Brooge Energy — Equity raise planned for Phase III project

BROG is developing its oil storage terminal facilities in three phases. Phase I has been operational since 2017, while Phase II is expected to be fully operational in Q321. The feasibility study for Phase III, which will make BROG the largest storage operator in Fujairah, will be completed soon. Based on current management assumptions, Phase III construction should start in H221 and complete by mid-2023, once the financing and project development plans are in place. Meanwhile, BROG is engaged in discussions with global oil majors to ensure that Phase III capacity is fully contracted (with multi-year take-or-pay contracts) prior to commencing construction.

Phase I operations ran at full capacity in 2020, with a combination of high storage demand and high automation, which resulted in no adverse impact from the COVID-19 pandemic-induced restrictions. Phase II is already fully contracted; on completion, BROG’s storage capacity will expand by 602,064m3, which, together with Phase I, will take the total capacity of the BPGIC Terminals to 1,001,388m3, making BROG the second largest independent storage operator in Fujairah.

Additionally, BROG is involved in negotiations (extended to Q221) for the 25,000b/d, low-sulphur, modular refinery with Phase I offtaker Al Brooge International Advisory (BIA). The refinery will be operated and maintained by BROG, while BIA will build and own it. BROG’s management expects the refinery activities to commence in H122.

The global shortage of oil storage space has increased demand for BROG’s terminals from trading companies that require reliable storage facilities, crucial for their ability to trade physical oil. In Q420, BROG took advantage of that situation and novated part of Phase I’s contracts, leading to a reduction of customer concentration risk (previously BIA was the only customer). The contracts with the five new customers (traders), for 58% of Phase I oil storage capacity, at 50% and 60% premium on a fixed fee over the previous contracts, were announced in December 2020. However, the new customers have no or minimal requirement for ancillary services (eg throughput services, blending, heating, and inter-tank transfers).

Ancillary services revenue may vary based on end-user needs, depending on expected refinery product prices and trading activity. Reduction in demand for ancillary services was observed globally in recent months (experienced also by Vopak, BROG’s peer), as oil storage facilities have been used more by traders, who typically have low demand for ancillary services.

Under the terms of the offtake contracts mentioned above, BROG will provide storage at its Phase I facility up to one year, consisting of an initial six-month period plus an additional six-month renewal period, subject to mutual agreement. That means in FY21 we will likely observe further deterioration in Phase I’s ancillary service revenue, putting pressure on Brooge’s operating margin.

Looking at the Phase II project, which management expects to be operational in Q321, its storage capacity is already fully contracted, and agreements can be renegotiated not earlier than after two years. The main customer is BIA (the Phase I offtaker). Based on historic operations, we would expect fixed storage fee and demand for ancillary service in Phase II to be broadly similar to Phase I levels before the addition of new Phase I 2020 contracts. Additionally, the EBITDA margin should expand with Phase II commencing, as direct costs (for example employee costs) would not increase in proportion to revenue increase and general and administrative (G&A) expenses would remain unchanged.

Our short-term financial forecasts will be driven by the Phase I and Phase II storage projects, and ancillary services revenue, which may vary. Consequently, there is significant uncertainty about the timing for revenue and cash flow forecasts for ancillary services. In FY20, ancillary services contributed 39% of revenue (versus 46% in FY19), down 18% y-o-y to $16.5m; 23% below our estimates. The discrepancy between actuals and our estimates came from our assumption of ancillary services for the new contracts signed in Q420, which we had based on FY19 historical demand (when BIA was the main customer for the whole of that year), while in the event, the new customers-traders used no ancillary services.

In this note, we update our forecasts to reflect the changes in ancillary services revenue, direct costs, and G&A expenses. Key components of our overall 29% reduction in FY21 EBITDA estimates comprise: 1) decline in ancillary service revenue for Phase I, which reduces our FY21 EBITDA estimate by 23%; 2) 5% reduction to reflect increase in direct costs, mainly due to higher employee cost; and 3) 1% decline from higher G&A expenses (Exhibit 1).

In our revised forecasts, we expect Phase I ancillary service revenue of $5.8m in FY21 (versus $16.5m in 2020), taking into account that 58% of the storage capacity is being used by five customers-traders that will have no or minimal requirement of ancillary services by the end-Q321 (12-month agreements). For Phase II, we have assumed 44% revenue from ancillary services, as the main offtaker would be BIA, historically using ancillary services. For FY22, we have assumed 44% ancillary revenue each for Phase I and II compared with 46% in our previous estimates (10% decline in ancillary services revenue versus previous estimates, reflecting uncertainties on ancillary services, Exhibit 1).

The company’s FY20 revenue from fixed fees was in line with our estimates and improved 6% y-o-y supported by new contracts. We leave our assumptions for FY21–22 unchanged, including the additional contribution from the new contracts of $7m in FY21.

In FY20, BROG’s direct costs went up 27% y-o-y mainly driven by higher employee expenses due to an increase in the cost of outsourced staff at the Fujairah plant, disaster management charges, and the port charges ($1.6m, previously netted off). The increase in G&A expenses (+147% y-o-y) to $6.5m, was mainly due to higher consultancy and audit charges. Those items are likely to recur, and we estimate that overall G&A expenses will remain at c $6m going forward, in line with management guidance.

The aforementioned factors led to a drop in FY20 EBITDA margin to 69% (versus 84% in 2019 and 80% Edison estimate). We forecast an EBITDA margin of 80% in FY21 (versus 89% previously) and 86% in FY22, supported by Phase II full contribution.

In November 2020, BROG issued a $200m bond to repay the Phase I financing facilities, fund capital projects for Phase II, repay payables, and pre-fund the liquidity account. Under the bond agreement, on the company level, Brooge Petroleum and Gas Investment Company (BPGIC) is subject to the following financial covenants: to maintain $8.5m in the liquidity account; leverage ratio not to exceed 5.5x at end-2020 (versus 4.9x reported end-2020), 3.5x at end-2021 and 3.0x anytime thereafter; and maintain positive working capital. At the group level, BROG is required to maintain a minimum equity ratio of 25% (versus 29.7% actual in FY20).

As of 31 December 2020, BROG’s net debt was $166m (excluding restricted cash and lease liabilities) leading to group’s net debt-to-EBITDA at 5.7x (versus 1.9x at end-2019, Exhibit 2), while net debt excluding restricted cash and including lease liabilities was $255m. We forecast FY21 operating cash flow of $39m, comfortably covering the $33m remaining capex for the Phase II project (total over 2019-2021e was $160.6m). This leads to our forecast end FY21 net debt of $160m (excluding restricted cash and lease liability) 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 from FY21.

The company is preparing to raise equity capital for its Phase III oil storage facility, and on 19 April 2021 filed a shelf registration statement (Form F-3) with the SEC. BROG intends to conduct an underwritten public offering of ordinary shares to fund the construction of the Phase III project. If the registration statement is declared effective by the SEC, up to $500m of various securities, including ordinary shares may be offered and sold by the company from time to time. The registration statement additionally relates to the potential sale of up to 6m ordinary shares that may be offered from time to time. The final terms will be published in the forthcoming final supplemental prospectus.

For Phase III, with the feasibility study expected to be completed in Q221, and with visibility around the planned equity raise, management should be able to provide more details project development plans in Q2–Q321. 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 $10.3/share, down from $11.4/share. The decrease in the blended valuation reflects the decline in ancillary services revenue and costs increase, leading to lower profit margin impacting both DCF and multiple valuations.

Our base case DCF valuation reduces to $11.7/share from $12.4/share, reflecting the impact of our revised estimates for FY21 on Phase I (significant decline in ancillary services revenue due to 12-month contracts with new customers, using little or no ancillary services, and higher costs based on FY20 cost increases). Additionally, we implement a more conservative approach to our revenue forecasts for FY22 and beyond to capture the uncertainties on ancillary service revenues. That results in 10% lower ancillary services revenue compared to our previous assumptions (Exhibit 1), leading to a 4% drop in total revenue (Phase I and Phase II). These assumptions drive a reduction in our FY22 estimated EBITDA margin (to 86% versus 90% previously, but still a step up from our current estimated FY21 EBITDA margin of 80%) and in our valuation. This was partially balanced by the positive impact of rolling forward to 2021 forecasts. In Exhibit 4, we provide sensitivity to the impact of varying costs of capital and terminal growth on the DCF valuation. Exhibit 5 shows 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 pre-construction work, including front-end engineering, the soil investigation and environmental report, and the ongoing the feasibility study (commissioned in February 2021) for the Phase III oil storage facility, management has yet to finalise and report details on timings and the financing structure. Phase III will be transformational for BROG and will involve an investment of c $1.1bn and it is likely to be a mix of debt and equity. BROG is involved in an ongoing process of negotiations with banks to secure financing of this investment and recently announced a proposed equity raise up to $500m (subject to the registration statement being declared effective by the SEC). There is, therefore, significant upside potential to our valuation of the company. We will update our valuation once we have more clarity about all the developments, including funding.

Our peer-based valuation of BROG uses FY22e multiples. In light of market volatility last year, we have factored in peer metrics since FY18 to account for historical and actual valuations. The peer group average P/E from FY18 to date is 12.6x and 10.2x for EV/EBITDA (unchanged from the previous note). Our valuation was negatively affected by the aforementioned downward revision in our forecasts.

On our assumptions for FY22, BROG currently trades at a P/E of 11.5x and EV/EBITDA of 11.3x (EV calculated with net debt excluding restricted cash and including lease liabilities). Looking at the peer group multiples for FY22e (Exhibit 7), BROG trades at a premium on both metrics (peers currently trade at an FY22e P/E of 11.4x and an EV/EBITDA of 9.2x) 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 mentioned in our initiation note, we highlight that there is no extensive group of listed midstream companies identical to BROG. Most of its peers are North American companies that, in addition to storage terminals, also own pipeline networks or distribution infrastructure, and have seen their valuations and earnings directly affected by the pandemic as oil demand reduced and oil exports and trading decreased. Exhibit 6 shows the impact of COVID-19 on the share prices of BROG’s peers.

Dutch company Koninklijke Vopak appears to be most similar to BROG. Although significantly bigger than BROG in market value and storage capacity, Vopak’s 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 the pandemic-related collapse in March/April 2020, BROG’s share price has increased 7%, while Vopak’s decreased 8%. Exhibit 7 shows the peer group valuation.