Phase II underway, Phase III feasibility study

BROG’s development of its oil storage terminal facilities is a three-stage process. Phase I has been operational since 2017. Phase II, with a COVID-19 related delay of about six months, is now expected to be fully operational by end July 2021. Phase III, which will make BROG into the largest storage operator in Fujairah, is about to start a feasibility study, which, on current management assumptions, could lead to construction starting as soon as summer 2021 and completion potentially by mid 2023, as long as financing and project development plans are in place.

Phase I operations ran at full capacity in 2020, with a combination of high storage demand, new contracts and high automation, which resulted in no adverse impact from COVID-19 restrictions. For most of 2020, Phase II’s construction was not meaningfully disrupted by the COVID-19 situation; however, the second wave of the pandemic at the end of the year led to supply chain disruptions, such that management now expects operations to start in July 2021, around six months behind the earlier schedule. Phase II is already fully contracted; management confirmed that the signed agreements are not affected by the launch delay and budgeted Phase II capital expenses remain unchanged, totalling $160.6m. On completion of Phase II, Brooge’s storage capacity will be expanded by 602,064m3, which, together with Phase I, will take the total capacity of the BPGIC Terminals to 1,001,388m3. That will make BROG the second largest independent storage operator in Fujairah.

Meanwhile, BROG has been involved in negotiations for the 25,000b/d, low-sulphur, modular refinery with Phase I off-taker Al Brooge International Advisory (BIA). The refinery construction was postponed due to the COVID-19 pandemic, and BROG’s management currently expects the refinery activities to commence in Q122, six months behind previous expectations. The refinery will be operated and maintained by BROG, while BIA will build and own it. BROG has moved the project location from Phase II land to Phase III land, as there is more space available for the refinery, although the refinery construction and operations will be independent from Phase III investments and decisions. We have incorporated this delay into our FY21 forecasts.

The current global shortage of oil storage space has created high demand for BROG’s terminals from trading companies that require reliable storage facilities, crucial for their ability to trade physical oil. BROG took advantage of that situation and novated part of Phase I’s contracts, for 58% of total storage capacity, leading to a higher EBITDA margin in FY21. In December, the company announced new offtake contracts for a total storage capacity of 129,000m3 (with three oil trading companies, from November) and 104,074m3 (with two oil trading companies, from December) at a 50% and 60% premium respectively to previous contracts. Under the terms of the new contracts, BROG will provide storage at its Phase I facility for one year consisting of an initial six-month period, plus an additional six-month renewal period, subject to mutual agreement.

Looking at Phase II we cannot expect any similar announcements of contracts with premiums. The Phase II storage capacity is already fully contracted, and the price flexibility is very low. The agreements may be renegotiated not earlier than after two years.

In this note, we update our forecasts to reflect the delay in Phase II and the modular refinery (25,000b/d) start-ups and the additional concluded offtake agreements for 26% of Phase I full storage (not included in our last valuation). Key components of our overall 34% reduction in FY21 EBITDA estimates comprise: 1) the delay in Phase II start-up, which reduces our FY21 EBITDA estimate by 30% (we now expect Phase II to become fully operational at end July 2021 (from January 2021 in our previous estimates); 2) a 5% reduction to reflect the delay of the refinery start-up (Q122 compared to Q321 previously), hence no inflow from the refinery business in 2021; and 3) a partly offsetting 3% increase due to the most recent offtake contracts being at a 60% premium to previous contracts for 104,074m3 of storage capacity (the contracts for 129,000m3 storage capacity was already discussed in the December update note). Our FY22 estimates are not affected by the delays and we leave these essentially unchanged.

For FY20, we estimate revenue and EBITDA in line with FY19, but include one and two months’ impact of offtake agreements (started in November and December 2020), at $1m or +3% on EBITDA versus our previous estimates. Full year results will be published in March/April 2021.

Short-term financial forecasts will be driven by Phase I and the Phase II storage project, and ancillary services revenue. In H120, storage revenue accounted for c 53% of revenues and we estimate this will reduce modestly to c 50% once Phase II becomes operational. The ancillary services revenue may vary and depends on end-user needs, according to 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, overall, and, at this point excluding any future outlays or financing for the Phase III project, 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 have increased to c $172m at end FY20 as capital is invested in Phase II, with $90m and $32m of total capex of $160.6m deployed in 2020 and early 2021. For Phase III, as feasibility study has now been announced, management should be able to provide further details on financing and project development plans in Q221. This would give a clear roadmap for the project, at which point we would be able to incorporate Phase III into our model and valuation.

We value BROG using a blend of DCF, and leveraged and unleveraged multiples, arriving at a valuation of $11.4/share, up from $11.0/share. The increase in the blended valuation reflects peer-based valuation and the roll forward of our calculations to FY22 to capture the full year effect of both Phase II and the modular refinery operations.

Our base case DCF valuation reduces to $12.38/share from $12.90/share, reflecting the impact of delays in Phase II and in the modular refinery start-ups. We continue to use 2020 forecasts as a base as the company has not yet released FY20 results. 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 DCF approach is based on Phase I and Phase II only. Although BROG has achieved important milestones for the Phase III project by undertaking some pre-construction work, including front end engineering and the soil investigation and environmental report, and commissioning (in February 2021) a feasibility study for its Phase III oil storage facility, management has yet to finalise and report details around timings and the project financing structure. Phase III will be transformational for BROG and will involve an investment of c $1.1bn. BROG is involved in an ongoing process of negotiations with banks to secure financing of this investment; we assume it is likely to be a mix of debt and equity. 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 peer-based valuation of BROG uses FY22 multiples. We believe the market is already attributing value to Phase II and therefore, for comparison, FY22 numbers are more relevant as they include the full year impact of both Phase II and modular refinery operations. In light of the market volatility over the last year, we look back to peer metrics since FY18 to account for historical and actual valuations. The peer group average P/E from FY18 to date is 12.5x and 10.2x for EV/EBITDA (down versus 12.7x and 10.3x respectively in our previous note). Despite lower peer group multiples, our valuation has increased as we roll our calculations forward to FY22 to capture the full year effect of both Phase II and the modular refinery operations. Our December note was based on FY21 numbers, which considered only half year operations of the modular refinery (planned to commence in Q321) and led to deflated peer-based valuation as BROG’s FY21 EBITDA and EPS do not yet include full year contributions. That explains part of the increase in our total valuation, as we migrate to FY22 numbers. Another factor that needs to be considered is the fact that FY22 numbers are positively affected by an additional year of inflation, which is also increasing our valuation.

Exhibit 6 shows a detailed reconciliation of changes in our modestly increased valuation. The starting point is the previous blended valuation from our December note: $11.0/share as an average of peer-valuations EV/EBITDA ($9.9/share), P/E ($10.2/share) and DCF approach ($12.9/share). Moving down, we present the impact of each factor on our price per share valuation, for each valuation methodology. At the bottom, the sum of all the changes leads to our current valuation: $11.4/share as the average of peer-valuations EV/EBITDA ($11.0/share), P/E ($10.9/share) and DCF approach ($12.4/share).

The main change comes from including a full year impact of the refinery, instead of a half-year (‘refinery – to full year’). The effect of ‘change in peers’ multiple’ was not significant. The ‘other’ line in the EV/EBITDA valuation column includes the positive impact from our estimated decline in net debt (end-2022 vs end-2021).

On our assumptions for FY22, BROG currently trades at a P/E of 12.4x and an EV/EBITDA of 10.7x. Looking at the peer group multiples on FY22e (Exhibit 7), BROG trades at a premium on both metrics (peers currently trade at an FY22e P/E of 10.6x and an EV/EBITDA of 8.5x) 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 that, 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. Exhibit 7 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 in 2020. Since the market recovered from its March/April 2020 COVID-19 related collapse, BROG’s share price has increased by 16%, while Vopak’s decreased by 6%. Exhibit 8 shows the peer group valuation.