Tag Archives: debt

Terraform Power: Buying When There Is Blood On The Streets?

Summary Terraforma Power shares collapsed over the past few months. Liquidity concerns and the funding of future commitments are worrying investors. I will dig into the liquidity issue to assess whether the company is a good investment opportunity at current prices. Terraform Power: buying when there is blood on the streets? The original quote is attributed to Baron Rothschild, who apparently made a lot of money by buying assets amid the panic that followed the Waterloo battle against Napoleon. Can we apply the same concept to Terraform Power (NASDAQ: TERP )? Only one thing is certain. There is a lot of blood on the streets. The stock is down almost 80% from 40$ in July to 8.4$ at the time of writing. A bit of a background may help those not familiar with the story. The company owns and operates clean power generation assets (solar and wind in particular). In a nutshell they buy the assets, they structure the financing, they negotiate power purchasing agreements (if they do not come already with the assets) and they distribute the income once operating costs and financing costs are repaid. A very simple business model. Two things make it complicated: Liquidity: in the good old days of a stock trading between 30$ and 40$ they signed agreements for acquiring a significant amount of assets knowing that they had a lot of options to finance deals (project financing, corporate bonds, loans and equity issues). The stock decline worried investors to the point that the liquidity issue is becoming a self-fulfilling prophecy: the stock goes down, cost of equity and debt goes up, they have fewer options available for financing and therefore the stock goes down even more. Issues at Group level. TERP is partially owned by its sponsor, Sunedison (NYSE: SUNE ), a developer of solar plants whose stock price has crashed even more due to high leverage, significant commitments to buy new projects and incredibly difficult to read financial statements, with a mix of recourse and non-recourse debt and questions on the future solvency of the business. In this report I will try to assess the current situation of TERP and the future commitments in order to establish whether the market overreacted to the liquidity issues and is mispricing the stock. A good starting point is the presentation of Q3 results. On slide 17 the company shows the most recent capital structure adjusted for the latest deals announced: (click to enlarge) Source: Q3 2015 Earnings presentation The company shows cash of 796 mln and a combination of recourse debt (two bonds for 1.25bn) and non-recourse debt (project financing for 1.3bn). The net financial position including all debt is therefore 1.76bn. This debt is against a 2016 ebitda run rate for the current portfolio of approximately 400 mln with a net debt / ebitda of 4.4x and against a portfolio of renewable energy facilities valued at approximately 4bn in the balance sheet. If we were talking about real estate we would say that the loan to value is 44%, a reasonably low level. Remember that we are talking about assets with highly predictable cash flows and long term power purchasing agreements in place (average life of 16 years). The status quo shows one thing: the company is currently under levered given the type of assets they held. One important supporting factor is the recent (November 6th) renegotiation of the debt on certain assets in the UK, the results of which are in the pro-forma figures showed above. The company managed to refinance those UK assets at a 4% all-in interest cost with non-recourse debt. That figure shows how – at an asset level – TERP’s portfolio is seen as extremely high quality. Now let’s look at the commitments. Here things start to become challenging. TERP committed to buy 1,453MW of solar and wind assets from Invenergy and Vivint as part of a deal structured by its parent Sunedison. The total cost of those assets is approximately 3bn. From the 10Q we can also see that the company has commitments to buy additional energy facilities from Sunedison for a total of 1,080MW (1.4 bn). Let’s analyse how the company is thinking about those commitments. On slide 18 of the Q3 presentation the company offers a picture of the current status of the financing plan for the Invenergy and Vivint acquisitions, showing 1.7 bn completed and 1.3bn in progress. (click to enlarge) Of the “in progress” part of the financing we have three components: Vivint Term Loan or TERP bond (250 mln) Project finance debt (726 mln) 3rd party infrastructure capital (300 mln) During the Q3 conference call the management stated that they are making good progress on the financing. My personal take is that a TERP bond is not realistic (the yield would likely need to be above 10% given the sentiment around the stock) while all other options appear credible. In particular the largest chunk is project finance debt and the company showed earlier this month that they can successfully raise that kind of capital at very good terms. Infrastructure capital should also not be a serious problem in a market full of yield hungry investors. I will let you make your judgement on this but I believe we are not talking about an impossible task for the company. Remember, all assets are cash generating with 15 years plus of revenues under contract with primary standing counterparties. Moving on to the commitments to buy the Sunedison facilities the company states in the 10Q that on October 26th SUNE entered into a purchase and sales agreement with a JP Morgan fund that agreed to buy three of the assets that are part of those commitments. Upon closing, expected on the fourth quarter of 2015, TERP will have a reduction in its commitment to buy SUNE assets from 1.4 bn to 580 mln. The company intends to deal with these commitments through a combination of project finance debt, company cash, assumption of current debt and the involvement of third party infrastructure investors. While TERP is currently working on securing the financing, SUNE is also looking for third parties that may be interested in taking the projects directly. In case of a sale by SUNE the commitments for TERP would decline further. A final point that I would make on the liquidity issue is that the company currently has in place an unused revolver credit facility equal to 725 mln that is going to increase to 1 bn and can offer further flexibility in structuring the financing for the deals mentioned above. My final take on the liquidity issue: it is very scary when sudden lack of confidence hits a company. TERP’s 2023 bonds moved from 95 at the beginning of the month to current values of around 70. Capital markets are clearly closed for TERP at the moment. That contrasts a lot with what the company managed to achieve by financing at the asset level , like they did in the UK. I particularly like the fact that at the moment there is only 1.3 bn of project finance debt in place against 4 bn of assets and that suggests me that deals similar to the UK refinancing could soon take place in other parts of the portfolio. I am confident the company will work in this direction and will eventually be able to finance all the deals even though spreads will certainly be higher than a few months ago. Finally let’s look at the stock. What are you buying at 8.4$? I will make a very simple analysis here. Let’s assume no equity is issued and all commitments are paid for with new debt. Let’s also assume that the incremental debt raised and its amortization completely eats all of the cash flow produced by the assets. That’s very harsh credit conditions. Even in that case we would have a company that can sustainably keep the current dividend rate at 35c (in reality the plan is to increase it to 0.425 in 2016) based on the cash available for distribution from the current assets while building some additional equity in all those projects thanks to the amortization of the debt. That is a 16.8% yield + the build-up of some equity in the current projects. Not bad. Worst case / best case. The worst case scenario would be a bankruptcy of parent SUNE, with certainty of some messy agreements that would need to be worked through, and complete lack of financing. In this case I believe the equity would still be worth something (let’s say 3 / 4 dollars a share) based on a liquidation of all the assets owned + commitments at a 25% discount to book while repaying all debt at face value. A clear sky scenario would see the company providing for all the liquidity needs through external sources at reasonable terms. In that case the stock would rebound and, even though I believe the 30$ – 40$ range will not be reached for a long time, we would likely see TERP trade back to around 25$ (three times the current level). Conclusions: although risks are extremely high and volatility will continue to characterize the stock, I believe TERP offers a great asymmetric return profile. The downside is large in a worst case scenario and therefore position sizing should take that into account but, at least this time around, I am a buyer despite all the blood on the streets.

Why Are Utility Black Hills Investors Seeing Red?

Black Hills recently priced a secondary offering at a full 30% off its peak price in 2014. The acquisition of SourceGas doubles its community count in states they currently service. While Moody’s and Fitch placed Black Hills on “Negative Watch”, they are generally supportive of the company’s business profile. Black Hills Corp (NYSE: BKH ) is a small cap diversified utility whose stocks price has collapsed from $60 in June 2014 to $40 currently, with share prices down 10% on Nov 17. The answer lies in two circumstances: its business profile and the issuance of dilutive equity to fund an acquisition. The first situation is more long-term and the second more short-term. Originally founded 132 years ago in Deadwood, ND (interesting name for an investment headquarters), BKH has a long history of dividend increases, stretching back to 1970. Black Hills is a utility with regulated natural gas and electricity assets and non-regulated assets, with the non-regulated assets generating the negative issues. BKH mines coal, generates electricity with coal, and explores for oil and natural gas. These business segments are currently out of favor with most investors, and are creating financial stress. Black Hills services 680,000 customers in Colorado, Iowa, Kansas and Nebraska along with 110,000 customers in South Dakota, Wyoming and Montana. 205,000 are electric customers and 585,000 are natural gas customers. Below is a graphic of its service territory. (click to enlarge) The annual dividend is currently $1.62, for a yield of 4.0%. The company has a 45-year string of dividend increases, driven in part by strong industrial load growth in electricity. Over the previous 5 years, Black Hill’s growth has been in its regulated utility business. In 2009, regulated utility business generated $126.2 million in operating income vs. $19.9 million for non-regulated. Last year, regulated businesses generated $222.4 million vs. $39.3 million for non-regulated. At no time over the previous 5 years has the non-regulated segment generate over $45 million in operating income while operating EPS over the same time frame increased from $1.38 to $2.93. Management has forecast operating EPS of $2.90 to $3.10 for this year, midpoint $3.00, and $3.15 to $3.35 for 2016, midpoint $3.25. According to S&P Credit, the states serviced have the following regulatory environment (based on three groups of regulatory friendliness – Strong, Strong/Adequate, and Adequate): Colorado and Iowa – Strong; Kansas, Nebraska, South Dakota, Wyoming, Montana – Strong/Adequate. Pre-2014, S&P Credit offered five categories of regulatory friendliness and it seems Colorado, Wyoming and Montana improved their relative positioning. In addition, Black Hills geographic service territory includes some of the higher economic growth rates. Below is a map from the Bureau of Economic Advisors of economic growth by State for 2014. As shown, Colorado and Wyoming exceeded the national average growth rate of 2.2% while the balance of the states served fell short. In general, the Rocky Mountain States saw their economic growth rate expand from 1.4% in 2011 to 3.9% in 2014 while the Plains saw their rate of growth slashed from 2.1% to 1.3%. This underlying economic growth helps to lift energy demand. (click to enlarge) Similar to the entire oil and gas exploration and production industry, BKH has experienced large non-cash write-offs for redetermination of its natural gas reserve values. The YTD charges amount to $2.53 a share, or $110 million, reducing Trailing Twelve Months reported earnings to $0.37 vs. TTM operating earnings of $3.07. In tune with their peers, BKH has slashed its capital expenditure budget for oil and gas exploration from $242 million to a measly $27 million. From an overall observation, BKH’s future lies with its regulated business, as the non-regulated business will continuing to provide a drag on investor interest. Presently, Black Hills can provide about 50% of its natural gas delivery needs from internal production, and with commodity pass-through provisions, allows BKH to be more self-sufficient than other small natural gas utilities. While not a large attribute in these times of low gas prices, if prices were to rise over time, this could add another potential profit layer. In early summer, Black Hills announced it was buying a neighboring natural gas utility from private sources. In July, BKH announced it was buying SourceGas from an investment fund owned by Alinda Capital Partners and GE Energy Financial Services for $1.89 billion, including assumption of $720 million in debt. The expansion will add 425,000 customers and solidify its position in its existing service states as the number of community served doubles to 800. In addition to the current seven states, BKH will add Arkansas customers. However, to fund the acquisition, this week management priced a 5.5 million share secondary offering at $40.50 a share, for a dilution of about 12%, based on 44.5 million shares outstanding before and 50 million after. The company will also offer equity units comprising of an interest in a 2028 subordinated debt and a collar contract to buy additional common shares between $40 and $47. When exercised, the equity units will further dilute share count by 10% and the equity unit is expected to yield 7.5%. Net proceeds from these two are expected to total $465 to $535 million on their close at the end of Nov. The original acquisition funding estimates called for $575 to $675 million in new equity. This still leaves new debt issuance of between $590 and $660 million, and is higher than the original estimate of $450 to $550 million. In connection with the acquisition, Moody’s and Fitch credit rating agencies lowered BKH’s outlook to “negative”. The added concern mainly focuses on higher debt levels BKH will take on. Moody’s comments : However, the decline in financial metrics is slightly offset by the anticipated improvement in the company’s business risk profile. The transaction brings increased scale and diversity as well as additional opportunity to grow rate base in the constructive regulatory environments that SourceGas operates in. It improves Black Hill’s overall risk profile as it adds low-risk LDC utility operations and reduces the proportional size of its higher risk E&P operations. The rating affirmations and stable outlooks on Black Hills Power and SourceGas reflect the companies’ stable utility operations with visible growth opportunities. Because Black Hills already operates in three of SourceGas’ four states, we expect Black Hills to improve efficiency by combining utility operations and to be better positioned in these states through the increased scale. Arkansas is the only state where Black Hills currently does not have any operations. In recent years, SourceGas has experienced improvements in its regulatory environment in Arkansas, including a reasonable outcome in its rate case in 2014. Fitch’s comments : BKH operates regulated electric and natural gas utilities in seven states, all of which allow for pass-through of commodity and/or purchased power costs and many feature other riders or recovery mechanisms that enhance timely recovery of expenses and invested capital. Transmission investments are regulated by the Federal Energy Regulatory Commission (FERC) or state regulatory commissions with most capital expenditures eligible for rider recovery. The diversity by regulated jurisdiction further enhances the predictability of cash flows and minimizes the effects of exogenous factors. Non-regulated investments consist of a legacy upstream energy exploration and development business. Fitch considers BKH’s coal and competitive generation businesses, which are largely contracted to BKH’s utilities, as possessing relatively low risk. BKH’s utilities, coal, and merchant generation businesses have a large degree of operational and financial integration, with jointly owned or contracted generation and common call centers. BKH has interests in the Mancos shale play and is committing relatively large capital investments in order to further assess and prove its potential reserves in the area. BKH’s proposal to place a portion of its natural gas assets into a nonregulated exploration and production subsidiary, which would supply its utilities with up to 50% of annual gas consumption through long-term contracts, if successful would reduce the inherent risks and volatility of the non-regulated oil and gas business segment and would be viewed positively by Fitch. BKH has traditionally managed this business in a conservative manner and uses swaps and other instruments up to two years in duration to hedge pricing risk. Black Hills has earned a disappointing S&P Equity Quality Below Average Rating of “B”. Fastgraph outlines the current valuation for BKH in the chart below, along with a historic review of return on invested capital ROIC. ROIC between 2006 and 2011 were at sector average of 4% to 5%., but has improved since 2011. (click to enlarge) Source: fastgraph.com (click to enlarge) Source: fastgraph.com Since 2014, investors have punished BKH with a substantial stock price haircut, but the barber may not yet be done. By all accounts, the acquisition of SourceGas will reduce the company’s risk profile by increasing its regulated footprint in states where they have a good PUC relationships. Black Hills would be more enticing with a further dip in price to generate a higher yield, but nibbling here could offer interesting opportunities as a small-cap portfolio diversifier serving the Rocky Mountain and Plains geographic area. Author’s Note: Please review disclosure in Author’s profile.

I Don’t Understand Why Ausnet Moved 10% Higher After Its Update

Summary Ausnet’s performance doesn’t seem to improve, and the high capex (sustaining + growth) results in a free cash flow negative result. Despite being FCF negative, Ausnet has actually increased the dividend, attracting more income investors. The dividends are currently borrowed by issuing more debt, but with a net debt/EBITDA ratio of in excess of 5, it might be locked out of the debt markets. I still prefer to sleep well at night, and I’m not taking a stake in Ausnet. Introduction Back in June, I warned investors Ausnet’s ( OTCPK:SAUNF ) dividend was at risk because the company had to borrow cash to fund the dividend payments. That’s a red flag for me, and even though a large part of the capex was growth capex, I still don’t feel comfortable investing in such companies. SAUNF data by YCharts Ausnet is an Australian company and you should most definitely use the Australian Stock Exchange to trade in the company’s shares. The ticker symbol in Australia is AST, and the average daily volume is approximately 3.25 million shares while the daily dollar volume is almost $4M. The H1 revenue jump was nice, as was the net profit result The top line looks really good, considering Ausnet was able to increase its revenue by 10% to approximately A$1.07B ($770M). In fact, the income statement looks really good, as not only did the revenue increase by a double-digit amount, operating expenses also fell by approximately 3%. While this doesn’t sound like a big deal, these two factors allowed Ausnet to increase its operating income from A$340M ($245M) to A$455M ($327M), a 34% increase compared to the first semester of the financial year 2015. (click to enlarge) Source: Financial statements The (much) higher operating income also led to a higher operating margin, which increased to 42.5% compared to 35% in H1 2015. The finance costs increased, which is directly due to the fact Ausnet had (and still has) to issue more debt to cover its dividend payments. Thanks to the higher operating income and despite the higher interest expenses, the pre-tax income increased by in excess of 50%. Additionally, the tax bill is much lower as well, resulting in a conversion of last year’s net loss into a net profit. The EPS was almost 11 cents per share. (click to enlarge) Source: Financial statements That’s good, but once you turn the page to have a closer look at the cash flow statements, you’ll start to see why I’m quite worried about Ausnet’s ability to cover the ongoing dividend payments. The operating cash flow was approximately A$284M ($203M), but this still wasn’t sufficient to cover the A$350M ($252M) capex. Yes, the negative free cash flow was lower than in H1 2014, but it’s still negative. And yes, some of the capex is growth capex and doesn’t impact the “sustaining” free cash flow, but still… But the cash flow doesn’t cover the dividend payments Based on the headline numbers, the free cash flow was negative as the total capital expenditures were higher than the incoming operating cash flow. And it doesn’t look like Ausnet is planning to slash the dividend to reduce the total cash outflow from its balance sheet. It has declared another dividend of A$0.04265 per share ($0.03) payable in December, and based on the current amount of outstanding shares, this dividend payment will cost the company almost A$150M ($107M). So I’m worried about Ausnet’s ability to continue to pay a dividend. And I’m not alone with this view. The Royal Bank of Canada (Nov. 18): Dividends are aggressively positioned and balance sheet is going to come under pressure if AST wishes to retain an A range rating. (…) We believe AST has an unhealthy reliance on the dividend re-investment plan to fund capex. And Deutsche Bank (Nov. 18 as well): AusNet reaffirmed guidance for FY16 distributions of 8.53cps, implying growth of 2%. Consistent with full-year guidance, and DB expectations, AusNet declared an interim distribution of 4.27cps. However, on our estimates, cash coverage ratios will remain stretched with the Electricity distribution business facing lower earnings from next year once the new regulatory period begins (lower regulatory WACC). We forecast FY17 distribution cash coverage of c.93%, which makes the company reliant on its DRP to help fund its FY17 distributions. I had the impression I was all alone with my warning back in June for Ausnet shareholders that the company might not be able to meet its dividend commitments, but financial institutions are becoming increasingly wary of the dividend coverage as well and are now openly wondering whether or not the dividend is sustainable, and the “reset” periods in the next 24 months will be important for Ausnet’s ability to generate cash flow. (click to enlarge) Source: Company presentation Investment thesis So there’s no reason why I would have to change the opinion I expressed in the article I wrote in June. Ausnet is paying a very handsome dividend with a current dividend yield in excess of 5%, but I fail to see how the company can afford this dividend. Right now, the current capital expenditures aren’t covering the dividend expenses, and the investment in growth capex will be offset by the expected lower revenues due to regulatory pressure. Ausnet still remains an “avoid” for investors, and even though shareholders might have been lured by the attractive dividend, I fail to see how this dividend could be maintained in the longer run (unless the company continues to have access to the debt markets, the regulatory situation improves or its shareholders continue to use the reinvestment plan). I understand people are attracted to high-dividend stocks, but I’m not comfortable with Ausnet’s dividend policy right now. And yes, that’s an (arbitrary) personal choice. 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.