Interactive Investor

Stockwatch: this bid shows huge appetite for market leaders

28th May 2021 12:41

Edmond Jackson from interactive investor

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Stocks providing essential goods and services are in high demand.

When discussing inflation a week ago, I mooted how companies offering essential goods/services and with strong market positions (hence freedom to price) are becoming an investment priority. They are best placed to pass on price rises. 

Déjà vu for Augean, versus Waste Recycling Group? 

Lo and behold, yesterday a potential bid was flushed out for AIM-listed Augean (LSE:AUG), the UK’s leading hazardous waste treatment group. I have followed this company since listing in 2004, given it had a predecessor of sorts from the early 1990s – the more broadly-based Waste Recycling Group plc.

Both companies were chaired by David Williams and embarked on acquisitions. Waste Recycling proving successful enough, that from small beginnings it was acquired by private equity for £315 million in June 2003.  

This all shows how private equity can make money in this sector. Interestingly, Waste Recycling Group was acquired again just three years later, for £1.4 billion, by the Spanish utilities and construction firm FCC.  

Augean saw its stock rise from 130p to 270p by March 2005, and in two years more than £100 million was spent on acquisitions to become UK leader in this specialist field. 

Reality did not match hopes: partly the stock then slumped progressively to lows around 24p by early 2011 and Williams resigned. He somewhat carried the can for an ambitious prospectus, overtaken by events.

The 2009 recession was blamed (lower industrial activity does affect waste output) but Williams also declared: “The hazardous waste market has not seen the growth expected when it de-merged from the general waste market in 2003”. Regulatory changes had also caused confusion and inhibited adoption of contracted revenue streams. 

The 2009 results showed an all-round deterioration in financial performance with profit/earnings/cash flow measures down two-thirds or greater, on revenue 23% easier.  

This was an early example in Augean’s history, and why I see a good chance of a takeover currently being agreed. If early shareholders remain, they will carry scars and know not to be greedy.

For a potential acquirer the margins and cash flow from hazardous waste treatment remain attractive. See from the table below how the 2020 operating margin was up to 19% and free cash flow 1.3x earnings. Return on capital remains at 35%.  

Morgan Stanley Infrastructure mulls an approach 

Such a private equity operator is likely to be attracted by Augean meeting current ‘top down’ objectives for businesses with strong positions in essential services.  

There are intriguing ‘behavioural finance’ drivers here. Jim Meredith became non-executive chairman in 2012, adjusting to executive from October 2017.

Interestingly, he had been CEO of the UK side of FCC, the Spanish group that acquired Waste Recycling plc in 2006. He should know plenty about honing businesses into shape and negotiating price. 

Shareholders can therefore feel content that either Meredith will ensure getting the best possible price or will have good reasons for rejecting any offer. The stock would still drop in response, but potentially could rate ‘buy’. Therefore I would not be edgy to sell despite there being no confirmation even of an approach by Morgan Stanley as yet. 

A long-term bull chart in the last decade 

I first drew attention to this stock exactly 10 years ago at 28p versus a net asset value of 40p a share, after five directors had bought a total 340,000 shares around 30p. Although it went a tad lower it then began a steady rise above 60p by May 2017, then came a slump back to 27p after which Meredith stepped up to an executive role. 

Not only had the company been affected by missed first-half 2017 trading, HM Revenue & Customs (HMRC) had begun claiming insufficient landfill tax had been paid.

The company disputed but did pay to remove the liability. This is why 2019 headline figures showed heavy losses, weighed down by a £26.2 million tax settlement charge. More than £40 million remains in dispute. The company had paid by December 2019 but the outcome of a first court hearing in September 2020 is awaited. 

Christopher Mills’ involvement may also be key 

He is a long-term investor but also deal-maker – in a career spanning over 40 years of supporting UK and US smaller listed companies. His investment company, Harwood Capital, remains Augean’s biggest shareholder with around 16%, despite selling 1.5 million shares at 230p last March. This shows ability to be objective and willingness to sell around what are high points on Augean’s long-term chart.  

There are scant chances to liquidate a 16% stake in an AIM company. Someone like Mills is also shrewd enough to know to leave something on the plate for the next operator.

Like Meredith, he knows both sides of acquisitions’ negotiating, has a keen sense for value, but is also pragmatic.  

Morgan Stanley may also have noted, another long-time non-executive director sold one million shares at 217p, retaining two million. He could have personal reasons for doing so, beyond a value-call, but it underlines how the directors are not soft about selling. 

Augean - financial summary
Year end 31 Dec

  2013 2014 2015 2016 2017 2018 2019 2020
Turnover (£ million) 43.5 55.0 61.0 76.0 67.0 79.7 107 91.7
Operating margin (%) 11.2 12.2 5.4 2.7 8.1 14.2 -13.7 19.2
Operating profit (£m) 4.9 6.7 3.3 2.1 5.4 11.3 -14.6 17.6
Net profit (£m) -1.8 4.9 1.6 0.4 -3.5 9.9 -12.8 13.3
Reported earnings/share (p) 3.1 4.5 1.6 0.4 3.9 8.2 -12.3 12.7
Normalised earnings/share (p) 3.3 4.0 5.3 7.4 5.6 8.5 4.5 14.9
Operating cashflow/share (p) 4.9 7.9 10.0 10.8 9.2 15.4 -17.0 26.9
Capital expenditure/share (p) 7.1 6.7 7.2 8.1 8.6 3.3 5.6 6.9
Free cashflow/share (p) -2.1 1.1 2.9 2.7 0.6 12.1 -22.6 20.0
Dividend/share (p) 0.35 0.50 0.65 1.0 0.0 0.0 0 0.0
Covered by earnings (x) 8.9 9.0 2.4 0.4        
Net Debt (£m) 8.5 5.7 4.3 10.8 10.8 -8.2 17.8 -3.1
Net assets per share (p) 47.3 51.8 53.2 53.1 48.7 58.1 45.8 58.1

Source: historic company REFS and company accounts

Potentially still good timing for a new private owner 

In October 2019, I drew attention to Augean once more as a ‘buy’ at 152p, on the back of strong trading updates and a modest forward price-to-earnings (PE) ratio of around 11x.  

In January 2020, I re-iterated this stance “on a multi-year view” at 212p: another update affirming momentum and the stock modestly rated for earnings. “Despite landfill tax uncertainties, the company has established a strong position for capital growth and resumption of dividends. PE multiple expansion nearer 20x would justify a stock price well over 300p.” 

This morning, the price edged up to 303p, currently 297p, although the stock recovered its pre-pandemic highs early last March after the 2020 annual results. 

The chairman’s statement included intent to resume dividends after a four-year break amid the HMRC dispute. “The group has set ambitious internal targets this year, and together with it starting strongly plus a robust pipeline, the board is confident in prospects.”   

Jam-tomorrow reassurance was needed given a slump in oil prices amid the pandemic had cut drilling waste management revenue on the North Sea Services side. But this could reverse now oil prices are soaring also management expects decommissioning work to grow. 

Adjusted 2020 revenue fell 16% to £77 million although the operations review read well.

Contracted/framework agreed work constituted more than 50% of revenue with an average duration over 4 years. Adjusted pre-tax profit rose just 3% to £20.5 million and adjusted earnings per share (EPS) eased 3% to 14.9p. 

A potential buyer may find enough sellers 

In medium-term context, the bid story has legs and under takeover rules Morgan Stanley has until end of 24 June to confirm intent.  

Private equity may recall the gains from Waste Recycling Group, coincidentally a majority of shareholders be amenable to an offer. Augean has jolted them a few times along the way.  

The 300p a share level currently represents 18x consensus 2021 earnings or 15x the 2022 projection. According to inside information Morgan Stanley might access, it could decide to pay more for control although as an outsider you would be gambling fresh money. Hold. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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