|
It's impossible to generalize when it comes to
renewable energy investments. Therefore, investors must approach
opportunities on a case-by-case—and state-by-state—basis. But
Jacob Securities Senior Vice President of Research John McIlveen
knows how to pick his plays in any market environment. In this interview with
The Energy Report,
John McIlveen names his best bets. As always, safety first.
The Energy
Report: In your last interview, your primary concern in
making investment decisions was safety. I know you focus primarily on
Canadian companies, but has all the "fiscal cliff" talk influenced
your approach to renewable energy investments?
John McIlveen: With the fiscal cliff, I could see how renewables might get pushed to
the back burner in the process of cutting a budget deal. Some renewable
incentive policies might even be used as a bargaining chip to get other
budget items through, such as higher taxes or spending cuts.
TER: How have the oil and gas market dynamics in 2012
affected the outlook for companies in the renewables industry?
JM: Renewables are very competitive with oil-fired
power, but not with gas or natural gas-burning plants. Gas sets the marginal
price for power and affects the prices for a new project that developers are
trying to build. This doesn't affect existing projects because these are all
under long-term contracts with fixed prices that generally include an
escalation clause. But for bidding a new contract, a low gas price pinches
the budget for developers.
TER: How much do current prices affect the timing of any
new investment decisions in the renewables field?
JM: In those states that don't have a renewable
portfolio standard—and about two-thirds of the states do have
one—there isn't going to be much incentive for renewable power, period.
States that do have renewable portfolio standards, such as California, have
to consider how they will achieve the percentage of renewable power
objectives that they have. If they really want to hit their portfolio
standards, they're probably going to have to pay up in terms of the power
price they're willing to contract for. There's still incentive on the state
level to proceed with renewable energy. But on the federal level, not so much.
Most of the incentive programs, such as investment tax credit grants and/or
biodiesel tax credits, for example, are all expiring.
TER: Are the dynamics different in Canada than in the
U.S.?
JM: Each province has its own way of going about things.
Some have incentive programs. Some do not. Some have a high tariff structure.
Some do not. In the U.S., if natural gas is going to affect the local market
in terms of new project prices and power prices, then developers may just put
a project on the back burner. They would perhaps look to areas outside the
U.S. that may be getting power supplied by oil-fired generation, such as much
of the Caribbean and more remote mining sites in South America. When you're
replacing the cost of oil, which in some jurisdictions is as much as
$250/hour, renewables at as much as $100/hour look pretty good.
TER: Where do you see the best growth opportunities in
renewable energy?
JM: Within the U.S. it's more case-by-case or more like
state-by-state, depending on how much they want renewable power. Probably the
best growth opportunities lie more in the Caribbean and Central and South
America where they don't have a natural gas supply and import oil to generate
electricity. Using renewable power and cutting oil imports is great for their
balance of payments and at the same time their consumers are getting a lower
price for the power.
TER: Getting to specific companies you cover, I see that
you've raised your target price for Ram Power Corp. (RPG:TSX) substantially, from $0.68 to $0.90/share. What's the story there?
JM: Ram Power just came on-line with 36 megawatts (MW)
in the last quarter and will add another 36 MW before the end of this year.
I'm looking for Ram to generate $40 million ($40M) in EBITDA for 2013. That
puts the current valuation down around four or five times
enterprise value to EBITDA. But the market has to see the cash flow before
it's going to give any value to it. It's looking for show-me stocks for
juniors, and this is not just limited to Ram Power. All the junior stocks are
capital constrained, so they have difficulty raising new money to expand or
to take on new projects, compared to the more mature companies that pay a
dividend, which have great access to capital and a decent valuation in the
market from which to raise more money.
"Probably
the best renewable power growth opportunities lie in the Caribbean and
Central and South America where they don't have a natural gas supply and
import oil to generate electricity. "
Back in
January, I thought safety was really the main concern, and that situation
still continues today. Whereas the dividend-paying, more mature power
companies have done well and are mostly up on a year-to-date basis, almost none
of the juniors are, barring a special situation such as a potential takeover.
This would be the case for Shear Wind Inc. (SWX:TSX.V), Western Wind Energy Corp.
(WND:TSX.V) and Finavera Wind Energy Corp. (FVR:TSX). So if you were interested in buying the junior
companies, you shouldn't be buying them expecting near-term growth, because
they're capital constrained. If you're buying them, you're hoping they'll get
taken over because their valuations are very cheap—much below what I
would think they would be in the private markets.
We're
starting to see M&A activity among the juniors, whereas the seniors are
still all about yield. In just the last four weeks the seniors seem to be
declining somewhat, which is perhaps an indication that the market is seeing
that yield stocks may have become a little bit too pricey and are starting to
look for value elsewhere. This also goes for banks, real estate investment
trusts and a lot of the yield stocks in general.
TER: In the oil and gas business it seems that almost any
company that's reasonably successful gets taken out after five or six years.
Is that going to be the case with most of these smaller companies in the
renewables field?
JM: I think so, but I'll put them into two categories.
There are junior companies with power plants that are on-line and those
without. I don't think the market is paying good money for a company with a
pipeline of undeveloped assets. So if you've got some rights to a bunch of
sites that you're evaluating, but no power purchase agreement signed, you're
not going to get much value for those assets. However, power assets on-line,
generating real cash flow, are going to be attractive to anybody larger than
that company.
TER: One of the companies you mentioned last time was U.S. Geothermal Inc. (GTH:TSX; HTM:NYSE). What's happened with that one since you last
talked with us about it?
JM: U.S. Geothermal has been bringing assets on-line and
hitting its milestones. I'm looking for it to produce an EBITDA of $15M in
2013 and be cash-flow positive for the first time. It has on-line assets,
which could make it an attractive takeover target. I would think that Ram
would be pretty attractive as well.
"Back
in January, I thought safety was really the main concern, and that situation
still continues today."
Alterra
Power Corp. (AXY:TSX) has had a number of events that
could make it a very interesting story. It received an offer for its
geothermal assets in Iceland. If this sale goes through, the company would
have more than $120M cash on the books and be debt-free. Alterra
also has other projects with permits and power purchase agreements where it
could redeploy that cash. Also, General Electric Co. (GE:NYSE) is selling some wind and hydro assets in British Columbia, two of
which involve joint ventures with Alterra—one
hydro and one wind. If the price is attractive enough, Alterra
might also sell along with GE or perhaps, if it's a passive buyer, it may
want Alterra to stay and run the assets. A lot of
events are working in Alterra's favor that can
create cash, which it could deploy into its other development projects.
TER: So, Alterra could become
some sort of midtier-type growth company that could
expand on its own, rather than being taken over immediately.
JM: If no one wants to take out Alterra,
then it's likely that by the time a number of these events unfold in 2013, it
may actually become a dividend-paying company in 2014 or 2015.
TER: There's been quite a bit of turmoil in the solar
energy industry this year, particularly for hardware producers. How are the
companies you follow in solar energy production doing?
JM: Hardware producers are a totally different animal
than the power producers. We get a lot of calls from the press relating to
government-guaranteed programs. A power producer has a fixed price and a
fixed quantity contract for 20 years, so it's a good bet for a loan.
Manufacturing, especially in the solar chain, involves many steps, and not
everyone is integrated through the whole chain. A lot of boom-bust cycles
occur within the equipment manufacturing industry, even for wind power. So,
there just isn't the type of certainty and predictability that you have in
financing a power generator.
TER: The wind energy production industry is also
dependent a lot on government subsidies. One of the companies you discussed
last time was Western Wind Energy, which has been embroiled in both internal
power struggles and possible takeover deals. Where does that one stand now?
JM: Western Wind put itself up for sale last summer and
has been allowing potential suitors into the due diligence room to look at
the company. We don't know who the eventual buyer will be or the price to be
paid. Over a year ago there was a soft offer from a suitor for $2.50/share,
so that's where the stock is hovering, waiting for more news on the potential
sale. But, a group of dissident shareholders did come forward and wanted to
change the board to people they felt would be more committed to the sale of
the company. The existing board beat that back in a shareholder vote and so
remains in control, but at the same time they state that they are committed
to selling the company. It looks good from a risk-return profile because
there isn't much downside to owning it at $2.50, whereas I think there could
be some significant upside when the final bids are in.
TER: Any projected time on when they might be accepting
an offer from somebody?
JM: We're expecting an update soon. They've been at it
now for a good three months of due diligence and it could be another three
months before a final offer is accepted.
TER: Have there been any interesting developments with
some of the other companies that you've been following?
JM: BIOX Corporation (BX:TSX), which makes biodiesel, is suffering from a symptom of the industry
as a whole. It's actually shut down its plant because of weak prices in the
biodiesel market due to the expiring of the $1/gallon tax credit and the fact
that the volume mandate set by the EPA is just about filled for this year.
So, they lose money at the market prices today, which I'm sure is the case
for many biofuel producers. This is an industry that is incentive driven and
needs those incentives to go forward.
TER: What happens with BIOX if there aren't some positive
developments in its favor?
JM: If you're in the business you've got to assume there
will be some recovery in prices. After all, the volume mandates set by the
EPA did go up by 28% for 2013. If too many plants shut down, producers can't
meet the EPA volume mandates, and prices will have to go up to make those
plants open up again. In the meantime, it's going to be a rough ride until
the market finds that equilibrium price for biodiesel.
TER: Can this become a cyclical thing that's going to be
on-again, off-again for some period of years?
JM: Each year, Congress allows the tax credit to expire.
In 2011 they let it expire for the whole year and then reinstated it at the
end of the year retroactively. This sort of incentive makes the market gyrate
and something more consistent is needed for this industry.
TER: On the other hand, if investors want to take a
crapshoot, it's an opportunity to play a little mini-cycle.
JM: That's right. So, if you've got some political savvy
and you think incentives are going to be restored, then that would be a good
play.
TER: What's been going on in the senior company sector?
JM: There's been an interesting development of late with
Just Energy
Group Inc. (JE:TSX), which is basically a reseller of electricity and
natural gas, along with some other activities across North America. The stock
has gone down from a one-year high of $14 to about $8.50/share today,
resulting in a dividend yield of almost 15%. I bring this up to make a point
about dividends. Investors often look at the dividends in a group, whether it
be banks, real estate or utilities. In the case of
power producers, the low yield in the group is around 4.3% and the high yield
is almost 15%. That's quite a spread, but when you see a high yield, as in
the case of Just Energy, it's because the market is pricing in the risk of a
dividend cut.
"We're
starting to see M&A activity among the juniors, whereas the seniors are
still all about yield."
So, just
because you see a high yield, don't go rushing to that when you see 14%
versus 6%. When a company has a 6% yield in the power sector, it's likely
because it's lower risk and the market thinks its dividends will increase
over time. If you don't want to do a lot of homework, the simple way to pick
these stocks is to pick the one with the lower dividend, because that one is
probably going to increase over time, whereas a high yield may see a dividend
cut.
TER: Are there any other of the more established
companies you'd like to mention that look interesting?
JM: If you want to sleep well at night, you've got to
be thinking Algonquin
Power and Utilities Corp. (AQN:TSX) and Brookfield Renewable Energy
Partners L.P. (BEP.UN:TSX), which are the two largest ones in the Canadian
space. Northland
Power Inc. (NPI:TSX) is also a premier company, which is about to double
its megawatt assets over the next year. I would expect the stock itself to
move a bit more sideways for about a year until it starts bringing all those
new assets on-line. Once it does, you can start thinking about a dividend
increase for 2014, but not for 2013. Innergex Renewable Energy Inc. (INE:TSX) is another solid company with a good track record of growth and
executing on its development projects. Algonquin and Brookfield would be my
short-term favorites here, and then late in 2013, I'd be looking at Northland
and Primary Energy.
After
that, we get to companies that are a little smaller but still decent investments. Capstone Infrastructure Corp. (CSE:TSX), Primary
Energy Recycling Corp. (PRI:TSX) and Sprott Power Corp. (SPZ:TSX) all have lower yields as well,
given that they have a good payout ratio. So they're 75% or lower in terms of
dividend to free cash flow.
TER: Given what you currently see on the horizon, how
should investors interested in alternative energy stocks play this market in
the coming year?
JM: I'm still emphasizing safety for the majority of
your holdings in this space. You might also want to pick up a few of the
juniors that you think could become takeover targets or already are, such as
Western Wind. We'll have to see what happens after the fiscal cliff is
hopefully avoided and whether the federal government turns some attention
back to renewables.
TER: We'll know much more about that relatively quickly.
Meanwhile, we appreciate your input.
JM: My pleasure.
Jacob
Securities Senior Vice President for Research John McIlveen has been with the firm five years and has a total
of 26 years' experience in special-situations research and merchant banking.
In 2004, he became Canada's first sell-side analyst to focus solely on
renewable energy research and consistently has been ranked a top performer by
Bloomberg on accuracy of estimates and returns. He is currently treasurer of
the Canadian Geothermal Energy Association and a published academic with 15
papers, including his and coauthor Alan Rugman's
1985 best Canadian book-nominated "Megafirms:
Strategies for Canada's Multinationals."
Want to
read more Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when
new articles have been published. To see a list of recent interviews with
industry analysts and commentators, visit our Streetwise
Interviews page.
DISCLOSURE:
1) Zig Lambo of The
Energy Report conducted this interview. He personally and/or his family
own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The
Energy Report: None. Streetwise Reports does not accept stock in exchange
for services. Interviews are edited for clarity.
3) John McIlveen: I personally and/or my family own
shares of the following companies mentioned in this interview: None. I
personally and/or my family am paid by the following
companies mentioned in this interview: None. I was not paid by Streetwise
Reports for participating in this interview.
|
