New offtake contracts support increased revenue

BROG recently presented its H120 results for the period ending 30 June 2020. Results were in line with our estimates, with revenue standing at $23m vs $22m in H119, as Phase I operated and continues to operate at full capacity despite COVID-19 restrictions. Ancillary services amounted to 47% of revenues in H120. EBITDA stood at $17m vs $19m in H119. The decrease in margins is mainly due to increases in operations staff salary costs, for which we have adjusted our forecasts, and costs associated with the new disaster management changes implemented by the Fujairah Oil Industry Zone (FOIZ).

Subsequent to the period end, and since our initiation note published on 17 August 2020, BROG completed the issue of the $200m, five-year senior secured bond with a borrowing limit of $250m in the Nordic bond market. The bond’s proceeds allow for debt consolidation and provide a flexible financial platform to support future growth.

As Phase II is now entering the final stages of development, with capacity already fully contracted, BROG has been focusing on completing negotiations for the 25,000b/d, low-sulphur, modular refinery with Phase I offtakers, Al Brooge International Advisory (BIA), to take on the capex to build the refinery, which will be operated and maintained by BROG. Management expects activities to commence in H221.

With near-term developments in place or close to completion, BROG has also been working on the transformational Phase III. The front-end engineering design (FEED) study was completed in July 2020 and pre-construction works started in October 2020. These are expected to be completed by the end of the year. Management expects Phase III to come online in late 2022, as BROG is already in talks to secure take-or-pay contracts for full capacity of the Phase II terminal from various customers before construction starts.

In this note, we update our forecasts to account for the H120 results and to include the impact of the recently concluded offtake agreements for one-third of Phase I full storage capacity. The 50% premium in new contracts results in a 4% increase in our revenue estimates for FY21, with adjusted EBITDA increasing by 2%, as we have also updated our estimates for higher operations staff salary costs, in line with what was observed in the first half of 2020. This results in a decrease of 4% in our FY20 EBITDA estimate. The key catalyst for FY21 revenues will be timing of Phase II start-up, which we continue to assume for the beginning of 2021, in line with management guidance, and the modular refinery to begin operations in the second half of the year.

For FY20, we estimate revenue and EBITDA in line with FY19, at $46m and $36m, respectively. Before conclusion of the new offtake contracts, management guided that once Phase II and the refinery were online, annualised revenue and EBITDA could stand at c $130m and $128m, respectively. We estimate Phase II coming online in the beginning of 2021 and the refinery in H221. This results in our forecast revenue of $127m and EBITDA of $115m in FY21.

Short-term financial forecasts will be driven by Phase I and Phase II storage and ancillary services revenue. In H120, storage revenue accounted for c 53% of revenues and we estimate the breakdown will remain at c 50% once Phase II becomes operational. The ancillary services revenue may vary and depends on end-user needs. These needs tend to vary based on expected refinery product prices and trading activity. Consequently, there is significant uncertainty about the timing for revenue and cash flow forecasts for ancillary services. However, we expect BROG to generate positive free cash flow starting from FY21. The company is relatively unlevered, with total debt at 30 June 2020 of $119m based on a number of term loans and net debt of $118m. We expect net debt to increase to c $183m at end FY20 as capital is invested in Phase II, with $122m of total capex of $160m to be deployed in 2020 and early 2021.

We value BROG using a blend of DCF, and leveraged and unleveraged multiples, arriving at a valuation of $11.0/share, in line with our last valuation. The key assumptions in our valuation include estimates of asset development costs, operational costs, and revenue and operating results for BPGIC Terminal Phase I and Phase II. We use publicly available sources for our key assumptions including company guidance.

Although BROG achieved important milestones for Phase III this year by completing FEED studies and initiating pre-construction works, there is still significant uncertainty around timings and the project financing structure. Phase III will be transformational for BROG and will involve an investment of c $1.1bn. There is therefore significant upside potential to our valuation of the company. Once we have more clarity around these developments and how they might be funded, we will update our valuation accordingly.

Our base case DCF valuation has increased to $12.9/share from $12.8/share, reflecting the impact of the 50% premium offtake contracts for one-third of Phase I capacity in FY21. The DCF also reflects Phase II starting operations at the beginning of 2021 and the modular refinery starting operations in H221. In Exhibit 4 we provide a sensitivity to the impact of varying costs of capital and terminal growth on the DCF valuation, and in Exhibit 5 the consequent impact on our blended valuation.

Our peer-based valuation of BROG uses FY21 multiples. We believe the market is already attributing value to Phase II and therefore, for comparison purposes, FY21 numbers are more relevant. Due to recent market volatility, we look at peer metrics since FY18 to account for historical and actual valuations. The peer group average P/E from FY18 to date was 12.7x and 10.3x for EV/EBITDA (versus 13.2x and 10.3x respectively in our previous note), both higher than the current valuations for the peer group. The increase in our blended valuation was slightly offset by the lower market valuations of BROG’s peers, and therefore remains at $11.0/share despite higher forecast revenues for FY21.

On our assumptions for FY21, BROG currently trades at a P/E of 13.2x and an EV/EBITDA of 11.1x,. Looking at the peer group multiples on FY21e (Exhibit 7), BROG trades at a premium on both metrics (peers currently trade at a FY21e P/E of 8.6x and an EV/EBITDA of 8.7x) and we believe the premium the market is attributing to BROG accounts for the fact that it is a growing company with efficient operations and significant expansion potential in the near future.

As we mentioned in our initiation note, we highlight that there is not an extensive group of listed midstream companies identical to BROG. Most peers are North American companies which, in addition to storage terminals, also own pipeline networks or distribution infrastructure, with recent valuations and earnings directly affected by COVID-19 as oil demand reduced and oil exports and trading decreased. Peers are trading at c 25% discount to early 2020 market values. Exhibit 6 shows the impact of COVID-19 on the share prices of BROG’s peers.

We believe the most similar peer to BROG is Dutch company Koninklijke Vopak. Although Vopak is significantly bigger than BROG, in market value and storage capacity, its business model is more in line with BROG than the North American peers. Like BROG, Vopak’s share price has largely held its value since the beginning of the year. While BROG’s share price increased by 20% year to date, Vopak’s decreased by 10%. Exhibit 7 shows the peer group valuation.