Vysarn Special: Investment thesis + CEO interview + FY23 results analysis
MORAM - Sunday 27th August 2023
We are updating the investment thesis of one of our best performing ideas in 2023 - as there are several important points to address - . We are talking about an Australian small cap company called Vysarn Ltd $VYS.AX which share price has rallied >110% since we published the thesis 6 months ago.
Today’s email cover:
Vysarn updated investment thesis
Our interview with James Clement - Vysarn CEO (August 2023)
FY23 Results analysis (Released on 25th August 2023)
Similarly, during the week, we have continued adding the analysis of 2Q23 earnings seasons for both, the companies we cover and its main competitors - All of them available on our website, where you can also find the summary & comments about the main events that happened during the earnings season (Jackson Hole, China ...)
We have taken advantage of this August to plan the rest of the year in each of the 3 pillars that make up our project: Investment Theses, Macroeconomic analyses and Education.
Small caps that we either see immediate opportunity in, or we discard during the analysis, explaining the process, or we leave them on the watchlist awaiting a trigger/market situation. Some of our recent analyses: Unidata, Arcos Dorados, New Fortress Energy, Twin Vee, ... & Serica next week
Discussion of current topics and their implications/actionable related ideas (e.g., BRICS vs G7 and effects on emerging markets)
Analysis of the functioning of specific sectors (Next week: How the LNG industry works - Data about all the existing Regas & liquefaction facilities in the world, import/exporting countries, each of the 734 LNGC vessels on the water,…)
Focus on the debt side - Types of debt, differences, things to look at when analysing a company…all from a practical standpoint & examples
Company valuation - Our idea is to replicate the process followed by an institutional
We will always provide some free content, but if you want to support our project and gain access to all our analyses & articles, monthly Q&As with the team, analyses than our users suggest and much more:
Vysarn Investment Thesis in a nutshell
Vysarn is a vertically integrated company with 4 business divisions providing water services in Western Australia. With a market capitalization of A$ $79M, this micro-cap is trading around 2024’s (FY ends on 30th June) 4.5x EV/EBITDA and less than 7x NPBT. Vysarn is experiencing high growth and entering more profitable and less capital-intensive segments. The Chairman of the company already led a company that multiplied the value of their share x37 in five years. Vysarn´s management is highly experienced in the sector and in M&A.
Core business (hydro dewatering) revenues are backed by multi-year contracts with tier-one iron ore producers. This segment is expected to contribute around 14-16M EBITDA per year.
Since the start of the operations in Sep 2019, they had a clear route of integrating the business vertically, acquiring compatible businesses with their core division. The diversification into more capital-light segments is starting to translate into higher valuation multiples.
After an H1 negatively affected by rig maintenance, on Friday 25th August they just reported the FY2023 results which were proof of the level of revenues and baseline earnings the company can achieve.
Possible catalysts for the share price:
Higher percentage of revenue by capital-light divisions.
Inorganic opportunities (CEO interview)
Dividend in the fiscal year 2024.
Increasing interest in water as a resource
Peter Hutchinson (current Chairman) bought MHM Metals, an ASX unlisted company, and renamed it as Vysarn in late 2017.
In April 2019 they agreed to buy drilling assets to Ausdrill for $16 million. In September, they relisted Vysarn on the ASX. With this funding ($7M from relisting + $8.8M from debt), Pentium Hydro, one of the subsidiaries of Vysarn, acquired the pre-agreed 10 drilling rigs plus some ancillary equipment (casing rotators, air compressors, rig carriers, etc.). The fair value of these assets was seven million higher than the purchase price.
A few weeks after the relisting, they signed the first contract to provide drilling services. Since then, they have moved from short-term contracts to longer-term ones with tier-one clients. Driven by strong demand, they bought other two drilling rigs. During these years they have accomplished almost full utilization rate during these years.
In November 2021, they completed the acquisition of Yield Test Pumping (Pentium Test Pumping) at less than 4 times EV/EBITDA, starting the company's vertical integration. Before the acquisition, Yield had already signed a two-year contract with Fortescue Metals Group (FMG) to provide test pumping services.
Only three months later, in February 2022, Vysarn launched their consulting division (Pentium Water) organically. And in the summer of 2022, they acquired ProEng for $2.6 million (3x EV/NPBT) entering the Managed Aquifer Recharge (MAR) segment. ProEng is one of the more clear proves of management's ability in M&A, with less than one year consolidated, once consolidated, ProEng has achieved more than $1.5 million in NPBT.
The latest movement by the company was to establish a 50/50 Joint Venture to enter the fluid containment solutions with Concept (a leader in this business in Eastern Australia).
In blue, you can see the steps in which Vysarn already competes. The company has already anticipated that for the following years, their focus is on Stages 1 and 4 as Stage 3 is much more crowded and where big competitors participate.
Vysarn Business lines
Hydrogeological drilling. Vysarn started their operations with Pentium Hydro, which continues to be the main revenue contributor. Pentium Hydro drills bore fields and extracts the water above the iron ore.
More than 75% of the iron ore mines developed since 2000 in the Pilbara region have a part of the ore below the water table, which must be dewatered to be exploited. This is achieved by pumping out from cased bores drilled by contractors like Vysarn. This pumping must be maintained continuously to keep the groundwater levels suppressed and the mine pit dry.
The service is essential because if the water mixes with the iron ore, this becomes low-grade and cannot be sold. The dewatered water is used for mine operations and town drinking water, and another percentage is returned to the environment through Managed Aquifer Recharge (other of the segments of Vysarn).
The dewatering process is:
Drill and case multiple boreholes.
Install pumps, which abstract water from the pit for reuse or disposal. Monitor and account for abstracted water.
Dewatering must be everyday operational for 3–6 months to allow sufficient drawdown.
Repeat the process as every 1–2 years the mine expands and takes over boreholes or deepens beyond dewatered zones.
The company has achieved steady operations from Pentium Hydro, earning around 1M EBITDA per month. A drilling rig can cost up to USD $5 million (AUD $7.2 million). The company has already commented that it is not in their plans to buy more drilling rigs, as they see more value in executing the vertical integration.
As they have been doing the last few years, Vysarn aims to continue signing multi-year and multi-rig contracts with tier-one clients, which are stricter with the conditions and characteristics of the rigs, but they are also more reliable and pay a higher price. The management seems confident with their aim to achieve longer-term and higher-priced contracts.
This segment will generate the necessary funding for prospective M&A or organic launches. It is the most capital-intensive business and the most vulnerable to unexpected maintenance or repairs and weather conditions.The upgrade of the rigs has led to better contract terms with Roy Hill and with this they have achieved the fantastic results in FY23, surpassing all the expectations.
Currently, they are only double-shifting one rig, but as they gradually double-shift more units (they expect three by the end of FY2024), the earnings power of a second shift coming out of a rig with a fixed cost base is material. The main reason for not double-shifting more rigs is the tightness in the labor market.
Pentium Test Pumping:
Test pumping/ Injection Testing. After the well is drilled and cased (services provided by Pentium Hydro), the next step is to measure the water-level response within the well and the surroundings (how effective has been the drawdown effect), and conduct tests regarding the pump rates and the hydraulic properties of the aquifer, among others. The five critical tests that the pumping unit does are calibration, step, constant rate, artesian well, and recovery tests.
This groundwater data is of great importance for clients because, from this data, companies take investment and production decisions.
Vysarn acquired Yield Test Pumping for $2.6 M in November 2021. At the time of the acquisition, PTP had just signed a Master Service Agreement with FNG. So, they inherited the entire MSA for its lifespan. Test pumping vehicles cost approximately $2-2.5M. And they will deploy a second unit in September 2023 and already booked to buy a third one that should be deployed around September 2024.
We see a clear path to growth in this segment. On the one hand, by the addition of new test pumping units and on the other for the extension of services offered. The latest will come thanks to a new patented valve technology developed by ProEng (other of their divisions discussed later). This will also expand Test Pumping operations into injection testing for which the company already has enquiries by customers and expects to start developing before year end.
Dwayne Moppet was the maximum shareholder of the acquired company and serves as a managing director of Pentium Test Pumping. At the time of the acquisition, Vysarn and Mr. Moppet entered into an employment agreement for the following three years. He has an incentive of up to $750,000 during the three-year period if they achieve: $650,000 EBITDA in year 1, $1,200,000 EBITDA in year 2 and $1,350,000 EBITA in year 3.
The acquisition has a clear sense of integrating the next service after drilling. Moreover, Test Pumping and Hydro can share some of the equipment: telemetric, compressors, etc. The strategy of the company is to cross-sell from Pentium Hydro to Pentium Test Pumping. Roy Hill and other clients asked them to enter the test pumping market and also in injection testing.
The main competitor and leader in test pumping is MacArthur Drilling and Pumping (MDP). Pentium test has a range of capabilities not only in mining but also in agriculture, municipalities, and government.
Water Consultancy. This division, launched in February 2022, provides an assessment of water management in hydrogeology, hydrology, and environmental planning. The clients are the resource, urban development, utility, government, and agricultural sectors.
The main idea of this segment is not to deliver financial results by itself, but to provide line of sight and entry opportunities across a spectrum of water, carbon, and environmental opportunities, both organically and through acquisition.
For example, they identified the growing demand and further possibilities for managed aquifer recharge capabilities. So, they acquired ProEng (discussed below). Other early opportunities already identified are water ownership and infrastructure, asset management, carbon farming, irrigated agriculture, mine closure, and urban rehabilitation.
The synergies with the rest of the divisions are easy to see. On the one hand, they will be more knowledgeable when offering MAR consulting and on the other, it will be much easier to execute cross-selling.
In the first year and a half of operations, they have considerably grown the team and possess a good pipeline of projects across a diversified range of sectors and clients. We expect this segment to maintain strong growth due to the increased importance of water management and the higher weight in earnings should help get Vysarn better multiples.
Managed Aquifer Recharge (MAR). It is an engineering business that designs and constructs managed aquifer recharge systems in the resource sector in Pilbara, and commercial fishing and aquaculture sectors.
To solve the high dewatering in the mines, MARs recharge aquifers under control conditions for mitigating the impacts of abstraction or just as a way of optimizing water storage. It is also important from an environmental perspective.
There are great barriers to entry. First, MAR systems are not simple to replicate. To operate them, a licence is needed. And Pentium Water is also looking how to complement this business segment with for example, aquifer characterization studies, which would suppose a competitive advantage.
In the next few months, they will launch the second generation of valves, which will be used also by Pentium Test Pumping for injection testing. But MARs can also be used outside the resources sector. ProEng already has clients in aquaculture. MARs can also recharge aquifers during heavy rainfalls and discharge them during droughts. One of the objectives is to enter this later segment that is expected to have a meaningful growth due to the extreme weather conditions in the Pilbara.
ProEng was acquired in October 2022 for $2.6M and the targeted EBT for 2023 was $850,000 (3x EV/EBT). However, they have achieved more than $1,500,000, what shows how the company is able to buy a small company, inject capital on it to remove the capital constraints and exploit their potential.
The focus of Vysarn in the segment is to transform its revenue model from a MAR constructor to a more recurring revenue and higher margin model in which the company also offers to install, operate & repair and SaaS and DaaS. The number of growth in the units is expected to be very high at least in the next two years.
Vysarn Concept Joint Venture
(Fluid Containment Solutions)
It is the most recent segment of Vysarn. Together with Concept, a leading fluid containment solution provider in Eastern Australia they have established a Joint Venture to provide the services in which Concept is a specialist in Western Australia where Vysarn has their operations and thus, the clients.
There are no budgeted earnings for FY24 and not much information has been provided yet. We would like to have more news about it because it can be very contributive to earnings even if they are able to sell just one unit.
Vysarn Sector, competitors, and clients
In this section, we will look at the competitive outlook in each of the segments in which the company operates. As Pentium Hydro and Test Pumping are very concentrated in three clients, we will briefly Roy Hill, FMG and BHP.
It is expected that 85% of Pilbara deposits will be below the table in 2024. The water abstraction in the Pilbara is expected to go from 450 gigalitres in 2020 to 600 GL in 2024.
The services provided by Pentium Hydro are for iron ore miners. 98% of the iron ore is used for steel production. During the last decades, Australia has experienced a strong demand derived from Chinese growth, and production grew exponentially. Despite the tensioning relationships between China and Australia, the rhythm of mines opening has not slowed.
It is worth mentioning that Australia is the world leader in iron ore production both because of the extracted amount and because of the cost of production which ranges from US$16 to US$18 per ton for FMG, BHP, and Roy Hill.
The competitive situation in the hydro drilling and test pumping is very fragmented with a lot of small players. We could not find any publicly traded competitor for Pentium Hydro nor PTP.
For water consultancy, there are also a lot of small players, but there is a big fish that outstands, Tetratech, a US listed company with 1,200 employees in Australia providing water, and environmental consulting, among other services. It is currently trading at almost 25x 2023’s EPS. They also have a good pipeline of projects. The most similar peer for the whole business was Ventia. But the range of services offered by Ventia is much broader.
One of the risks of Vysarn is the client concentration in Hydro and Test Pumping. Although the three clients are tier-one.
The three companies have a similar profile, with little or no growth but with a high ROE and ROIC, and a strong balance sheet position. In their presentations, these companies confirm that over the medium term, there will be an increase in below-table mining.
Vysarn Management team
A great part of the thesis relies on the management’s ability to conduct the vertical integration. We feel confident about their ability as they have already shown up their skills in Vysarn and other previous listed companies.
The three key men in the company are Peter Hutchinson (Chairman), James Clement (CEO), and Sheldon Burt (Executive Director and Director of Pentium Hydro).
Peter Hutchinson (Chairman) has 30 years as a business leader. He founded Forge Group which went public in 2007 with a market cap of $12M and when he resigned from his CEO position in 2012, the market cap was $450m. Some years later, he founded with James Clement, among others, Mareterram which was also bought at a 22% premium.
James Clement (CEO) has a great experience in M&A when working in Mareterram (2014-2019). Previously he was an institutional dealer and retail fund manager specialised in Western Australian small-cap industrial and resource companies.
Sheldon Burt (Executive Director) has a broad experience in the drilling sector (+30 years). He previously worked for Ventia.
The compensation of the three key men is the following:
In November 2022, Board and Management had 22.45% of shares.
Due to the difficulties in 2021 and 2022, they have been extremely cautious with their guidance for 2023 (also, as we have repeated endlessly in the latest memes since our company's numbers (very precise, as we have confirmed in discussions with the management) were significantly higher than their guidance).
To sum up this part, we think that the three are great professionals and businessmen, with experience starting a company from scratch and developing a strategy at a safe and good pace.
Concentration risk. Currently, in Pentium Hydro, the rigs are deployed to only 3 clients. And Pentium Pumping only services FMG.
Employee shortage. In Australia and in the mining sector there is a high demand for qualified workers. In previous periods, the company emphasized the efforts they were making to attract and retain talent.
Australian iron ore demand was driven by strong economic growth in China. As it is happening, the relationships between countries are worsening and this can drive this demand down. We want to remark that Vysarn is not a commodity company.