Augean — Update 30 November 2016

We believe that the announcement on 14 November of Augean’s partnership with the Port of Dundee to open a Decom Waste Management Hub offers Augean and its shareholders a positive earnings story over the coming years. More importantly, however, it gives Augean a toe-hold in the growth market of decommissioning North Sea energy infrastructure. Finally, it demonstrates the company’s market leadership in the integrated treatment and disposal of hazardous waste, a capability that transfers to a number of industrial sectors, which are legally required to pay for hazardous waste to be treated and disposed of responsibly.

According to an Oil and Gas UK research report (Decommissioning Insight 2016), £17.6bn will be spent on decommissioning oil and gas infrastructure between 2016 and 2025. The report estimates that 895,000 tonnes of infrastructure will come onshore to be processed and recycled over the same period and that it will require spending of £214m on onshore recycling and waste disposal. It is noteworthy that Oil and Gas UK believes the peak years for the emerging decommissioning industry will not be until midway through the 2020s.

Exhibit 1 shows several of the most important port and decommissioning yards for the North Sea in the UK and continental Europe. According to Decom North Sea, there are currently 46 decommissioning projects under way in the North Sea. Scrap recycling and hazardous waste treatment (Onshore recycling in Exhibit 2) only constitutes a small part of the overall industry size, with items such as well plugging and abandonment comprising the bulk of the overall forecast spend.

Oil decommissioning has a high degree of political sensitivity, especially in Scotland. There was a backlash from GMB and the press after Maersk Oil sent its Janice Floating Production Unit to Norway to be decommissioned. It was reported at the time that the work was carried out in Norway as the Scottish government was reluctant to support the decommissioning industry, as it did not fit with its political narrative of high future output and cash flow from North Sea oil.

This chimes with the fact that, in 2014, the Scottish government published a paper, Scotland’s Independent Expert Commission on Oil and Gas: Maximising the Total Value Added, in which it recommended that a proposed decommissioning regulator should have “the authority to delay, refuse or amend a decommissioning application”. However, by the summer of this year, First Minister Nicola Sturgeon appeared more resigned to decommissioning and indeed supportive of the nascent industry as a potential job creator. She said in the Holyrood parliament: “although we do not want to see premature decommissioning in the North Sea, decommissioning nevertheless is a massive economic opportunity for us”.

The long-term potential for the decommissioning industry is significant. We would argue, however, that there is very obvious potential for delays in the industry as a whole as it could be in the interests of both the UK government and the energy sector to delay decommissioning. Under UK law, the Westminster government funds half of decommissioning costs through tax rebates. Given the pressure on both energy companies’ and central government finances, it is entirely conceivable that decommissioning revenues take longer to materialise than currently forecast.

The Oil and Gas Authority (OGA), which regulates the oil and gas sectors as a whole, is a significant player in the sector. In its July 2016 Decommissioning Strategy, the OGA outlined its strategic objective as Maximising the Economic Recovery (MER) of the UK Continental Shelf by: prioritising cost certainty and reduction, decommissioning delivery capability and decommissioning scope, guidance and stakeholder engagement. The OGA is the most influential regulatory actor in UK oil and gas sector in general and decom specifically. Beyond its regulatory authority, it also has the power to issue licences and sanctions (fines) in the sector and is in overall control of budgeting in the decommissioning space.

The Port of Dundee is one of several in the UK to have realised the potential of decommissioning and invested capital in equipping its facilities with the ultra-heavy lifting facilities required to receive ‘topsides’ (the above-sea superstructure of a platform) into port. In its announcement, Forth Ports (the owner of the Port of Dundee) said it would invest £10m on a new quayside and heavy-lift capability to complement its existing deep-water berth and 60 acre land area. This will complete the three necessary pieces of infrastructure to carry out decommissioning work – draft, weight-loading facility and waste services infrastructure.

The partnership is consistent with Augean’s strategy in ANSS. Management has publicly stated its goal to win “new contracts for production platform, onshore waste management and decommissioning, diversifying away from exploration drilling waste management”. Augean hopes to have the requisite hazardous waste treatment permits in place by early 2017, with the facility expected to be fully operational by late 2017. By definition, the revenue stream from the partnership will be lumpy, with no framework contract in place, so forecasting earnings is difficult.

We estimate that ANSS will receive £2m of revenues from the partnership in 2018, which will produce £240k of operating profit based on a 12% margin. This would significantly increase our segmental operating profit forecasts by 27%, although the impact at group level is only 2.5% based on our forecast assumptions. We wait for more concrete news from management about future potential revenues as the installation nears commissioning in late 2017, but we would expect the facility to handle the decommissioning (scrap and waste treatment) of between four and six topsides pa when fully ramped up towards the end of the decade. We believe Augean’s revenue per project could be in the range of £500k to £1m. Long-term forecasting will be imprecise due to intermittent revenues from project work. Exhibit 2 shows the estimated impact of the Dundee partnership on the ANSS segment and group operating profit to 2018.

We also take the opportunity to tweak the rest of our forecasts to bring them in line with the current trading conditions, although the net effect of this is immaterial.

Until we have a clearer idea of the cash flow opportunity from the Dundee partnership, we do not attribute significant value to it. We explicitly forecast three-year forward cash flow, which incorporates the expected c £240k of EBIT and operating cash flow in 2018. This nudges up our NPV fair value per share by 2p to 90p. However, we acknowledge that this does not capture the potential future value. Exhibit 4 explores potential revenue and EBIT contributions from the Dundee partnership in more detail.

We increase our fair value from a range of 60-90p to a blended average of 80p (NPV, EVA and sector-based target EV/EBITDA). The increase in valuation reflects our explicit forecasts of the ANSS project plus other small changes at divisional level. We compare Augean to its closest UK-based and international peers. If we applied a European waste sector average one-year forward EV/EBITDA multiple (5.7x) on our revised earnings for Augean, it would imply a fair value per share of 84p (from 90p previously based on target P/E). We take an average of this number, our NPV-derived fair value per share of 90p (from 88p; post-tax WACC 8.5%, terminal growth 1%) and an EVA analysis (62p; previously 60p) in arriving at our fair value of 80p.