Aggreko AGK
February 07, 2014 - 12:07pm EST by
rhg
2014 2015
Price: 15.27 EPS $104.00 $0.00
Shares Out. (in M): 267 P/E 14.7x 0.0x
Market Cap (in M): 4,077 P/FCF 25.0x 0.0x
Net Debt (in M): 552 EBIT 386 0
TEV: 4,629 TEV/EBIT 12.0x 0.0x

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  • High ROIC
  • High Barriers to Entry, Moat
 

Description

Summary

Aggreko (LON:AGK) is the world’s largest provider of temporary power solutions. Aggreko has gone from a no-moat and a mediocre low returns on capital business (10% to 12%) in 2003 to a wide moat and a very high returns on capital business today (25% to 35%). The high ROCE is the result of their global integrated hub-and-spoke model allowing them to respond quickly to customer needs and thereby optimizing their fleet utilization. The business’ “wide” moat continues to widen thanks to their global scale and a unique low cost structure relative to other industry players (more on this later). The business has had significant tail winds due to the growing need of temporary power. Aggreko has compounded revenue by ~20% and EPS by ~30% over the last decade.  

We believe that Aggreko has plenty of growth runway ahead and a strategy in place to tap into this growth, yet the market is offering us the unique opportunity to own this phenomenal business at a very reasonable valuation EV/EBIT of 12x or P/E of 15x. Aggreko is trading at 1,527 pence as of Jan 31, 2014, very close to its 52 week low of 1,429 pence.

Aggreko has two large contracts (Japan and the Military) that are rolling off in 2013-2014 causing low visibility into revenue growth and margins in the near term. We believe that Aggreko’s business is inherently one of high variability and low visibility on a near-term basis, and is no cause for worry in the long-term (on  a five year rolling period). Mr. Market hates unpredictability and hence he is is offering us the opportunity to buy Aggreko at a reasonable valuation.

Business Overview

Aggreko is a specialist energy services business, offering temporary power and temperature control on a global basis. Their services are mission-critical, asset-intensive, often involving significant engineering input, and are frequently used in response to emergencies. Aggreko has a global presence in around hundred countries and has a very large power fleet that is capable of providing more than 9,100 MW of power. We highly recommend that you watch the five minute “Aggreko: What we do?” video before you read further. http://bit.ly/1cHhusr

 

CAGR

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

Revenue

19%

1,583

1,396

1,230

1,024

947

693

541

418

324

332

EBIT

28%

385

341

315

255

202

134

87

60

45

42

EBIT Margin

 

24%

24%

26%

25%

21%

19%

16%

14%

14%

13%

Diluted EPS

29%

104

97

79

62

46

30

17

14

7

10

ROCE

 

24%

28%

32%

29%

28%

26%

22%

19%

-

13%

(In £ millions except per share data in pence)

Aggreko has an outstanding track record over the last decade. Total shareholder return during this period has been ~1,000%.

The business operates in two segments: Local Business and Power Projects. Much of the business’ resources are shared across the two segments.

  • Local Business rents power and temperature control equipment to commercial, industrial, utility and government users.

  • Power Projects sells electricity, supplying and operating utility power plants, mainly in emerging markets to utility and government users.


(In £ millions)

CAGR

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

Revenue

                     

 Local Business

15%

905

734

695

544

580

453

372

308

253

258

 Power Projects

29%

638

554

460

422

282

181

125

87

68

67

   Segment Total

19%

1,543

1,288

1,156

966

862

634

497

395

320

324

 Pass-through fuel

 

40

108

74

58

85

59

43

23

3

8

   Group Total

19%

1,583

1,396

1,230

1,024

947

693

541

418

324

332

EBIT

                     

 Local Business

23%

175

124

145

95

122

83

60

41

29

27

 Power Projects

34%

212

215

168

158

77

49

25

18

16

15

   Segment Total

28%

386

339

313

253

199

132

85

59

45

42

 Pass-through fuel

 

-1

2

2

2

3

2

2

1

0

0

   Group Total

28%

385

341

315

255

202

134

87

60

45

42

EBIT Margin

                     

 Local Business

 

19%

17%

21%

18%

21%

18%

16%

13%

12%

10%

 Power Projects

 

33%

39%

37%

37%

27%

27%

20%

20%

23%

23%

  Group Total

 

24%

24%

26%

25%

21%

19%

16%

14%

14%

13%

ROCE

                     

 Local Business

 

20%

18%

26%

20%

27%

23%

22%

na

na

11%

 Power Projects

 

31%

40%

40%

42%

29%

34%

22%

na

na

25%

  Group Total

 

24%

28%

32%

29%

28%

26%

22%

19%

na

13%


Local Business

The Local business serves customers from 194 service centres in 47 countries in North, Central & South America, Europe, the Middle East, Africa, Asia and Australasia. This is a business with high transaction volumes: average contracts (excluding major events such as the Olympics where contracts can be worth tens of millions of pounds) have a value of around £17,000 and last a handful of weeks. The Local business represents 59% of Aggreko’s revenues, excluding pass-through fuel, and 45% of trading profit. Although most of this business is planned in advance, about 25% of its revenues come from responding to emergencies. It is therefore essential to have the capability to deploy equipment and people to the customer’s site within a matter of hours. Aggreko’s 194 service centres look after customers who are normally within a radius of 200 miles, and they offer the complete range of products and services.

EBIT margin and ROCE in the Local Business has nearly doubled since 2003. The Local Business was run out of standalone depots (59 in North America and 39 in Europe) in 2003. Each depot ran a separate P&L and was not measured on returns on capital employed (ROCE). Operational administration like call handling, contract management, local purchasing, and debt management was handled at the depot level.

The current CEO when he took over management in 2003 recognized the potential to improve Aggreko’s operations. The standalone depot business was restructured into a “hub-and-spoke” model which is in place to date. The model has two types of service centers: the hubs hold larger items of equipment as well as provide service and repair facilities; spokes are smaller and act as logistics points from which equipment can be delivered quickly to a customer’s site. The hubs and spokes are organised into areas in which a manager has responsibility for the revenues, profitability and the return on capital employed within that area. In this model, most administrative and call handling functions are carried out in central rental centers.

Power Projects

The Power Projects business sells power which Aggreko delivers using power plants built, owned and operated by them. Whereas in the Local business a contract with a customer is described in terms of renting specified items of equipment for a period of time, most of the contracts that Power Projects performs are for providing a defined amount of electrical power, for which a customer pays a fixed monthly capacity charge; they then pay, in addition, a variable charge for each MW-hour they take. Under the terms of these contracts, Aggreko is responsible for installing and operating the equipment and the invoice to the customer is for power generation capacity not equipment rented. Most projects in this business are worth over £1 million a year and some can be worth very much more than that; in 2012, Aggreko invoiced its largest utility customer around £95 million. A typical contract in this business would be for the rental of 20 to 50MW for an initial period of 6-12 months, which will often be extended. Aggreko’s power-plants are highly modular, and their capacity can be flexed in 1MW increments using standard containerised units of their own proprietary design, designed and built in their factory in Scotland; importantly, these generators are also in widespread use in the Local business, so fleet can be shared between the two businesses. They use either diesel or gas as fuel and are designed to be easily transportable, reliable and robust; in 2013 Aggreko also announced the availability of generators that can run on Heavy Fuel Oil, which is significantly cheaper than diesel. Power projects can arise anywhere in the world and the required response time is generally weeks rather than the hours or days needed in the Local business. To support these projects, Aggreko concentrates its fleet in a number of hubs – in Central America, Europe, the Middle East and Asia. From each hub, large amounts of equipment can be shipped or flown rapidly to wherever it is needed.

Power Projects customers are almost all in emerging markets and over 84% of their revenues come from utilities but Aggreko also serves governments, armed forces, as well as oil & gas and mining companies. In 2012, the Power Projects business generated revenues of £638 million, or 41% of Aggreko’s total revenue excluding pass-through fuel.

Aggreko’s strategy for the Power Projects business has been to grow as fast as it prudently can, to secure for itself the operating efficiencies and competitive advantages which come from being the largest global operator. So far, it has been very successful in executing this strategy and the Power Projects business is many times larger than its next largest competitor.

Global Scale and Competitive Advantages

The global hub-and-spoke model has allowed Aggreko to become more profitable over time in mature markets. The most profitable hubs have been the ones where Aggreko has dense network of service centers which share equipment, staff and customers, and benefit from low transport cost being physically close to customers. In the mature markets, Aggreko has focused on adding new service centers and upgrading the existing service centers to be more capable. At the same time, Aggreko has used the profitability in mature markets to expand its global footprint in fast-growing economies. This has helped Aggreko deliver ~30% compounded revenue growth over the last decade and gain significant market share from its competitors.

The resulting global scale has added yet another dimension to Aggreko’s competitive advantages. Standardised operating processes and investment in a single global IT platform has brought visibility and homogeneity. Global utilisation statistics have allowed Aggreko to spot where equipment is under-utilised, and where it can be moved to for the best return, and this has reflected in the increase in sales/gross rental assets, a financial measure of equipment utilisation; between 2004 and 2012, sales/gross rental assets in the Local business increased from 62% to 78%.

The reason why it is advantageous to be a global operator in Power Projects is because demand can shift rapidly between continents. In 2003, South America and Asia were probably the largest markets, and Africa was only a small proportion of global demand. In 2009, the market in Africa was larger than South America and Asia combined. In the last couple of years, the position (as measured by fleet-on-rent) reversed with South America and Asia representing around 50% of Aggreko’s fleet on rent. These shifts in demand were driven in part by rainfall patterns, in part by the relationship between economic growth and investment in permanent power generation, and in part by, geopolitical issues. To be successful in the long run, therefore, requires the ability to serve demand globally, and that requires sales, marketing, and operational infrastructure to be present in all major markets.

Being able to address demand on a worldwide basis means higher utilisation. When fleet returns from a customer at the end of a contract, the speed with which it can be put back on contract again is a major determinant of profitability and returns on capital. Fleet will find new work far more quickly if it can address the total pool of world demand than if it is only able to operate in a single region.  By the time customers have decided they really do have to spend money on temporary power, they generally want it as fast as possible. Being able to offer very fast delivery of large amounts of generating capacity is a significant competitive advantage. Small operators cannot afford to keep 250-300 MW of capacity (say, £30-£40 million of capital) sitting idle waiting for the next job. Because the equipment used in Power Projects is also used in the Local business fleet, Aggreko manages its large generators as a common global pool. Between the Local business and Power Projects, Aggreko currently has a fleet of over 6,000 of these large generators, and can deploy hundreds of MW of capacity from their various businesses around the world on very short notice. A good example of Aggreko’s speed of delivery would be the power contract in Japan where, in response to the Fukushima disaster, it was able to deliver and commission 200MW across 2 sites within 70 days of the contract signature; most of their competitors would find it difficult to deploy that amount of fleet in that lead time.

The management of risk is a critical part of Aggreko’s business; It places tens of millions of pounds worth of capital assets in countries where the operational, political and payment risks are high – sometimes very high. While it takes great care to mitigate these risks, it is probable that sooner or later Aggreko will have a loss of either receivables or equipment, or both. However, because of their scale, such a loss would not imperil the Group as a whole. Aggreko minimises the risk of losses doing material damage to the business by having a broad portfolio of exposures, none of them correlated. For smaller companies, their portfolio of country risk is inevitably much more concentrated; the probability of loss in any one country for smaller companies is no less than it is for them, but their ability to withstand the consequences of a large loss is. Scale therefore allows Aggreko to deal in markets where others might, with good reason, fear to tread.

Returns from rental businesses are heavily dependent upon the underlying capital cost of the rental fleet. Clearly, large buyers should get better terms than small buyers and, since Aggreko is by far the largest purchaser of power generation for rental applications in the world, by Aggreko’s estimates their capital cost/MW is typically 20-40% lower than competitors’. The fact that Aggreko has the scale to justify having its own manufacturing and design facilities also means that it can source equipment which is better suited to their precise requirements, and more cheaply, than smaller operators

Many rental businesses provide standard products to their customers. The car or hammer-drill you rent is the same as the one you can buy. Aggreko’s equipment is different: manufacturers of generators and temperature control equipment generally design their product to be installed and stay in the same location for its working life. For Aggreko’s business, however, this equipment has to be lifted and transported hundreds of times during its working life. It must be able to work in extreme conditions – the same generator might be working in –40°C on an oil rig in Russia one week, and in +50°C in the Saudi Arabian desert the next. Designing and building equipment that can do this, while remaining safe, quiet, reliable and compliant with environmental and safety regulations, is a key skill of Aggreko. Unusually for a rental company, Aggreko designs and manufactures most of its equipment and its specialist in-house teams based in Dumbarton, Scotland understand intimately the requirements of the environment in which the fleet operates. Not only does Aggreko have industry-leading equipment, it also has a great deal of it – £2,331 million worth at original cost as at 31 December 2012.Unlike most other rental businesses, Aggreko has a policy of keeping equipment for its useful life. This gives Aggreko a powerful incentive to maintain it well, which gives it both longer life and better reliability. Aggreko has a large number of skilled engineers, well-equipped workshops and rigorous servicing regimes to ensure that its equipment is maintained to the highest standards.

In summary, a large global operator will have lower volatility of demand, better lifetime utilisation of equipment, be better able to respond to customer requirements, and will have a lower capital cost per MW of fleet.

Valuation

For most of the last decade, Aggreko was a favorite among “growth” investors. Very rarely has Aggreko traded at < 15x P/E as it is trading today.


 

TTM

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

P/E

15.3

16.7

16.8

20.7

18.8

14.9

9.8

17.8

25.2

19.8

24.0


15x P/E may seem rich by traditional valuation standards, but here we have a business that has a long runway for growth at very high returns on incremental capital employed. We would argue that 15x P/E is not rich. For more thoughts on this topic, we recommend you to read this.

One of the reasons that Mr. Market is offering the opportunity to own this compounding machine at such a reasonable valuation is because of the relatively “dull” 2013-2014 outlook for Power Projects as a result of two big contracts, the Military and Japan, are rolling off.



In our opinion, this by no means a permanent impairment to Aggreko’s business and is a somewhat minor blip in our opinion to the Aggreko’s long runway of growth. Aggreko’s business has always been one of high variability and low visibility.

However, we are confident about Aggreko’s future primarily because of its top-class management team. Aggreko has been holding five year strategy sessions since 2003. Not only do they revise these goals every five years, but they also evaluate how they have done over the last five year period. Aggreko’s management team has not only overshot most of the goals, but is very upfront and accountable for the goals they have missed. We highly recommend that you read the strategy presentations on their investor relations website.

So, if we take their word (which we would argue they have more than earned), Aggreko is projecting the following for 2013-2017

In addition, as growth slows, Aggreko will be more cash generative as incremental capex slows down. Aggreko’s management believes that most of the excess cash will be returned to shareholders. If this is true, it isn’t hard to see how free cash flow can compound at 12-15%.

We believe that depreciation is a good proxy for maintenance capex for Aggreko. Using 30% tax rate, we get: Net Operating Income After Tax (NOPAT) = EBIT * (1 - Tax Rate). Assuming 2013 is a flat year, we have 2013 NOPAT = 385 * (1 - 0.3) = £270m. As per management, we assume NOPAT can grow at 12 - 15%. We get 2018E NOPAT = £475m - £540m. Using a terminal multiple of 15x (given that Aggreko can continue to grow slightly above inflation due to pricing power), we get 2018E enterprise value of  £7.1 - £8.1 billion. It is currently trading at an enterprise value of £4.6 billion. Backing out net debt of £500m, we get current market value to be £4.1 billion and 2018E to be £6.6 - £7.6 billion. If we discount for the time value at 10%, you see that if Aggreko grows at 12% CAGR for next 5 years, it is currently trading close to fair value and if it grows at 15% CAGR for next 5 years, it is trading at 70% of fair value. For a high quality wide moat business that has the ability to compound for much longer than 5 years, we think this is a great valuation to start a position at.                                             

Lastly, it is reinforcing to know that the managers at FPA International Funds own a 6% position in their portfolio at price levels not too different from here. Also, the Yacktman Funds started a small position (<1%) at these levels.

Risks

Running a business such as Aggreko’s is not without risks. The three main risks that can cause permanent impairment (all related to the fact that some of their operations are in political unstable jurisdictions) to Aggreko’s business are:

  1. Political Risk

  2. Failure to Collect Payments or Recover Assets

  3. Failure to Conduct Business with Integrity and Honesty

All three are listed and well-addressed in our opinion in the risk section of the Annual Report. We believe that Aggreko’s management is well aware of these risks and has the appropriates measures in place to address to impact the Group’s business on a long-term basis.


I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Aggreko is a compounder, passage of time.
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    Description

    Summary

    Aggreko (LON:AGK) is the world’s largest provider of temporary power solutions. Aggreko has gone from a no-moat and a mediocre low returns on capital business (10% to 12%) in 2003 to a wide moat and a very high returns on capital business today (25% to 35%). The high ROCE is the result of their global integrated hub-and-spoke model allowing them to respond quickly to customer needs and thereby optimizing their fleet utilization. The business’ “wide” moat continues to widen thanks to their global scale and a unique low cost structure relative to other industry players (more on this later). The business has had significant tail winds due to the growing need of temporary power. Aggreko has compounded revenue by ~20% and EPS by ~30% over the last decade.  

    We believe that Aggreko has plenty of growth runway ahead and a strategy in place to tap into this growth, yet the market is offering us the unique opportunity to own this phenomenal business at a very reasonable valuation EV/EBIT of 12x or P/E of 15x. Aggreko is trading at 1,527 pence as of Jan 31, 2014, very close to its 52 week low of 1,429 pence.

    Aggreko has two large contracts (Japan and the Military) that are rolling off in 2013-2014 causing low visibility into revenue growth and margins in the near term. We believe that Aggreko’s business is inherently one of high variability and low visibility on a near-term basis, and is no cause for worry in the long-term (on  a five year rolling period). Mr. Market hates unpredictability and hence he is is offering us the opportunity to buy Aggreko at a reasonable valuation.

    Business Overview

    Aggreko is a specialist energy services business, offering temporary power and temperature control on a global basis. Their services are mission-critical, asset-intensive, often involving significant engineering input, and are frequently used in response to emergencies. Aggreko has a global presence in around hundred countries and has a very large power fleet that is capable of providing more than 9,100 MW of power. We highly recommend that you watch the five minute “Aggreko: What we do?” video before you read further. http://bit.ly/1cHhusr

     

    CAGR

    2012

    2011

    2010

    2009

    2008

    2007

    2006

    2005

    2004

    2003

    Revenue

    19%

    1,583

    1,396

    1,230

    1,024

    947

    693

    541

    418

    324

    332

    EBIT

    28%

    385

    341

    315

    255

    202

    134

    87

    60

    45

    42

    EBIT Margin

     

    24%

    24%

    26%

    25%

    21%

    19%

    16%

    14%

    14%

    13%

    Diluted EPS

    29%

    104

    97

    79

    62

    46

    30

    17

    14

    7

    10

    ROCE

     

    24%

    28%

    32%

    29%

    28%

    26%

    22%

    19%

    -

    13%

    (In £ millions except per share data in pence)

    Aggreko has an outstanding track record over the last decade. Total shareholder return during this period has been ~1,000%.

    The business operates in two segments: Local Business and Power Projects. Much of the business’ resources are shared across the two segments.


    (In £ millions)

    CAGR

    2012

    2011

    2010

    2009

    2008

    2007

    2006

    2005

    2004

    2003

    Revenue

                         

     Local Business

    15%

    905

    734

    695

    544

    580

    453

    372

    308

    253

    258

     Power Projects

    29%

    638

    554

    460

    422

    282

    181

    125

    87

    68

    67

       Segment Total

    19%

    1,543

    1,288

    1,156

    966

    862

    634

    497

    395

    320

    324

     Pass-through fuel

     

    40

    108

    74

    58

    85

    59

    43

    23

    3

    8

       Group Total

    19%

    1,583

    1,396

    1,230

    1,024

    947

    693

    541

    418

    324

    332

    EBIT

                         

     Local Business

    23%

    175

    124

    145

    95

    122

    83

    60

    41

    29

    27

     Power Projects

    34%

    212

    215

    168

    158

    77

    49

    25

    18

    16

    15

       Segment Total

    28%

    386

    339

    313

    253

    199

    132

    85

    59

    45

    42

     Pass-through fuel

     

    -1

    2

    2

    2

    3

    2

    2

    1

    0

    0

       Group Total

    28%

    385

    341

    315

    255

    202

    134

    87

    60

    45

    42

    EBIT Margin

                         

     Local Business

     

    19%

    17%

    21%

    18%

    21%

    18%

    16%

    13%

    12%

    10%

     Power Projects

     

    33%

    39%

    37%

    37%

    27%

    27%

    20%

    20%

    23%

    23%

      Group Total

     

    24%

    24%

    26%

    25%

    21%

    19%

    16%

    14%

    14%

    13%

    ROCE

                         

     Local Business

     

    20%

    18%

    26%

    20%

    27%

    23%

    22%

    na

    na

    11%

     Power Projects

     

    31%

    40%

    40%

    42%

    29%

    34%

    22%

    na

    na

    25%

      Group Total

     

    24%

    28%

    32%

    29%

    28%

    26%

    22%

    19%

    na

    13%


    Local Business

    The Local business serves customers from 194 service centres in 47 countries in North, Central & South America, Europe, the Middle East, Africa, Asia and Australasia. This is a business with high transaction volumes: average contracts (excluding major events such as the Olympics where contracts can be worth tens of millions of pounds) have a value of around £17,000 and last a handful of weeks. The Local business represents 59% of Aggreko’s revenues, excluding pass-through fuel, and 45% of trading profit. Although most of this business is planned in advance, about 25% of its revenues come from responding to emergencies. It is therefore essential to have the capability to deploy equipment and people to the customer’s site within a matter of hours. Aggreko’s 194 service centres look after customers who are normally within a radius of 200 miles, and they offer the complete range of products and services.

    EBIT margin and ROCE in the Local Business has nearly doubled since 2003. The Local Business was run out of standalone depots (59 in North America and 39 in Europe) in 2003. Each depot ran a separate P&L and was not measured on returns on capital employed (ROCE). Operational administration like call handling, contract management, local purchasing, and debt management was handled at the depot level.

    The current CEO when he took over management in 2003 recognized the potential to improve Aggreko’s operations. The standalone depot business was restructured into a “hub-and-spoke” model which is in place to date. The model has two types of service centers: the hubs hold larger items of equipment as well as provide service and repair facilities; spokes are smaller and act as logistics points from which equipment can be delivered quickly to a customer’s site. The hubs and spokes are organised into areas in which a manager has responsibility for the revenues, profitability and the return on capital employed within that area. In this model, most administrative and call handling functions are carried out in central rental centers.

    Power Projects

    The Power Projects business sells power which Aggreko delivers using power plants built, owned and operated by them. Whereas in the Local business a contract with a customer is described in terms of renting specified items of equipment for a period of time, most of the contracts that Power Projects performs are for providing a defined amount of electrical power, for which a customer pays a fixed monthly capacity charge; they then pay, in addition, a variable charge for each MW-hour they take. Under the terms of these contracts, Aggreko is responsible for installing and operating the equipment and the invoice to the customer is for power generation capacity not equipment rented. Most projects in this business are worth over £1 million a year and some can be worth very much more than that; in 2012, Aggreko invoiced its largest utility customer around £95 million. A typical contract in this business would be for the rental of 20 to 50MW for an initial period of 6-12 months, which will often be extended. Aggreko’s power-plants are highly modular, and their capacity can be flexed in 1MW increments using standard containerised units of their own proprietary design, designed and built in their factory in Scotland; importantly, these generators are also in widespread use in the Local business, so fleet can be shared between the two businesses. They use either diesel or gas as fuel and are designed to be easily transportable, reliable and robust; in 2013 Aggreko also announced the availability of generators that can run on Heavy Fuel Oil, which is significantly cheaper than diesel. Power projects can arise anywhere in the world and the required response time is generally weeks rather than the hours or days needed in the Local business. To support these projects, Aggreko concentrates its fleet in a number of hubs – in Central America, Europe, the Middle East and Asia. From each hub, large amounts of equipment can be shipped or flown rapidly to wherever it is needed.

    Power Projects customers are almost all in emerging markets and over 84% of their revenues come from utilities but Aggreko also serves governments, armed forces, as well as oil & gas and mining companies. In 2012, the Power Projects business generated revenues of £638 million, or 41% of Aggreko’s total revenue excluding pass-through fuel.

    Aggreko’s strategy for the Power Projects business has been to grow as fast as it prudently can, to secure for itself the operating efficiencies and competitive advantages which come from being the largest global operator. So far, it has been very successful in executing this strategy and the Power Projects business is many times larger than its next largest competitor.

    Global Scale and Competitive Advantages

    The global hub-and-spoke model has allowed Aggreko to become more profitable over time in mature markets. The most profitable hubs have been the ones where Aggreko has dense network of service centers which share equipment, staff and customers, and benefit from low transport cost being physically close to customers. In the mature markets, Aggreko has focused on adding new service centers and upgrading the existing service centers to be more capable. At the same time, Aggreko has used the profitability in mature markets to expand its global footprint in fast-growing economies. This has helped Aggreko deliver ~30% compounded revenue growth over the last decade and gain significant market share from its competitors.

    The resulting global scale has added yet another dimension to Aggreko’s competitive advantages. Standardised operating processes and investment in a single global IT platform has brought visibility and homogeneity. Global utilisation statistics have allowed Aggreko to spot where equipment is under-utilised, and where it can be moved to for the best return, and this has reflected in the increase in sales/gross rental assets, a financial measure of equipment utilisation; between 2004 and 2012, sales/gross rental assets in the Local business increased from 62% to 78%.

    The reason why it is advantageous to be a global operator in Power Projects is because demand can shift rapidly between continents. In 2003, South America and Asia were probably the largest markets, and Africa was only a small proportion of global demand. In 2009, the market in Africa was larger than South America and Asia combined. In the last couple of years, the position (as measured by fleet-on-rent) reversed with South America and Asia representing around 50% of Aggreko’s fleet on rent. These shifts in demand were driven in part by rainfall patterns, in part by the relationship between economic growth and investment in permanent power generation, and in part by, geopolitical issues. To be successful in the long run, therefore, requires the ability to serve demand globally, and that requires sales, marketing, and operational infrastructure to be present in all major markets.

    Being able to address demand on a worldwide basis means higher utilisation. When fleet returns from a customer at the end of a contract, the speed with which it can be put back on contract again is a major determinant of profitability and returns on capital. Fleet will find new work far more quickly if it can address the total pool of world demand than if it is only able to operate in a single region.  By the time customers have decided they really do have to spend money on temporary power, they generally want it as fast as possible. Being able to offer very fast delivery of large amounts of generating capacity is a significant competitive advantage. Small operators cannot afford to keep 250-300 MW of capacity (say, £30-£40 million of capital) sitting idle waiting for the next job. Because the equipment used in Power Projects is also used in the Local business fleet, Aggreko manages its large generators as a common global pool. Between the Local business and Power Projects, Aggreko currently has a fleet of over 6,000 of these large generators, and can deploy hundreds of MW of capacity from their various businesses around the world on very short notice. A good example of Aggreko’s speed of delivery would be the power contract in Japan where, in response to the Fukushima disaster, it was able to deliver and commission 200MW across 2 sites within 70 days of the contract signature; most of their competitors would find it difficult to deploy that amount of fleet in that lead time.

    The management of risk is a critical part of Aggreko’s business; It places tens of millions of pounds worth of capital assets in countries where the operational, political and payment risks are high – sometimes very high. While it takes great care to mitigate these risks, it is probable that sooner or later Aggreko will have a loss of either receivables or equipment, or both. However, because of their scale, such a loss would not imperil the Group as a whole. Aggreko minimises the risk of losses doing material damage to the business by having a broad portfolio of exposures, none of them correlated. For smaller companies, their portfolio of country risk is inevitably much more concentrated; the probability of loss in any one country for smaller companies is no less than it is for them, but their ability to withstand the consequences of a large loss is. Scale therefore allows Aggreko to deal in markets where others might, with good reason, fear to tread.

    Returns from rental businesses are heavily dependent upon the underlying capital cost of the rental fleet. Clearly, large buyers should get better terms than small buyers and, since Aggreko is by far the largest purchaser of power generation for rental applications in the world, by Aggreko’s estimates their capital cost/MW is typically 20-40% lower than competitors’. The fact that Aggreko has the scale to justify having its own manufacturing and design facilities also means that it can source equipment which is better suited to their precise requirements, and more cheaply, than smaller operators

    Many rental businesses provide standard products to their customers. The car or hammer-drill you rent is the same as the one you can buy. Aggreko’s equipment is different: manufacturers of generators and temperature control equipment generally design their product to be installed and stay in the same location for its working life. For Aggreko’s business, however, this equipment has to be lifted and transported hundreds of times during its working life. It must be able to work in extreme conditions – the same generator might be working in –40°C on an oil rig in Russia one week, and in +50°C in the Saudi Arabian desert the next. Designing and building equipment that can do this, while remaining safe, quiet, reliable and compliant with environmental and safety regulations, is a key skill of Aggreko. Unusually for a rental company, Aggreko designs and manufactures most of its equipment and its specialist in-house teams based in Dumbarton, Scotland understand intimately the requirements of the environment in which the fleet operates. Not only does Aggreko have industry-leading equipment, it also has a great deal of it – £2,331 million worth at original cost as at 31 December 2012.Unlike most other rental businesses, Aggreko has a policy of keeping equipment for its useful life. This gives Aggreko a powerful incentive to maintain it well, which gives it both longer life and better reliability. Aggreko has a large number of skilled engineers, well-equipped workshops and rigorous servicing regimes to ensure that its equipment is maintained to the highest standards.

    In summary, a large global operator will have lower volatility of demand, better lifetime utilisation of equipment, be better able to respond to customer requirements, and will have a lower capital cost per MW of fleet.

    Valuation

    For most of the last decade, Aggreko was a favorite among “growth” investors. Very rarely has Aggreko traded at < 15x P/E as it is trading today.


     

    TTM

    2013

    2012

    2011

    2010

    2009

    2008

    2007

    2006

    2005

    2004

    P/E

    15.3

    16.7

    16.8

    20.7

    18.8

    14.9

    9.8

    17.8

    25.2

    19.8

    24.0


    15x P/E may seem rich by traditional valuation standards, but here we have a business that has a long runway for growth at very high returns on incremental capital employed. We would argue that 15x P/E is not rich. For more thoughts on this topic, we recommend you to read this.

    One of the reasons that Mr. Market is offering the opportunity to own this compounding machine at such a reasonable valuation is because of the relatively “dull” 2013-2014 outlook for Power Projects as a result of two big contracts, the Military and Japan, are rolling off.



    In our opinion, this by no means a permanent impairment to Aggreko’s business and is a somewhat minor blip in our opinion to the Aggreko’s long runway of growth. Aggreko’s business has always been one of high variability and low visibility.

    However, we are confident about Aggreko’s future primarily because of its top-class management team. Aggreko has been holding five year strategy sessions since 2003. Not only do they revise these goals every five years, but they also evaluate how they have done over the last five year period. Aggreko’s management team has not only overshot most of the goals, but is very upfront and accountable for the goals they have missed. We highly recommend that you read the strategy presentations on their investor relations website.

    So, if we take their word (which we would argue they have more than earned), Aggreko is projecting the following for 2013-2017

    In addition, as growth slows, Aggreko will be more cash generative as incremental capex slows down. Aggreko’s management believes that most of the excess cash will be returned to shareholders. If this is true, it isn’t hard to see how free cash flow can compound at 12-15%.

    We believe that depreciation is a good proxy for maintenance capex for Aggreko. Using 30% tax rate, we get: Net Operating Income After Tax (NOPAT) = EBIT * (1 - Tax Rate). Assuming 2013 is a flat year, we have 2013 NOPAT = 385 * (1 - 0.3) = £270m. As per management, we assume NOPAT can grow at 12 - 15%. We get 2018E NOPAT = £475m - £540m. Using a terminal multiple of 15x (given that Aggreko can continue to grow slightly above inflation due to pricing power), we get 2018E enterprise value of  £7.1 - £8.1 billion. It is currently trading at an enterprise value of £4.6 billion. Backing out net debt of £500m, we get current market value to be £4.1 billion and 2018E to be £6.6 - £7.6 billion. If we discount for the time value at 10%, you see that if Aggreko grows at 12% CAGR for next 5 years, it is currently trading close to fair value and if it grows at 15% CAGR for next 5 years, it is trading at 70% of fair value. For a high quality wide moat business that has the ability to compound for much longer than 5 years, we think this is a great valuation to start a position at.                                             

    Lastly, it is reinforcing to know that the managers at FPA International Funds own a 6% position in their portfolio at price levels not too different from here. Also, the Yacktman Funds started a small position (<1%) at these levels.

    Risks

    Running a business such as Aggreko’s is not without risks. The three main risks that can cause permanent impairment (all related to the fact that some of their operations are in political unstable jurisdictions) to Aggreko’s business are:

    1. Political Risk

    2. Failure to Collect Payments or Recover Assets

    3. Failure to Conduct Business with Integrity and Honesty

    All three are listed and well-addressed in our opinion in the risk section of the Annual Report. We believe that Aggreko’s management is well aware of these risks and has the appropriates measures in place to address to impact the Group’s business on a long-term basis.


    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    • Aggreko is a compounder, passage of time.

    Messages


    Subjectnice w-up
    Entry02/07/2014 12:27 PM
    MemberWeighingMachine
    I generally like this company/stock.  The main concern I have is that the downturn in emerging markets (Power Projects business) is a source of uncertainty/downside here as power demand growth could be constrained for the next few years (since AGK is supplying power for acute shortages, the impact may be magnified).  How do you think about this risk? 
     
    Looking out 5 years an exacerbated downturn should allow for a stronger LT outlook as 1) this raises the cost of capital for EM countries - slowing supply build and creating the potential for more pronounced acute shortages in the future (with longer duration) and (2) slowing the rate at which their competitor APR Energy is able to attract capital to build their fleet.
     
    AGK does have some very exciting properties - in particular being a business w/ strong ROCE that (in a good market) has ample high return organic deployment opportunities, being a competitively advantaged business operating in a duopoly, a strong bal sht, and top tier management.  

    SubjectRE: nice w-up
    Entry02/07/2014 01:23 PM
    Memberrhg
    By 2015, approximately 1,000 GW (20%-25%) of world's installed power generating capacity will be over 40 years old, a close proxy to the life of a permanently installed power plant. The coming years will see the beginning of a replacement cycle during which a large part of existing power-plant construction capacity will be dedicated to replacing existing plants in North America and Europe, rather than building replacement or additional capacity in developing countries. The sums which need to be mobilised over the next 10 years to re-build the power distribution and generation capacity in North America and Europe are huge; in the UK alone, the regulator estimates that up to £200 billion will be required. This means that developing countries will have to compete for funds with developed countries, where investment risk is perceived to be far lower.
     
    Furthermore, it should also be noted that additional capacity in emerging markets is highly concentrated in two countries, India and China (70% of non-OECD new capacity). Doing aggregated analysis is not very useful, since shortfall in one country cannot be met by surplus in another. 

    Shortfall non-OECD ex China 2012 ~70 GW
    – Has been growing at 13% CAGR; Aggreko projects it to continue at same rate
    • Estimate of 2012 temporary power projects market 8.4 GW
    • Implied conversion rate of shortfall into demand for temporary power 12%
    • Estimated CAGR in market size 07-12 20%
    – Implication is that penetration is increasing
    • Looking ahead, Aggreko believes Power Projects market will grow at 10-15% CAGR 

    I highly recommend the 2012 strategy slides / presentation - http://ir.aggreko.com/investors/results-and-presentations/2012.aspx
     

    SubjectRE: competition
    Entry02/07/2014 04:55 PM
    Memberrhg

    Within the Local business, barriers to entry are relatively low; many companies, small and large, drift in and out of the rental business, and competition in each market is fierce. Typically, competitors in the Local business are either privately-owned specialist rental businesses, or divisions of large plant-hire companies. Their common characteristic is that they are local: most of them operate in a single country and, often, in just a particular part of a country. In their own territory they are very effective, but they find it difficult to operate outside their home market. So in most areas in which Aggreko operates, competition in the Local business is fierce; but the names with whom Aggreko battles tend to be different country by country, or even county by county.

    For Power Projects, in some regions – notably South America and Asia – there are a number of companies that compete with Aggreko in their home territory, but they find it hard to operate outside their regional base. There are about 10-15 Caterpillar dealers who compete vigorously for power projects but, again, they tend to stick to neighborhoods they know. These companies find it hard to organise themselves globally, however, and it is difficult to operate efficiently in the Power Projects business without a large homogenous fleet and the infrastructure to market, sell and operate it in a consistent manner around the world. There is only one other company that has the proven ability to operate globally, which is APR Energy plc, based in Jacksonville, Florida, and Aggreko has been competing with them, on and off, for about eight years. Their 2012 revenue were $266 million, which is about 10% of Aggreko's.

    Over the last ten years, some very large and powerful companies who have global scale in other markets have tried to emulate Aggreko but none has yet succeeded in building a global integrated power and temperature control business of the same scale. Aggreko is currently the only business in the market which has grown large enough to capture the economies of global scale and, in turn, these efficiencies have enabled Aggreko to fund rates of investment far ahead of any competitor. As a consequence of this rate of investment, Aggreko has grown to be significantly larger than any other company operating in this market.


    SubjectRE: Technological change
    Entry02/08/2014 02:11 PM
    Memberrhg
    The two recent technological innovations in this area have been:
    • New products that improve emmisions performance improving emissions compliance.
    • Technology that delivers MW at lower cost (e.g. natural gas powered technology).
    Being such a large player, Aggreko is in close relationship with the engine manufacturers and has good visibility into their product development pipelines. When new products / technologies appear, they introduce into their fleet pretty quickly. For instance, gas power generation already accounts for 1000 MW of their fleet. I don't see this as a major risk.

    SubjectMultiples
    Entry02/10/2014 07:55 AM
    Memberdarthtrader
    Hi there,
     
    I hear you on the rationale that Aggreko tends to always trade on a high multiple as it is a great business, potentially with a lot of growth ahead of it.
     
    I was just wondering if you could lay out the assumptions behind the statement that it trades on 15x P/E and 12x EV/EBIT.
     
    I think consensus is for 92p of earnings for the FY13 when they report it, then 84p in 2014 as the effects you refer to in the writeup play out, then back up to 91p in 2015. If consensus is right, the P/E, depending upon which year you are looking at, would be 17.1x-18.7x, quite a bit above the 15x you mention. Similar for EV/EBIT.
     
    Was just wondering if you have some forward estimates that are above consensus? Or are you doing some kind of normalisation?
     
    If the consensus numbers are right, does this change the investment case at all do you think?
     
    Many thanks

    SubjectRE: Multiples
    Entry02/10/2014 08:52 AM
    Memberlalex180
    I totally share darthtrader comments regarding the PE / EV EBIT multiples mentioned in your write up, it would be great to get further clarity on how you get to 15x PE.
    Separately, could you comment how do you get comfortable with the bear argument claiming margins will be structurally lower for the IPP business following termination of the highly lucrative Japanese and US military contracts?
    Many thanks

    SubjectRE: RE: Multiples
    Entry02/10/2014 11:48 AM
    Memberrhg
    I am using 2012 numbers for the multiple, I don't have a variant view on what the 2013/2014 numbers will be.
     
    Having said that, I modeled using the numbers projected by management in their strategy session. In my opinion, the street is too focused on the near-term (which I agree looks dismal), but management has repeatedly said that this is a business of high variability but on rolling 5 year basis, they feel they can meet their targets. 
     
      2012 2017E
      Actual Low Mid High
    Local Business        
      Growth %   8% 10% 12%
      Revenue 905 1,330 2,142 3,774
      EBIT Margin % 19% 18% 19% 20%
      EBIT 175 239 407 755
    Power Projects        
      Growth %   10% 12% 14%
      Revenue 638 1,028 1,811 3,487
      EBIT Margin % 33% 28% 30% 32%
      EBIT 212 288 543 1,116
    Group*        
      Revenue 1543 2,357 3,952 7,261
      Growth %   9% 11% 13%
      EBIT 387 527 950 1,871
      EBIT Margin % 25% 22% 24% 26%
    Taxes   30% 30% 30%
    NOPAT   369 665 1,309
    Multiple   12 13 14
    Enterprise Value 4629 4,427 8,646 18,331
    Net Debt 552 552 552 552
    Market Value 4077 3,875 8,094 17,779
    Total Return   -5% 99% 336%
    CAGR Return   -1% 15% 34%
    *Group Totals are excluding pass-through fuel.

    SubjectRE: RE: RE: Multiples
    Entry02/10/2014 11:52 AM
    Memberrhg
    Sorry, incorrect formulaes in my excel sheet. Redoing it again.

    SubjectRE: RE: RE: RE: Multiples
    Entry02/10/2014 12:04 PM
    Memberrhg
    Here are the updated numbers:
     
      2012 2017E
      Actual Low Mid High
    Local Business        
      Growth %   8% 10% 12%
      Revenue 905 1,330 1,458 1,595
      EBIT Margin % 19% 18% 19% 20%
      EBIT 175 239 277 319
    Power Projects        
      Growth %   10% 13% 15%
      Revenue 638 1,028 1,175 1,283
      EBIT Margin % 33% 28% 30% 32%
      EBIT 212 288 353 411
    Group*        
      Revenue 1543 2,357 2,633 2,878
      Growth %   9% 2% 2%
      EBIT 387 527 630 730
      EBIT Margin % 25% 22% 24% 25%
    Taxes   30% 30% 30%
    NOPAT   369 441 511
    Multiple   12 14 16
    Enterprise Value 4629 4,427 6,170 8,172
    Net Debt 552 552 552 552
    Market Value 4077 3,875 5,618 7,620
    Total Market Return   -5% 38% 87%
    Total Dividends Return   7% 8% 9%
    Total Return   2% 46% 96%
    Total CAGR Return   0% 8% 14%

    SubjectRE: RE: RE: RE: RE: Multiples
    Entry02/11/2014 04:19 AM
    Memberdarthtrader
    Many thanks for coming back.
     
    Not knocking the idea at all, but IMHO, this does change the case slightly. At 15x P/E, the case read along the lines of high quality company available at the very low end of the 10 year P/E range, excluding the crisis. At 17x-19x you are actually a bit nearer the higher end than the lower end. Another way of looking at it I guess would be to look at your "Mid" case, which contemplates equity value of ~£5.6bn in 2017 - with dividends it would be 46% upside, but that is an IRR of "only" about 8%-9% for a company without much earnings momentum in the short-term where the market seems to be pricing in more bad news (has struggled to really do much against the FTSE after the "reset" in expectations). Obviously you do explicitly state that at the bottom of the table in the posting you put up, so not really a criticism. And obviously if the high case plays out, then great.

    SubjectRE: RE: RE: RE: RE: RE: Multiples
    Entry02/11/2014 01:29 PM
    Memberrhg
    darthtrader,
     
    Yes, I tried pointing out that if the mid-case works out then the stock is at fair value in my original write-up. We think this is a good place to start a position. We will build our position as the multiple comes down. I should have attached the full table of low/mid/high case in the original table. Thanks for the question and reading the write-up.
     
    RHG

    SubjectCEO resigns
    Entry02/28/2014 04:09 AM
    Memberdarthtrader
    Okay so no profit warning, but as mentioned before, it did seem from the price action that the market had gotten a whiff if the fact that something bad was about to happen. The UK being the leaky market that it is, this has proved to be the case with the announcement today that the CEO has resigned. Does this change anything in your view? Did Serco just make Rupert an offer he couldn't refuse?

    SubjectRE: CEO resigns
    Entry02/28/2014 11:41 AM
    Memberrhg
    It is disappointing to see CEO Rupert Soames leave Aggreko. Rupert came in to Aggreko 11 years ago when Aggreko was at a low point. Rupert not only turned around Aggreko but built Aggreko into this wide moat company it is today. 

    Aggreko is a 3% position (our initial position size is generally 3%, we run a concentrated portfolio) and we plan to watch and see if the CEOs departure changes the thesis for us.

    We believe Rupert is leaving Aggreko less because of Aggreko's issues but more because he sees an opportunity for a major turnaround at Serco group. Serco has been troubled lately. We think Rupert is a great operator, Serco Group is going on our research deck list.

    RHG

    SubjectAGK post Q1
    Entry05/14/2014 07:40 AM
    Memberlalex180
    Stock is back above 1700p, was wondering if there have been any significant news that i might have missed? IPP order intake was stronger in Q1 yoy, do you believe we've reached the turning point in IPP?
    Thanks

    SubjectFor rhg on APR
    Entry07/16/2014 11:01 AM
    Memberlalex180
    Hi rhg
     
    Given your writeup on AGK, i imagine you are familiar with APR as well - do you have a view on why it is down -50% since the acquisition of GE towards the end of 2013 ?
     
    Many thanks
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