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Competition Markets Authority released its summary decision, with management confident that dividends can be sustained under new rates. Management discussed additional levers to find value at Bristol Water, including new financing options, additional efficiencies and increased leverage. Overall, following the decision, valuation has been derisked and significant upside maintained. Nearly two months ago, we published a report on Capstone Infrastructure Corporation ( OTCPK:MCQPF ), a Canadian small-cap infrastructure company. The company has a variety of critical infrastructure assets, from solar, wind, hydro and biomass power generation, to natural gas co-generation, district heating and a water utility. The firm’s assets are geographically diverse, with the power assets located in Canada, the district heating business in Sweden and the water utility located in the U.K. The company has a market capitalization of just over C$300 million (US$230 million) and is traded primarily on the Toronto Stock Exchange under the symbol “CSE.” Today, we would like to share some analysis of a recent regulatory decision that we believe adds considerable certainty to the future sustainability of Capstone Infrastructure and confirms the company as an attractive value play. At the time of publication of our initial report, one of the material risk factors to Capstone’s valuation was the pending U.K. Competition Markets Authority (CMA) decision in the appeal of a previous Ofwat regulatory decision for its Bristol Water business. This pending decision was a major factor in the decline in Capstone’s share price and has been a drag on the stock’s value for the past several months. We are happy to now see this decision released, and investors can largely put this concern behind them. The regulator’s press release and a summary decision regarding Bristol Water was released on October 6 , clarifying several factors for the business, including increased operating expenses, increased capital expenditures on a reduced scope, a higher return on equity and higher customer billing rates. While the company felt that the billing revenue side of the decision was disappointing, overall the decision will, in the view of management , enable Bristol Water to maintain its dividend level going forward. We agree that their approach to managing the lower rates does seem reasonable and that dividends at or very near the previous levels should be able to be maintained. The trading response to this decision has been fairly muted, perhaps because the outcome is not substantially different from the preliminary findings of CMA released earlier this year. But today we stand faced with more certainty about the short-term sustainability of the dividend, which at nearly 10 percent is underpinning a great deal of the company’s value today. In our valuation case presented in our original piece, we indicated that the impact of the Bristol Water decision would be plus or minus C$7 million on adjusted funds from operations. It seems that via management’s responses on the conference call, overall distributions from Bristol Water should be maintained at their previous levels, in line with our “mid-case.” With this uncertainty removed from the picture, we can tighten the 2017 share price target range from C$2.92-7.53 to C$3.82-6.56, maintaining our mid-case target of $4.90 per share. (thousands) Low Case Mid Case High Case Comments Start: 2014 AFFO $56,412 $56,412 $56,412 Impact of Cardinal ($36,000) ($36,000) ($30,000) Low case is with project financing, high case is without. Impact of Bristol $0 $0 $0 2015 Commissioned Wind $5,000 $6,000 $7,000 Skyway 8, Saint-Philemon, Goulais 2015 AFFO $25,412 $26,412 $33,412 2016 Commissioned Wind $2,500 $3,500 $4,000 2016 AFFO $27,912 $29,912 $37,412 2017 Commissioned Wind $0 $3,500 $4,000 Corporate Savings $2,000 $5,000 $10,000 Management projects $10 million in corporate SG&A, project cost, interest and tax savings 2017 AFFO $29,912 $38,412 $51,412 2017 Projected Share Count 96,408 96,408 96,408 Based on 93,573 outstanding at Dec 31, 2014, increased by 1% annually for DRIP 2017 AFFO per Share $0.31 $0.40 $0.53 Payout Ratio 80% 80% 80% Projected 2017 Dividend/share $0.25 0.32 $0.43 Projected Dividend Yield 6.5% 6.5% 6.5% Conservative dividend level based on peer group 2017 target share price (CAD$) $3.82 $4.90 $6.56 There are still risks present in this valuation of course, including Bristol’s inability to implement cash flow enhancements to the level that management currently anticipates, or potential schedule issues or underperformance on their new energy assets. Even if these risks materialize, however, we believe the downside is not much lower than where the stock is trading today. At a significant discount to book value, this is a true value play with considerable upside for investors. We believe there is considerable short-term upside here heading into the third-quarter results in early November, and of course stand behind our call for considerable upside into 2017. To summarize, this decision derisked the situation at Capstone Infrastructure, while in the subsequent trading days, the company has maintained a substantial discount to what we perceive as a fair value. With a dividend that we’re comfortable with calling sustainable at near 10 percent and future cash flow growth supported by a higher degree of regulatory certainty, Capstone Infrastructure is currently positioned as a fantastic value play for investors with a greater than 50 percent upside to our target price and a sustainable 10 percent dividend. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. Scalper1 News
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