Description

*I haven’t been able to add my model to the write-up, but I’m happy to answer any questions on the model in the comments

Investment Case

Vopak is the world’s largest independent tank storage service provider.  The Company plays an important role in the transport and logistics of bulk liquids.  It owns ~80 terminals in 28 countries, having grown capacity to over 30 million cbm at a ~4% CAGR over the last 7 years (including disposals).  The majority of these terminals are strategically located in areas where new capacity would be difficult to add due to space constraints, or would be less attractive to customers (e.g. at lower draft, so smaller ships would need to be used, increasing freight costs). These structural advantages allow the Company to earn attractive margins on these assets.

Historically the company has also been able to grow using its free cash flow to add new capacity at high incremental returns.  The basis for those high returns on capital is as follows:  The Company’s global storage network and strong customer relationships give it unique insight into global trends, and allows them to identify potential projects where they believe there will be strong, consistent flows and a structurally advantaged position. The Company then leverages its close relationships with clients, and its leading reputation for safety, quality and efficiency, to lease at least 60% of the capacity on a long-term basis, before beginning any project.  This ensures at least a baseline ROI (~8% unlevered, according to analysts).  Yet, once the project is up and running, increasing flows allow Vopak to further leverage its customer relationships and strong reputation to increase utilization and further boost returns.  Furthermore, the Company can then add brownfield capacity to the existing terminal, where the cost is simply steel, and incremental ROI is very large.

The company experienced a golden decade prior to 2013 as it profitably grew its capacity as described above, and benefited from a period of strong contango after the Global Financial Crisis.  When a market is in contango the price to buy the product today on the spot market is cheaper than the price you can buy it (or sell it) for later (or today on the forward market).  When the contango is strong enough that the difference between the spot and forward markets is larger than the costs of storage, traders will come in and buy at spot, sell the forward curve, store the product and then deliver on the forward contract.  In addition users of the products (e.g. chemical companies using crude) will hold higher inventory locking in a low cost of goods.    This is great for storage companies as demand and therefore utilization (and often price) will increase.

In 2012/3 however, the contango that Vopak had enjoyed reversed while low industrial demand in Europe further reduced the need for bulk liquids storage.  This put pressure on the stock as utilization declined, which was then exacerbated by the fact that the growth pipeline appeared to have dried up.   In the past few years the company hasn’t announced any new projects, and has had only two growth projects in the works:  Pengerang in Malaysia and Hainan in China.  Furthermore the Hainan project was not the usual growth project described above, but a high-risk, high-reward project that requires an “if you build it they will come” leap of faith.  The stock declined dramatically as growth investors fled while earnings consolidated.

By 2014 the company acknowledged that it had entered a new phase in its development, and needed to adjust its strategy accordingly.   At a strategic update in July 2014, the company emphasized a stronger focus on FCF rather than growth, stating: “‘With the shifting emphasis in its strategy execution Vopak will sharpen its focus on increasing free cash flow generation throughout the company and on improving its capital efficiency, to support cash flow return and EPS objectives.”   While the company acknowledged that the global imbalances between where bulk liquids are produced and consumed continue to grow, creating opportunities for future growth, they would be streamlining their business to emphasize cash returns.   To this end they planned to rationalize their terminal capacity to contain only strategic hubs, import-export terminals, and industrial terminals. While barriers to entry in storage in general isn’t particularly high, these types of terminals have a wide moat.  Strategic hubs include Amsterdam-Rotterdam-Antwerp in Europe, Fujairah in the Middle East, Houston in the US and Singapore in Asia.  These terminals are prime real estate, where new building is often not possible (e.g. in Singapore or Rotterdam), or where Vopak has a privileged position (e.g. private jetty, and deeper draft in Fujairah).  Industrial terminals are connected by pipeline to their customers and are thus very stable businesses with very long-term contracts.  Import-export terminals have the smallest moat of the three, but benefit from Vopak’s global customer relationships and the increasing imbalances between production and consumption of bulk liquids.

The strategic plan therefore called for the divestment of 15 non-strategic terminals, the reduction of 2014-2016 capex by 100m and a reduction in Vopak’s cost base by 30m.  This would allow them to reach an EBITDA > Eur768m by 2016 at the latest.  With the 30m reduction in the cost base this would increase EBITDA > Eur800 after 2016.  Maintenance and improvement capex would be reduced to 275m/year, with pure maintenance capex estimated at 150-200m per year in 2015 and 2016, and potentially lower going forward. (Growth capex for existing expansions is 500m total from 2015-2019).  With this adjustment Vopak has thus positioned itself as a low growth, solid, fixed asset company with attractive FCF in the same vein as, for example, a cable company .

But while the company has embarked on their strategic plan two important things have happened.

1)      The markets have returned to contango

2)      The Euro has weakened against the USD and SGD

3)      China’s slowing growth has created a short-term supply-demand imbalance impacting Vopak’s Asia utilization and EBITDA, as additional capacity by competitors is slow to be absorbed.

The first situation is quite positive for Vopak, and has resulted in increased utilization, particularly in the Netherlands segment.  The second situation is positive as Vopak reports in Euros but 16% and 23% of its earnings are received in USD and SGD.  This translation effect would add over Eur45m to the 2014 strategic plan guidance of > 768m. The third situation has been quite negative and has decreased utilization and EBITDA in Asia from 95% to 88% and from ~213m to ~190m respectively.   Unfortunately the third situation has dominated the narrative and resulted in as much as a 36% peak to trough correction last year (although to be fair the market was also pricing in a lot more immediate benefit from contango than they should have).  Nevertheless in Q3 Asia’s utilization crept back up (from 85% to 89%), providing some relief to the market.

              While the drama of the over-hyped contango and the Asian slowdown have negatively affected sentiment around the stock, the business has actually experienced some very positive developments.   I believe the market is not attributing any value to the following three developments:

1) Contango has strengthened and has extended to the product markets

While the hype over contango was initially overplayed, as the ramp up in utilization didn’t improve EBITDA as much as hoped, we are currently seeing further improvements in the market, particularly the Netherlands, as product markets beyond crude oil enter contango, and the pricing leg of the storage yield comes into play.   While the contango curve started at the end of 2014 for future contracts, the front curve (i.e the first 2 months) was still in backwardation.  Since August 2015 however, the market has been in steep contango (which should continue due to continued strong supply of oil).  VTTI, a peer of Vopak, has noted that prices in the Amsterdam-Rotterdam-Antwerp region went up from approx. €2.50/cbm/month to around €3.25/cbm/month very rapidly.  While I haven’t been able to find a current market price, because most land based storage is full and contract renewals are yet to take place, in the 2009 contango prices went north of €4.00 and today traders’ P&L is more favorable with lower interest rates and a greater willingness of banks to lend especially given the lower starting price of oil.  For reference, 40-45% of Vopak’s capacity is oil related products, and 1/3 of contracts get renewed each year.

2) The company has made great progess on their non-core divestments, generating significant cash inflows and establishing private market valuations for their asset base 

The company has been able to generating ~700m Euro of cash while divesting only ~53m of EBITDA.   These divestments have been at high EBITDA multiples, showing the desirability of these assets.  Indeed, towards the end of last year Vopak accepted an unsolicited bid for their UK assets on an estimated EBITDA multiple of 15x-20x.

3) The two new terminals in Asia, which have been expected to be loss-making as they ramp up, have been able to ramp up quicker due to the contango as excess capacity is filled by traders

Furthermore, recent channel checks in these markets suggest that Vopak is now able to require traders to sign 3-6 month contracts rather than very short-term spot storage contracts providing a bridge as commercial contracts are signed in those locations.   On a longer-term view Pengerang is already showing itself to be a resounding success as it becomes part of the “Southeast Asia Hub” along with Singapore (where further expansion is not possible).  From May 2015, Platts started including Pengerang in its Singapore pricing assessment giving traders flexibility to load cargoes there and validating Vopak’s strategic decision to build its oil terminal here.  The industrial terminals have also been validated as they have been developed in conjunction with Malaysia’s national oil company, Petronas, to serve their world scale Refinery and Petrochemicals Integrated Development (RAPID) project.  Vopak’s CFO has suggested that Pengerang is without doubt one of the best strategic decisions the company has made.  Hainan has yet to be validated for its original strategic concept, to service the needs of Chinese refineries for different specifications of crude oil.  On the other hand, Hainan has always been a high-risk, high-reward play to which the market has never attributed much value, and which Vopak only has their 50m equity investment at risk (it is a non-recourse JV) and their share of operating losses (but which will be reduced due to current market conditions).  In addition, China has at least expressed interest in renting the terminals on a long-term basis for strategic storage (a low value use, but a use nonetheless).

As a result of these developments, Vopak should be able to generate EBITDA in excess of the 768m 2016 estimate from Vopak’s 2014 strategic update, despite their additional divestments and the drop in their Asian EBITDA.  Without any further benefit from contango (which, as price increases, should drop straight to the bottom line) Vopak is already generating EBITDA of 755 over the past 12m on a pro forma basis adjusting for divestments (including the UK divestment which will take place in 1Q16).  The cost saving plan is on track and will still generate some benefit in 2016, increasing this further

My current estimate of net debt (FYE 2015) is Eur2120.  Adjusting this for the Eur380m cash inflow from the UK divestment gets us to 1740.   At a current share price of Eur38.5 per share, this leads to an Enterprise Value of Eur6650 putting Vopak on an LTM EV/EBITDA of 8.8x.   That number actually overstates the true EV/EBITDA since JV results are included in Vopak’s EBITDA by adding their attributable Net Income.  If one were to instead add Vopak’s proportional share in their EBITDA (while also adding Vopak’s proportional share of their net debt to the EV) one would get an EV/EBITDA < 8x.

LTM FCF to equity is as follows:

*taking mid-point of management “conservative estimate” and reducing proportionally by subsequent divestments; **giving partial credit for reduced net debt, net interest on current gross debt is ~10m higher

              On a market cap of Eur4,910, this is a FCF of 7.5%.  

Both the EV/EBITDA and FCF Yield valuations strike me as too low for the quality of these assets.  Vopak itself sold non-core terminals (of substantially lower quality than its own terminals) at valuations between 10x and 15x EBITDA.  In addition, earlier this year EQT sold their Koole Terminals at a price that, according to Bloomberg, was “significantly above EUR 1bn.”  These terminals generated Eur80m of EBITDA, and thus a price of Eur1.1-Eur1.3bn implies multiples of 13.8-16.3x.  85% of the Koole terminals’ capacity is in Rotterdam, adjacent to Vopak’s terminals.  By all accounts the Koole terminals are inferior to Vopak’s assets.

 Despite this low valuation, there is also no value being attributed to the additional cash that will be generated from the contango pricing cycle (which falls straight to the bottom line) and had a substantial impact the last time it occurred in2009.  Furthermore the company will grow capacity 13% through 2019, the majority of which is already backed by commercial contracts.  Hainan still represents a high-upside option. Finally, the company continues to take costs and capex out of the business.

During Vopak's growth period, the company's ex-growth FCF yield was <3% and its forward EV/EBITDA multiple was >12x.  I think an EV/EBITDA multiple above 10x and a FCF yield below 6.5% is a fairer valuation for these high quality assets and their prospective EBITDA growth.  This rerating, plus the FCF generated in 2016 provides a YE price target of Eur48, for 25% upside.  This is a conservative upside calculation, since I would expect the market to continue to put such a multiple on Vopak's growing EBITDA as the contango cycle intensifies (despite the fact that this is lower quality EBITDA and would therefore not deserve a high multiple).  The blue sky scenario is if Vopak's public market valuation meets the private market transaction values we've seen in 2015.  While a private equity takeout would be difficult since HAL (the Dutch publically-traded holding company) owns 48% of the stock, it is not beyond the realm of possibilty that HAL themselves would be interested in a buyout.  The company has a large cash position due to the recent IPO of its Grandvision asset, and furthermore would probably not even require that much cash for an LBO considering the leverage these assets could support with the majority of EBITDA backed by long-term contracts.

Risks

1)     The main risk is the continued decline in Asian utilization as a result of weak industrial demand.  The mitigating factor is the long-term imbalance and demand trend, which will absorb excess supply over time.

2)     Markets switch from backwardation to contango.  But, while backwardation and contango are cyclical phenomena, we haven’t seen all that much benefit from contango yet.

Catalyst

1) Above consensus results and guidance

2) Continued improvement in FCF generation, resulting in increased shareholder payouts, new developments and other EPS enhancing activities