Neste: We have to wait for the margin to turn

Translation: Original published in Finnish on 10/25/2024 at 00:30 am EEST

Neste’s Q3 report or the first comments from the new CEO offered no surprises. The market outlook for Renewable Products, suffering from oversupply, is challenging also for next year, but with market growth, we expect the current low gross margin to be higher in the medium term. Relative to these forecasts, the stock valuation is rather moderate looking over next year, so we reiterate our Accumulate recommendation. Reflecting our estimate changes, we lower our target price to EUR 17.5 (was EUR 19.0). The Q3 interview with Neste’s new CEO can be viewed here.

The steep fall in margins was largely as strong as expected

Neste's Q3 comparable EBITDA decreased by 3% to 293 MEUR, landing between our and consensus forecasts. A significant decrease in earnings relative to the comparison period was driven by clear reductions in margins in both main segments that were broadly as expected. The gross margin for Renewable Products suffering from the difficult market situation and oversupply fell to a low level of USD 341/ton in Q3 (Q3’23: USD 912/ton). Earnings were clearly below our expectations in Renewable Products, which reflected the effects of maintenance shutdowns and unfinished capacity ramp-up (incl. costs and limited production). However, this was offset by an earnings overshoot driven by higher-than-expected sales volumes in Oil Products, although it also suffered from a low refining margin as expected. The new CEO said that he has launched a comprehensive analysis of the company’s full potential, focusing on commercial activities, costs and, e.g., investments. Apart from the discontinued medium-sized hydrogen project investment, concrete measures from the analysis are expected next year.

Margin in Renewable Products likely to be subdued also next year

Neste reiterated its Renewable Products guidance updated in September, where sales volumes for the segment are expected to increase to 3.9 Mt (+/- 5%) and the comparable gross margin is expected to be USD 360-480/ton in 2024. We only fine-tuned our short-term forecasts. Reflecting this and the Q3 result, our forecast for the current year’s comparable EBITDA is 1,375 MEUR. 1,332 MEUR). However, our 2025 comparable EBITDA estimate decreased by 4%, mainly driven by the gross margin forecast. We believe the key uncertainty factor is still the gross margin in Renewable Products that will suffer from oversupply next year. The supply situation, together with the expected end of the tax relief (BTC), depresses Neste’s margin while increasing sales of renewable aviation fuel should strengthen it. In the medium term, we feel the margin is on a more stable footing and we expect market growth to restore a healthy margin, but it is naturally challenging to assess the exact timing of this.

Mixed valuation but we believe that patience will be rewarded

The valuation of the share is mixed, as the valuation multiples are very high with this year's weak performance. The overall picture of the valuation multiples does not turn attractive next year either (EV/EBIT 14x and P/E 15x), as we expect the Renewable Products' margin to still be at a low level. However, our medium-term forecasts for Renewable Products are significantly higher, relative to which the share is cheap. Thus, we believe that earnings growth based on increased sales volumes and a higher gross margin in Renewable Products create an attractive expected return.