Augean: High Barriers To Entry And Long Term Growth Drivers

17th Dec '19 by Jack Brumby

22 comments 6153 reads

Augean (LON:AUG) is the UK’s leading hazardous waste management business, taking care of difficult to handle leftover materials. This solves a tricky problem for its industrial customers that, given the growing social concern around environmental sustainability, isn’t likely to fade anytime soon.

Augean was formed in 2004 and listed on AIM that year with a market cap of £118m. In 2012 it branched out into servicing North Sea oil companies and has been steadily expanding into new areas ever since. Today it has a market cap of around £200m. Revenue has grown steadily over its decade and a half of operations.

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Augean’s valuation and growth metrics are undemanding, with a forecast PE ratio of 12.4 times, a trailing twelve-month price to free cash flow of 10.8 times and a forecast PEG ratio of 0.7. The share price has been strong over the past year.

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With a renewed focus on growing, profitable key markets, Augean looks as though it is investing in the right areas to drive growth in the years ahead. The group generates solid return on capital figures.

Certainly the brokers have been revising up their expectations:

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The high barriers to entry in its waste disposal markets, its modest valuation (despite recent share price strength), and encouraging long-term trends all point to Augean as a promising candidate for further research.

Potted history

In 2010, the group found itself struggling for growth and Augean was, at this point, valued at just £30m. This was after a couple of years of sluggish market conditions following on from the 2008 financial crash. Throughout this period, Augean continued to invest in its operations and grow revenues, although margins at times suffered.

From this nadir the group raised funds to diversify its revenue streams and expand into new businesses.

Jim Meredith graduated to chairman in 2012, where he remains to this day after building up a 2.4% stake in the company. That same year, Augean paid out its maiden dividend. In 2013 Paul Blackler was replaced as CEO by Dr Stewart Davies.

Since 2017, the group has been busy trimming costs and repositioning itself to take advantage of higher growth areas in its markets. It looks to be working. For the past two years, there has been…

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andrea34

17th Dec '19

Good article, Jack - I have recently bought back (sub-190p), and I think the HMRC payment removes significant uncertainty. The huge growth that the company are showing should in turn feed through to quickly return them to a good cash position for potential further acquisitions. I don't know of any company that has such a presence in this sector, and I think a further key point is that they operate in quite a number of segments within waste treatment that should lessen the cyclical fears.

Jack Brumby

Yes, the tax issue seems to have arisen from quite a fundamental difference in how HMRC and Augean interpret the rules.

Given the apparent lack of clarity here, and the fact that regulation and taxation around environmental sustainability is probably quite politically sensitive, it's definitely possible that there could be a similar situation in future.

Hopefully Augean (LON:AUG) has learnt from this episode and will maintain closer comms with HMRC in future to prevent this type of thing happening again...

Jeffvshepherd

I bought Augean in early October, more by luck than judgement. I was tempted to sell at 50% profit but managed to stop myself. I'm going to run with this one until its story changes.

Tony1249

Fantastic and extremely detailed article Jack. I find your comments around there offerings to be 'moat like' encouraging.

Regarding future tax liabilities, it would only be reasonable to expect, that HMRC would provide metrics or a formula, as to how the tax is calculated. Consequently, providing the company with the ability to accurately calculate the same going forward. It will certainly be interesting to see the outcome of the appeal, especially as their legal team appear to be confident.

I'm a relative newbie to the Stocko community (since August 2019) and this is one of the shares I bought into based on the detail provided. I purchased at 98p and it has more than paid for my subscription. I am considering topping up on any dips in light of this article.

Thanks again,

Tony

Martin Verlaine

hi all

I profess to having sold my modest holding a while back when i took the view that they needed to pay off HMRC ( I know from a legal eagle that HMRC are quite aggressive on tax issues relating to waste... the industry has it share of cowboys ) but they seemed determined to battle it out. I have always liked the business but saw it as uninvestable given the size of the tax liability. The barriers to entry were what attracted me to the business in the first instance. Logically, these are now greater given the cleaner environment we all desire. I have this now back on my radar. I would be a little cautious after such a strong rise especially given the company’s history has from time courted controversy which in this industry goes with the territory. Logically this is a takeover target for a bigger entity

FREng

Might it also be possible that HMRC have been over aggressive with Augean (LON:AUG) and that clarification might lead to an exceptional profit?

GrahamF

Nice review, Jack. A lot of work clearly went into it so for the sake of clarity could you let us know if you have any position in this company?

“The UK government will not grant permits for new hazardous landfills“

Great. But what if that changes? It should be remembered that their customers will see them simply as a cost rather than anything that brings value to their business. So, if those costs are high (due to regulation and lack of competition) their customers (or potential customers) will lobby the government hard to find alternative options for disposal (may be the opening of a new disposal site) and argue that a single company should not be allowed such high market share.

If a moat/competitive advantage is only there by grace of another party (government regulator in this case) then it is a potentially fragile moat.

Tightening environmental regulations are nothing new. So, I am uncertain as to what the compelling event is that makes this a much more lucrative business in the future.

Much hazardous waste used to be generated by industry. But as heavy industry is in terminal decline in the UK will that not act as a drag on overall growth?

I currently have no position in this one. While it is interesting, I don’t see quite enough positives here to change that.

lightningtiger

A superb article Jack, well done.This is one of my shares too. There is a valuation from VectorVest of 300p, which means they rate it undervalued and a stop set at 750p.

Stockopedia shows all green lights for relative strength percentage. Hopefully it will continue to fly up the page and possibly some dividends paid at some point in the future.

I don't have a position, but like you I think it is an interesting company.

Re. moats - I agree that regulation could change and this is one of Augean's risks in the years ahead. I would rather have a moat by the grace of another party than no moat at all though, which is what most companies actually have.

Re. heavy industry - Augean (LON:AUG) has been busy repositioning itself in markets with long term growth drivers. Whether you believe this or not, I suppose, plays a large part in the investment case.

Slide 7 of this investor presentation breaks down why management expects its markets to grow.

stockscreen

19th Dec '19

The management changes have done wonders for this business, which seemed over-complex and to be struggling a few years ago. My only concern is that the HMRC issue is ongoing - there still seems to be landfill tax to be paid on significant scale in relation to profits, in effect a business cost which does not look like it is factored into brokers' forecasts or indeed recovered from customers.

Management has done a tremendous job in raising cash (the company's and banking facilities) to deal with the potential HMRC liability, refocussing the biz and getting momentum into it. It may seek to dilute the problem with an acquisition or fund raising, but it's still an unresolved issue.

I'm a holder.

racthompson

I have been a shareholder of Augean, but unfortunately sold out about 2 years ago having doubled the value of my holding. I consider that the Tax issue is the major risk for the future. It would be useful, and interesting to know what is the basis for the HMRC tax demand, and does it include several years of back taxes? If HMRC is right, and there will be a similar annual charge, what would it be? The basis of the current HMRC tax demand should be stated by the company so that a potential Land fill tax liability can be included in the forecasts, if necessary.

laurie

c. 40.4 million (vague figure which includes penalties and interest) potential miscalculation involving unpaid landfill tax --vs-- total (FY) after tax profit since the company became consistently profitable (2010) c. £32.7 million

Questions I have been pondering since 2017--I have no answers:

If Augean (LON:AUG) is obliged to pay this extra landfill tax as the liability arises, how will this affect future profitability? If AUG raises its prices in the future to pay for landfill tax which HMRC says is due, will they no longer be the most cost effective provider of waste services? Which ongoing contracts will no longer be profitable if there is a greater liability for landfill tax?

disclosure: No current holding

cmpeckham

I agree that it is difficult to get a fix on future profitability. Another bit of evidence is Biffa (LON:BIFF) which is a well run business operating in the same markets as Augean (incl hazardous waste, energy from waste etc).

Augean has margins of 10-15% while BIFFA has margins of 1-5%. Why is that? Is it because Augean are that much better run, or is there another explanation? BIFFA have not had any issues with the way it pays landfill tax.

bobsandy12

20th Dec '19

Very helpful Jack; thanks for such a comprehensive review

I now have this on my watchlist but, would like to understand the basis of HMRC calculation and hence its impact on future results

Have a good Christmas

Robert Smith

21st Dec '19

Would be interesting to know the reason for the board changes earlier once the HMRC assessment became known if the company was confident of its own position. Or would this be a knee-jerk reaction?

Ben1

22nd Dec '19

A very interesting article on a very interesting company. I will certainly research it further.

One initial thought though is of the potential for an environmental leak or accident if they are dealing with such hazardous waste, and what effect that might have.

I remember in the past looking at risk from the two perspectives of probability and impact. The chance of a major incident might be small but could happen, if it did what sort of clean up costs could the company be obliged to pay for? Could the company survive a BP gulf of Mexico type scenario?

Tony Y

31st Dec '19

Any landfill site in East Anglia is at potential risk of flooding, as in 1963/4 floods. If there is a risk of sea water rising through melting ice, it would be another thing for Augean to investigate and make clear to investors.

James Walley

5th Jan '20

Rounding up the calendar these fines are basically for 2014, 2015, 2016, & 2017. Which by my calculations makes the fine circa 13% of turnover and therefore leaves them with a net profit margin of 1%?

I hope I'm wrong.

abtan

27th Feb '20

I thought I would add my thoughts on Augean (LON:AUG) after yesterday's results in the hope that someone can critique, or preferably agree with, my workings/observations.

Please note that I have a small holding in Augean (LON:AUG) .

OBSERVATIONS

I was put off by the rather large NSS customer, which represented 40% of all NSS revenues (a growing area according to the company) and 15% of all company revenues. Was anyone else worried by this?
I noticed that ROCE seems to have gone down in 2019 H2. It was 44% annualised in H1 2019 and the Year End figure was 37.8%. Both are a significant improvement vs the prior year, so for now this is merely an observation.

HMRC LIABILITY GOING FORWARD

I'm no expert on landfill tax, but I've put together a few assumptions on the HMRC liability and what it could mean going forward.
a) £40m HMRC landfill tax was underpaid between the last 3 months of 2013 and the first 3 months of 2018.

b) I have proportioned this £40m across the above time frame based on both the hazardous revenues and the total waste tonnage to see what the additional landfill tax liability would have been by year
(NOTE: the landfill tax is a set £ amount/tons disposed so presumably there is some correlation between these metrics)

c) 2018 hazardous waste revenues were not provided, so I have taken an average from 2015-2017 to help with b) above (this metric was provided from 2013-2017, but not in 2018 or 2019).

d) Finally I've simply extrapolated what the landfill tax would have been in 2019 based on total tons of waste disposed. This is by no means an accurate measure. especially without knowing tons of hazardous waste disposed of, so if anyone has any ideas on how to extrapolate more accurately, please do let me know.
These workings imply that TOTAL LANDFILL TAX FOR 2019 should be closer to £24.1m vs £15.6m that will be paid, a difference of £8.5m.
Assuming that Augean (LON:AUG) so indeed need to pay the difference of £8.5m for 2019, then underlying cash generation would have c£14.5m.

Assigning a multiple of 15-20 provides a market cap target range of £218m - £290m.

The current market cap is £220m.
In my opinion the worst case scenario of HMRC winning their case therefore doesn't look too bad. There would undoubtedly be a hit to the share price as sentiment hits, but if growth continues, then any downside might be short-lived.

Any thoughts on this very assumption-driven theory would be much appreciated.

Cheers

28th Feb '20

Augean (LON:AUG)

For anyone interested in understanding more on the HMRC landfill tax issue.

Start from 9:45

https://www.youtube.com/watch?v=pJUfYj8jdX4&t=0s

Augean: high barriers to entry and long term growth drivers

Potted history

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Jack Brumby

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