According to the data, the Total Equity Risk Premium for North Macedonia as of Dec 31, 2021 is 7,8% https://pages.stern.nyu.edu/~adamodar/, and risk free rate is app 3% (10 years US treasury bond yield), for a total of 10,8%.
To calculate the Earning Power, first we need to adjust the op. earnings (by subtracting the part of CAPEX needed for regular business operations and adding back the amortisation, since amortisation is an accounting, but not cash cost). Since Okta doesn’t make any significant new business investments, we consider that the full CAPEX amount is needed for regular current functioning of the business.
Average CAPEX (2016-2021) = 114 mil den
Average amortisation (2016-2021)=220 mil den
Earning Power (before taxes) = 462 + 220 – 114 = 568 mil den.
Tax rate 10%
Earning Power = 511 mil den.
Second, we discount the Earning power with the cost of capital (our required return on capital).
Earning Power Value (EPV) = EP/WACC = 511/12*100 = 4.258 mil den.
Lastly, we need to add the cash in the balance sheet, of 3.527 mil den
We get total company value of 7.785 mil den, or 9.267 den per share.
If we use discount rate of 10.8%, we get share value of 9.831 den.
One could (rightfully) claim, that in our calculation we dismissed the cost of 950 mil den claimed by the Customs office, which significantly influences the total earnings for the period 2016-2021. By taking out this amount (and including the results for q1 2022) we get an average operating margin of 1.19%, EP of 375 mil den and EPV of 7.919 den per share, using 12% WACC.
However, observing the trend of increasing operating margin in the last 3 years and the fact that Custom’s penalties refer to the past period from 2014 – 2018, we consider that the current real earnings power is closer to our initial calculation of app 500 mil den, if not higher.
GROWTH POTENTIAL
While the energy crisis and higher oil prices in H2 2021 and 2022 have dramatically increased the revenues of Okta (during the winter the company also facilitated the import of 150.000t of petroleum jelly for thermo electric plant “Negotino”), we think that in the longer term Okta has no significant room to increase its revenues from its current operations on the domestic market, above the levels of approx 30 bil den. 2022 could be an exception with 11 bil den of revenues already achieved in Q1.
However, in the likely case of re-opening of the pipeline, the announced strategy of Hellenic Petroleum is for Okta to become a regional storage and distribution hub, covering the Balkan countries where Hellenic already operates - KOS, MNG, SRB and BG. This can potentially significantly increase the revenues and earnings of Okta.
“…HELPE to propose investments both in RES (Renewable Energy Sources) projects in the neighbouring country and in the conversion of OKTA facilities into petroleum transportation hubs for other neighbouring countries where the Greek oil group is active”. (Quote from news report detailing the negotiations between MK government and Hellenic regarding opening of the pipeline https://www.ot.gr/2022/03/08/english-edition/north-macedonia-requests-the-operation-of-the-elpe-okta-oil-pipeline-due-to-ukraine-war)
Lastly, despite the announcements of “peak oil” and gradual electrification of transportation in the developed countries, we don’t consider that electric vehicles penetration in the key Okta markets, will be more that symbolic any time soon. Thus we don’t expect any significant impact on the current fossil feels consumption levels in the next 5-10 years.
DIVIDEND AND CAPITAL ALLOCATION
The company is paying low, but relatively regular dividend.
Considering the huge cash position in the balance sheet and strong FCF, as well as their considerable impact on the valuation, we need to analyse this topic in more detail.
What is the reason for accumulating so much cash in the balance sheet?
Answering a shareholder question on the ASM back in 2017, the management explains that the high cash level is connected to the expected re-opening of the pipeline. "...It is a period of low prices of our products which may increase, and on the other hand, the pipeline might become operational, due to which the company will need higher available funds".
Hence, we could assume the cash is being prepared for:
- CAPEX investments in turning Okta into regional distribution hub for Hellenic (as per company strategy) by improving and expanding the unloading and storage facilities.
- Increased investments in RES as per Hellenic company strategy and as part of negotiations settlement with the Government (one possible negotiation outcome is for the Government to pay the 32 mil eur damages to Hellenic, but Hellenic to oblige to invest a similar amount in RES projects through its Okta subsidiary)
- Payment of the penalty to the Customs office (as per reservation of 954 mil den).
- Possibly large one-time purchase of diesel fuel needed to fill in the pipeline*
* Our back of the envelope calculation shows how much diesel is needed to fill in the pipeline. The pipeline is 213km long x 16 inches diameter, this gives a total volume of 26.765 m3. With specific weight of diesel of 0.85 we get to 22.700 tons of diesel to fill in the pipeline. If we use a rough wholesale price of diesel of 0.5 eur, we get 11.375 mil eur needed to fill the pipeline.
With this operation we can expect the cash position to decrease and inventories to increase.
- Acquisition (in the limited extend this is possible on the small domestic market)
- We should also notice that in 2021 the cash balance additionally increased due to changes in the working capital. We can expect similar changes in the opposite direction in the future that would somewhat further decrease the cash position.
But despite capital allocation options mentioned above, which are expected to push the cash balance significantly lower in the period after negotiations are settled and the pipeline is opened, we should also keep in mind that Okta is also a “money making machine” with positive FCF of around 600 to 800 den per share per year.
So how can the company allocate this excess cash? Another possibility, of course, is returning the excess capital to the shareholders through higher dividend. In our view increasing the dividend in the future (or even paying out extraordinary dividend), would make the most sense – but we don’t know when and if Okta would do it - certainly not before negotiations between Hellenic and the Government are settled (more on this in the next part). An encouraging sign for the dividend policy in the long term, comes from the practice adopted by basically all other large Greek majority owned companies in the country – Stopanska Banka, Usje and Mermeren Kombinat – which are all using very high dividend payout of over 70% to return the capital to their majority owners. We can only hope that Okta would a follow a similar policy, once the negotiations between Hellenic and the Government are settled, in which case we could expect a much higher dividend payout in the future.
If we estimate that in a typical year the company has FCF of around 600-800 den per share, it could easily distribute a dividend of anywhere from 250 to 500 den, without missing a beat.
THE NEGOTIATIONS AND PIPELINE
Opening of the pipeline can be an important catalysts in the next 6 to 12 months that could influence the earnings, change the investor’s sentiment and increase their interest for the stock.
After several years of announcement and postponing, there are concrete reports about potential re-opening of the diesel pipeline in second half of 2022 - From the Hellenic Petroleum 2021 Annual report published in April 2022 (page 56):
"International activities refer to the OKTA facility, which is located in Skopje and is connected to Thessaloniki refinery through a pipeline for the transportation of high value-added products (e.g. diesel). The pipeline has not been operational since 2013 and is expected to commence operation during October 2022".
We should keep in mind that the opening of the pipeline is part of the complex ongoing negotiations between Hellenic and the Government of North Macedonia regarding the damages claimed by Hellenic in the amount of 32 mil eur (for the period 2008-2011). The process in front of the arbitrage court in Paris has been temporarily paused, so the two sides can reach an agreement.
One assumption could be that the Government is withholding the license for reopening of the pipeline and using it as a “bargaining chip” in these negotiations. We don’t know when the negotiations could be resolved, but the signals from both sides indicate it could be this year. The interest to resolve the issue is mutually boosted by the raging energy crisis in Europe.
"The government of North Macedonia is said to have scoped out the management of Hellenic Petroleum for the reopening of an oil pipeline between the Thessaloniki refineries and the OKTA oil facilities in Skopje that has been closed for the past nine years.... According to reports, the new government was mobilised after the turmoil caused by the Ukrainian war on Europe's energy efficiency. North Macedonia wants to open the taps of the pipeline again so that there is a safe and alternative supply of their country with petroleum products from HEL.PE." Source: https://www.ot.gr/2022/03/08/english-edition/north-macedonia-requests-the-operation-of-the-elpe-okta-oil-pipeline-due-to-ukraine-war
Once the agreement is finally reached and the license to opening of the pipeline is issued, it should significantly lower the transportation costs for Okta and result in increased profitability. This will also mean the beginning of the process to turn Okta into a transportation hub for the wider Balkans region for Hellenic Petroleum. In addition, Okta can start renting out its storage capacity to other companies using the pipeline. The company could amend its dividend policy (it would not be burdened anymore by the possible negative media and political reactions due to high dividend payout during negotiations). Lastly, the media attention around successful finish of negotiations and opening on the pipeline should put the stock back on the investor’s radar.
RISK FACTORS
1. Profitability of Okta is heavily influenced by the international oil prices (around 300 mil den from the EBIDTA in 2021 is a result of positive appreciation of inventories) – hence we should not use 2021 or 2022 as a “typical” year for the financial performance of the company. It seems more prudent to somewhat discount those results to “average” out the fluctuations in the oil price (as we did in our valuation).
2. Okta is purchasing all the products it sells from its majority owner (98% or costs are for purchases from Hellenic). Hence, there is room for potential price manipulation with Okta paying artificially higher prices, therefore siphoning potential profits directly towards Hellenic. Minority shareholders have no visibility, if and to what extent, this is happening.
However we should note that after opening of the pipeline, the profits from the storage services that Okta might charge from other companies, as well as all the profits from future RES investments, will be direct profits for Okta and the best and simplest way for Hellenic to reclaim these profits will be through dividends.
3. Some news analysis point to the fact that the pipeline will most likely be available for use for all interested importers in North Macedonia, meaning Okta would not have monopolistic position (the pipeline is not owned by Okta, but by Hellenic through its Vardax subsidiary and a smaller percentage by Government of North Macedonia). So Hellenic might continue to siphon out profits by charging high fees to Okta for using the pipeline. Despite this, it's hard to believe that the gross margin of Okta will not increase from current levels after opening of the pipeline.
4. The maximum penalty by the Customs, according to internal Okta estimates can reach 1.120 mil den, meaning potential additional costs of 145 mil den above the already booked 975 mil den.
5. Okta currently pays a low dividend, which on the domestc market (where investors are predominantly interested in dividend yield), makes the stock rather unattractive.
6. The stock has small free float and low liquidity, making it unattractive for institutional investors and majority of retail investors.
7. Future CAPEX investments in RES, could potentially be capital destructive for the shareholders if not properly planned and executed (the high energy prices in the foreseeable future significantly decrease this risk).
8. In the balance sheet the company has an old receivables position of 769 mil den in an “Escrow’ account (inherited from before the purchase of the company by Hellenic in 1999). Those have not been written off, while the possibility for them being collected is practically non existing. As per company statements, the balance on this account is also zero.
9. Since Hellenic has 81,5% of shares there’s a (minimal) risk for the majority owner to buy off the shares of Pucko Petrol and from few other small shareholders, thus quickly reaching 95% of ownership and triggering the legal obligation for the remaining small shareholders to sell their shares to Hellenic.
10. North Macedonia is facing general economic, political and security risks typical for undeveloped frontier market (hence we use a conservative rate for the cost of capital of 12%).
FUTURE OUTCOMES
Our baseline scenario was outlined in the valuation above - with current level of profitability we estimate that the company has earning power of around 500 mil den per year and valuation of around 9.000 den per share. We assign a 50% chance to this outcome.
In the bull case, opening of the pipeline unlocks increased operating margin and profitability, while investments in RES and transformation of Okta into a regional distribution hub, start bringing significant additional earnings. This depletes the cash on on balance sheet (as it gets invested), but likely doubles the earnings power in the next 3-5 years. Change in the dividend policy and high dividend payout becomes additional catalyst for the investors and expands the stock price multiple. In this case we estimate roughly doubling of value compared to the baseline case (minus the invested cash), or 12.000-15.000 den per share in 3 to 5 years. We assign a 35% chance to this outcome.
In the bear case - the reopening of the pipeline is postponed indefinitely, or Okta starts paying artificially high fees to Vardax/Hellenic for using it, keeping the profit margin low (but not lower than current levels). Payment to Customs office wipes out 1 to 1.2 bn den from the cash balance. All the remaining cash is invested in RES projects, but investments are done poorly and destroy the capital by generating low returns. Without the cash on the balance sheet, the fair valuation decreases to around 6.000 den per share. A global recession brings pessimism in the equity markets, so the stock price further decreases from the current levels to around 2.500-3.000 den per share.
But, as stated before, there are several important factors that make this outcome less likely and "protect" the investors (Customs penalty is already priced in, Okta, along with the whole energy sector, keeps generating record profits in 2021, 2022 and beyond due to sustained high oil prices, electricity prices in Europe will stay high in the coming years, etc). Hence, we assign a 15% chance to this outcome.
CONCLUSION
Okta has until recently faced a fair share of negative factors, but our thesis is that those have been mostly discounted in the current share price. On the other hand, the company has a very strong balance sheet, plus it generates high return on capital and strong FCF.
Most importantly, there are several potential catalysts in the next 6 to 12 months that could turn a new page and unlock the full potential of the company, while having significant positive impact on the price.
But even if those catalysts fail to materialise any time soon, the current price offers a wide margin of safety. A patient investor is acquiring a net-net stock able to generate 400-500 den of earnings per share in a typical year and able to pay out a high percentage of these earnings through dividends.
While he/she is waiting for the catalysts to trigger a price appreciation, he/she is compensated with a dividend yield of approx 2%.
In conclusion, at the current price, the upside vs. downside potential is highly asymmetric, making the stock a very favourable investment.
"My largest positions aren’t the ones I think I’m going to make the most money from. My largest positions are the ones where I don’t think I’m going to lose money." Joel Greenblatt
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