Tag Archives: massachusetts

Eversource Energy Prepares For Earnings Growth By Alleviating The Northeast’s Energy Shortages

Summary Northeast electric and natural gas utility Eversource Energy reported Q2 earnings that beat on both lines by keeping its costs low even as revenue increased. The company is preparing the groundwork for long-term future earnings growth via multiple large capex projects to import additional electricity and natural gas to ease the region’s supply constraints. Its short-term outlook has been hampered by the development of strong El Nino conditions, which will likely cause Q4 and Q1 temperatures in its service area to be warmer than normal. The company’s shares are trading at low valuations, however, and they will be attractively valued if the price falls below 15x future earnings in response to a warm winter. Northeast electric and natural gas utility Eversource Energy (NYSE: ES ) reported Q2 earnings at the end of July that beat on both lines , as the company’s three major segments all reported strong YoY increases to income. Eversource occupies a unique position as a major utility in the U.S. Northeast, which suffers from a lack of natural gas supply infrastructure following the conversion of many of the region’s coal-fired power plants to natural gas. This shortfall causes the price of natural gas, which is finding increasing use in heating applications as well, to experience substantial volatility during the winter as supply is insufficient to meet both heating and electric generation demand. The utility has been undertaking large-scale transmission projects to minimize this volatility while simultaneously selling unattractive generation assets, both of which will support its planned earnings growth. Its share price has fallen YTD despite these moves, however (see figure). This article evaluates Eversource Energy as a potential long investment opportunity. ES data by YCharts Eversource Energy at a glance Formerly known as Northeast Utilities, Eversource Energy took on its current name and ticker symbol in February 2015. The changes followed the utility’s merger with Massachusetts utility NSTAR in April 2012. Headquartered in Hartford, CT, Eversource Energy provides electric and natural gas utility services to a total of 3.6 million customers in Connecticut, New Hampshire, and Massachusetts via multiple regulated subsidiaries (all of which now share the Eversource name). The company’s operations are broadly divided into three segments: electric transmission, electric generation and distribution, and natural gas distribution. Its transmission segment includes 4,270 miles of lines in all three of the states located within its service area. Likewise, its generation and distribution segment, which includes 72,000 miles of distribution lines, also operates in all three states. Finally, the natural gas segment, which includes 6,459 miles of pipeline, operates in Massachusetts and Connecticut. Massachusetts became the largest state by population in the company’s service area following the merger and it now provides for 1.4 million electric customers and 283,000 natural gas customers. Connecticut is close behind with 1.2 million electric customers and 222,000 natural gas customers. New Hampshire, on the other hand, only has 510,000 electric customers. The latter’s small number led Eversource to announce in March 2015 that it intends to sell 1,058 MW of electric generating capacity in the state. The majority of the capacity is coal- and oil-fired and the company determined that, given the relatively small customer base in the state, pending environmental regulations on power plants made their continued ownership by it unattractive. New Hampshire’s governor signed off on the divestiture agreement in July. That said, it remains to be seen whether potential buyers will find the agreement’s terms, which includes requiring the buyer to honor the existing collective bargaining agreement and keep the plants open for 18 months post-acquisition, to be too onerous. Even as it is reducing its exposure to generation (Eversource Energy will continue to distribute purchased electricity to its New Hampshire customers), the company is expanding its natural gas and electric transmission segments. Natural gas and heating oil prices moved in opposite directions following the advent of shale gas extraction, with the former falling to a fraction of the latter’s price. While the recent fall in the price of crude has offset the advantage of natural gas to a large degree, customers in the Northeast have been switching from heating oil to gas in large numbers. Eversource, for example, is targeting 16,000 new natural gas customers annually through 2023 via such conversions. This shift has coincided with a broader move by power plants to abandon coal in favor of natural gas, first due to the latter’s low price and more recently to comply with expanding federal regulations on power plant emissions. Natural gas distribution capacity in the Northeast has not managed to keep up with the combined demand effects of this increased consumption. While sufficient supply is achieved in the summer when heaters aren’t running, natural gas shortages and consequent price volatility have been frequent occurrences in the Northeast during the winter months, especially during the type of exceptionally cold winters seen in 2014-15, for example. In an effort to offset increased demand for natural gas by its customers, Eversource Energy is building the high-voltage Northern Pass Transmission [NPT] line that will connect its service area’s electric grid to the Quebec province by way of New Hampshire. The $1.4 billion will construct 187 miles of new transmission lines that will run the length of New Hampshire and, in the process, connect the service area to 1,200 MW of Canadian hydroelectric capacity. The project is still several years away from completion, with the company stating that it doesn’t expect it to be in service until the first half of 2019, assuming that construction begins by the end of 2016. Complementing the Northern Pass project is a natural gas pipeline that Eversource announced late last year in partnership with Spectra Energy (NYSE: SE ). The $3 billion project is actually an expansion of pre-existing pipelines in the Northeast that supply natural gas to 60% of the region’s natural gas-fired power plants. When completed, the Access Northeast project will supply 5,000 MW of gas-fired electric generation capacity with natural gas from the Utica and Marcellus Shale regions, further helping to alleviate the Northeast’s natural gas shortages in the winter. The full expansion is expected to be in service as early as November 2018. Q2 earnings report Eversource Energy reported Q2 revenue of $1.8 billion, up by 8.3% YoY (see table) and beating the consensus estimate by $70 million. The increase came despite lower retail sales across its segments, with electric distribution sales down 0.1% YoY and natural gas sales down 1.2% YoY. Total operating income rose to $412 million from $294 million YoY as operating expenses failed to increase by the same amount as revenue. The company’s O&M costs fell as well, helping to offset an increase to purchased power costs over the same period. Eversource Energy financials (non-adjusted) Q2 2015 Q1 2015 Q4 2014 Q3 2014 Q2 2014 Revenue ($MM) 1,817.1 2,513.4 1,881.1 1,892.5 1,677.6 Gross income ($MM) 1,131.9 1,351.4 1,538.8 1,057.2 950.7 Net income ($MM) 207.5 253.3 221.6 234.6 127.4 Diluted EPS ($) 0.65 0.80 0.70 0.74 0.40 EBITDA ($MM) 588.6 667.0 594.3 606.0 451.7 Source: Morningstar (2015). Net income rose to $209.5 million from $129.2 million YoY, resulting in a diluted EPS of $0.65 versus $0.40 over the same period and beating the consensus estimate by $0.09. The strong earnings result was due to a number of factors related to both the company’s core operations and regulatory changes. Its electric generation and distribution segment fared best, reporting earnings of $121.6 million compared to $83.4 million in the previous year. The gain, which the company attributed to rising revenue and lower O&M expenses, occurred across all of the segment’s subsidiary entities. The electric transmission segment generated earnings of $80.4 million, up from $43.9 million YoY. The gain was almost entirely due to a FERC charge that was accounted for in the company’s Q2 2014 earnings report and was not repeated in the most recent quarter. Finally, the natural gas distribution segment had a slow quarter due to seasonal issues, although its earnings more than doubled from $2 million to $5.3 million YoY as a result of cold weather early in the quarter that resulted in a larger number of heating degree-days. Of Eversource’s total $0.25 YoY gain to diluted EPS, $0.11 was due to the previous year’s FERC charge and $0.10 was due to higher revenues in the most recent quarter. The Q2 earnings were in line with management’s earnings expectations and the company reaffirmed its estimated FY 2015 EPS range of $2.75 to $2.90 during the Q2 earnings call . The company also increased its quarterly dividend by 7.7% YoY to $0.42, resulting in a forward yield of 3.6%. Outlook Eversource Energy’s outlook has been dampened over the last year due to adverse regulatory decisions. The first of these was a decision by Connecticut state regulators to limit the company’s ROE to 9.17% , with 50/50 earnings sharing for the 100 basis points over that amount. This ROE was less than the company had expected and relatively low compared to those permitted for its industry peers. Second, federal regulators recently reduced the company’s transmission ROE from 11.14% to 10.57% . This latter decision in particular is a negative for Eversource given its large investment in new transmission assets. I am also concerned about the weather outlook for the company’s service area over the next six months. This year’s El Nino event is now expected to be one of the strongest on record even if it doesn’t actually set a new record. Previous El Ninos of similar strengths have been characterized by warmer-than-normal winter weather across the northern half of the U.S. that, as far as the eastern seaboard is concerned, pushes as far south as Washington D.C. This year’s event is expected to last into the spring, meaning that Eversource Energy’s service area is likely to experience fewer heating degree-days than normal (and certainly fewer than last year’s bitter winter) during its traditional high-earnings quarters of Q4 and Q1. It should be noted that El Nino’s impacts are not as severe on the eastern seaboard as on the western seaboard and, just as importantly, the forecast is still quite uncertain. That said, investors should not be surprised if the company reports YoY declines for the period from October to March. Eversource Energy’s longer-term outlook is improved by its heavy planned capital expenditures, especially on natural gas pipelines and electric transmission lines. In addition to providing a basis for future rate case increases, the capex is also intended to serve a more fundamental purpose by reducing the Northeast’s notorious natural gas price volatility, particularly in the winter months. As discussed earlier, the widespread replacement of coal in power plants and heating oil in homes by natural gas leads to shortages when temperatures turn colder, resulting in wide price swings in states such as Massachusetts that aren’t reflected by the Henry Hub price (see figure). In addition to being onerous for consumers who find their heating and, more recently, electric bills spiking each autumn and winter, this volatility threatens long-term consumption trends by encouraging consumers to find alternatives. Massachusetts Natural Gas Citygate Price data by YCharts While Eversource’s proposed capex is intended to lay the groundwork for long-term earnings growth via both rate and volume growth, potential investors should be aware that, as a regulated entity, many of these plans are dependent on the support of multiple regulated entities. The Northern Pass project has encountered numerous instances of NIMBYism in sparsely-populated New Hampshire that have driven up its costs by requiring some of the line to be buried, for example, and despite its relatively advanced stage, the company doesn’t expect final permits to be received until the end of 2016. Likewise, while the Access Northeast pipeline has political support due to the history of natural gas shortages in the region, there is always the potential for a combination of NIMBYism and environmental concerns to cause delays and additional expenses. Valuation The consensus analyst estimates for Eversource Energy’s diluted EPS in FY 2015 and FY 2016 have remained relatively flat over the last 90 days as its Q1 and Q2 earnings have largely met expectations. The FY 2015 estimate has increased from $2.85 to $2.87, near the top of management’s expected range, while the FY 2016 estimate has remained flat at $3.04. Based on a share price at the time of writing of $47.47, the company’s shares are trading at a trailing P/E ratio of 16.5x and forward ratios of 16.5x and 15.6x for FY 2015 and FY 2016, respectively. All three of the ratios are near, but not quite at, the bottom of their historical respective ranges since the beginning of 2012, having fallen substantially since the beginning of the year (see figure). ES PE Ratio (TTM) data by YCharts Conclusion Electric and natural gas utility Eversource Energy reported Q2 earnings earlier in the summer that beat on both lines, as its cost-saving efforts offset slight declines to retail volumes. The company is in the midst of a strategic shift following its recent merger that will see it move from electric generation and distribution to electric transmission and natural gas distribution. This is a forward-looking move that, in addition to providing the company with years of large capex to support future rate cases, is aimed at mitigating the natural gas shortages that affect its service area on an annual basis. Furthermore, unlike some logistics projects (the Keystone XL pipeline being the most visible example), neither the Northern Pass nor the Access Northeast projects are likely to be especially offensive to the environmentally-conscious residents of the region, with the former in particular connecting the company’s service area to zero-emission electricity. NIMBYism and opposition to natural gas do create some regulatory uncertainty regarding both projects’ futures, of course, but these are more likely to increase their costs rather than result in their cancellations. The company’s share price is trading at low valuations in terms of both trailing and future earnings. The only thing that prevents me from buying its shares today is the presence of an especially strong El Nino, which increases the likelihood that the company’s service area will experience warmer-than-normal temperatures in Q4 and Q1 2016, especially on a YoY basis. Disappointing earnings results in one or both quarters could cause the company’s shares to fall a bit further, especially if such an announcement follows on the heels of an expected interest rate increase by the Federal Reserve at the end of 2015. It has been more than three years since Eversource Energy’s share price has remained below 15x future earnings for a lengthy period of time, however, and I consider its shares to be an attractive long investment opportunity in the event that they decline below $45.60, or 15x FY 2016 earnings at the time of writing.

For The Love Of The Game: How To Keep Learning In The Market

Summary This is a philosophical piece intended to help young aspiring analysts. I will share my mistakes and lessons learned on the buy side. I will briefly discuss Cheniere Energy. This is a philosophical piece with two goals in mind: To inspire young aspiring analysts, and to share the multitude of career mistakes that I made. With the benefit of hindsight and reflection, I know others can benefit from my self-inflicted missteps. Given the significant amount of time I spend engaged on the Seeking Alpha website, I am noticing more and more talented authors. For some of the folks more junior in their careers ascents or for aspiring analysts trying to make it into the research arena, I think my experience and unique observations may benefit them. So, in the spirit of trying to help others, I sincerely hope to pass the baton and impart some insights that may benefit them as they progress in their careers. The Power of Mentors For context, I will provide my brief background and relevant professional investment research experience. During my undergraduate days, I attended the Isenberg School of Management at the University of Massachusetts at Amherst. I was passionate about investing since middle school, as my dad sparked my intellectual curiosity. While at UMass, I gained access to an alumni list and then emailed as many people in the industry as possible. After getting a response, I would then call them, usually early in the morning, before their hectic day’s beginning. So here I was talking quietly in the dorm room hallways (trying not to wake up my floor at 7 am). As I had virtual no industry contacts, this was the best strategy. However, long on confidence, I was convinced that I was the next up-and-coming star analyst and I only needed to be discovered. From that point, I would land a junior analyst role. Not only I was incredibly naïve, but I had an exalted sense of self, which was unwarranted and unhelpful. However, nice alumni looked past this misplaced arrogance and focused on my passion. Through these calls, I was able to connect with many smart and talented UMass alumni who were actual market participants on the buy side. One individual was, and still is, a portfolio manager at prestigious Wellington Management. He is piercingly bright, very generous with his time, and passionate about helping UMass alumni learn about investing. Although I haven’t been in as close contact with him lately, he was extremely influential in my progress and evolution as an investor. I have one other mentor, whom I originally connected with on LinkedIn in 2004. This was a period between jobs, and I was still questing for that elusive foothold on the buy side. This individual is currently an equity portfolio manager at Alpine Funds. Yes, he has the shiny credentials of a top MBA and CFA, but more importantly, he is a great investor and extremely hardworking. He and I have been friends through email since 2004, and we constantly trade investment ideas via email. Over the course of thousands of email exchanges, my writing and thought process continued to improve. Specific investment lessons from these two mentors For context, my mentor at Wellington is a portfolio manager at Wellington, and manages international equity growth funds with approximately $4 billion in assets under management (AUM). Over the course of our friendship and multiple email exchanges, he explained (using the Socratic method) how growth stocks work. He said that the only thing that matters is consensus earnings estimates. In order to take a position in any equity, you need to qualitatively and quantitatively understand how the market arrived at current consensus estimates. If, and only if, you deeply study the company and build your high-level models that capture the major drivers of revenue and earnings can you have an opinion. Never, never, never have a strong opinion on a stock unless you have really done the work. The fastest way to get dinged during an interview on the buy side is to come across long on opinion and short on analysis. It is always better to say “Here is what I have read, and here is how I think about it, but perhaps I am missing certain angles.” It is much better to informed and humble than arrogant and overly confident, especially when speaking with actual market participants. He then taught me that many people fall into the trap that a stock is overvalued because it has a high P/E ratio compared to the market or its sector. With the supercomputers of today, crunching ratios is a waste of time, as it is fully reflected in the stock price, given that the market is very efficient at incorporating actual events. Again, you have to understand consensus estimates better than the Street. If your model and work are materially different from the consensus, only then should you make a bet. For a concrete example, over the course of a few emails, he walked me first-hand through why in mid-2003 Research in Motion, now BlackBerry (NASDAQ: BBRY ), was his largest holding. I think BBRY’s stock ultimately ended up increasing by 5,000% from 2003 to 2007. If any reader cares to do some searching on Google, they will find that the vast majority of then-leading experts thought BBRY was going to zero. They saw that they were losing money and also saw the company’s cash burn, and erroneously assumed that BlackBerry had nothing noteworthy in its pipeline. Now, my mentor will freely admit that he happened to have met with management (that is a major advantage of being a professional money manger – access to management teams to kick tires). During his visit to BBRY’s corporate HQ, he was able to work out first-hand how technologically advanced the company’s products were, and envisioned their appeal to chief technology officers in the Fortune 500. He also understood the huge addressable market, the potential margins on the handsets, the security features of its product, and that BBRY was really a great software company. Had I known then what I know now, I would be retired at age 35 if I had put on a concentrated long bet on BBRY and simply held it for four years. Clearly, I wasn’t wise enough to understand that I was handed a lottery ticket with winning numbers on it. (click to enlarge) My mentor from Alpine Funds has also taught me a great deal. Once a new investor gets up to speed on the core blocking and tackling, like being able to read financial statements and the basics of accounting, the best way to make money is to develop a great imagination. Stock prices will rise or fall past on their future cash flow and revenue growth relative to consensus estimates. For another vivid example, in 2004, this mentor of mine walked me through his largest holding in his personal account, Silver Wheaton (NYSE: SLW ). If I recall, SLW was then a $4 stock. He explain to me that he was very bullish on silver, and that this was the best vehicle to participate in silver’s ascent. He explained how silver was a by-product, and mining is extremely CAPEX-intensive, so producers who are targeting gold or copper are willing to sell their silver by-product production (or silver streams) for an upfront payment and then for a low price of $4 per ounce. The producers would then use the upfront payment to fund their CAPEX. Silver Wheaton eventually traded as high as $50 in May 2011, though it was a bumpy ride, with the stock dropping down to $2.50 during the 2009 equity crash. My mentor also emphasized the importance of being willing to take a contrarian stance if you have enough conviction in your idea. When he was traveling the hedge fund circuit, as he had two stints as a hedge fund analyst, he learned the importance of managing your downside risk, but also that betting big when the risk/reward was greatly in your favor. Although he was capable enough, he determined that the hedge fund world didn’t suit his personality and investment process. This is my long-winded way of stating that mentors are invaluable. They will encourage you, push you, and if you put in the effort, they will help you become a better investor. I am still in constant contact with my friend at Alpine Funds. I distinctly remember when he once told me, “My wish for you is that you greatly surpass my as an analyst.” That illustrated to me that he was invested in my success, and he was humble enough and had had the benefit of mentors while he was in his formative stages. Don’t get into fights with your boss My next piece of advice is that if you do make it to the buy side, know your role and keep your ego in check. Although the barriers to entry are very steep, just because you made the team doesn’t mean you can’t get cut. Despite an insatiable curiosity and undeniable passion for investing, my ego and poor semantics while expressing my investment ideas wrote proverbial checks that I couldn’t cash. The collective bill came due when I couldn’t meet the proverbial margin call. My five years of solid performance and exemplary annual reviews were marred by aggressive and arrogant interactions with senior analysts. No one want to be told they are wrong and that their thesis is wrong, especially from a 29-year old. You can’t tell your boss that you think you are a better investor than him. This is a career-limiting move, trust me. So the takeaway is that if you can surmount the incredibly high barriers to entry, take it slow, listen, observe and ask questions. Investing isn’t like the NFL, it isn’t a pure meritocracy. You have to work hard, learn, be likeable and keep your head down. If folks sense that you are not a team player (however misplaced this label may be), your career at that shop is effectively over. Know yourself Beside the fact that I didn’t have the right temperament for Liberty Mutual, you have to know yourself. Reflecting upon my five years at Liberty, I probably knew it wasn’t the right cultural fit in year three. However, don’t do the impulsive Jerry Maguire letter and then quit, as this is terrible career mistake that has to be explained away in future interviews. There are exceptions, but the buy side generally requires a CFA, Ivy League education (at least on the equity side), lots of networking, and even more luck to find your foothold. Although I made it into the industry, I only advanced to the bottom rungs of the ladder. There is an alternative pathway. There are excellent open source sites like Seeking Alpha, and different ways to make a living. However, this is the path less traveled, and it will invariably take years of building your brand, developing a portfolio of great research as evidence, and getting the marketing aspect right. There are members of the Seeking Alpha community who have successfully done this, so they would be a much better resources. I only write articles in my free time as a hobby. The Power of Redemption Moving along, let me power down my philosophical side of my brain, and let’s talk about one of my recent investment ideas written here on Seeking Alpha that seems to be playing out. I want to specifically highlight two investment pieces that I wrote recently on Cheniere Energy (NYSEMKT: LNG ). The point of bringing this up is that through the comments section of my first article, the Seeking Alpha community inspired me to improve upon my first article that some labeled incomplete. I viewed this as constructive criticism and an opportunity to dig deeper and write a follow-up article. Incidentally, my original thesis seems to be playing out, as Mr. Chanos disclosed a new short position in shares of Cheniere. However, I am not spiking the football on the one-yard line, as the stock has now become a battleground stock between the bulls, including investing greats like Seth Klarman and Carl Icahn, and the bears, like Jim Chanos. I have done a lot of research on the company and have shared my bearish view on the site. Again, I’m not writing to gloat, but simply suggesting that if we are passionate about our craft, we can make good investment calls. Of course, the buy side has its advantages of access to management team and access to many research publications. However, with the power of Google and some intellectual curiosity, you want produce compelling work. I can’t tell you the last time I read a sell side report. As a general rule, I completely ignore sell side research, as I like to do my own research. Moreover, when an idea finally works and it gets recognized by the market, it brings a great feeling of satisfaction and even redemption for hobbyists like me. To sum up Mr. Chanos’s bearish arguments: There will be massive global overcapacity in the LNG space. LNG is priced based on Brent prices, and Brent has collapsed from $110 to $50, so incremental new long-term supply agreements will be less lucrative. The industry is plagued by massive cost overruns (look at Chevron’s greenfield projects). Cheniere’s contracts aren’t sacrosanct. The company is way too promotional and has yet to sell any LNG. Its capital structure and executive compensation polices leave much to be desired. Concluding Thoughts Investing is more of an art than a science once you understand the fundamentals. For aspiring analysts: Find great mentors, don’t get in fights with your boss and know yourself. Investing is an extremely humbling pursuit; therefore, savor your victories, because they can be fleeting. Good luck, and thanks for reading. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Just Energy Is In Hot Water

Summary Just Energy is an energy reseller. The business model has many questionable elements. Several factors could cause the earnings to decline in FY2016. Just Energy (NYSE: JE ) is a Canadian retailer of energy across select regions in North America and the UK. The company has a long rap sheet of customer complaints, fraud charges, and consumer watchdog warnings. Investors have bid the stock up in recent weeks on a swing to profitability in the first quarter. That profit is based on a one-time item. Beneath the surface, Just Energy is a company with lengthy legal concerns, a declining customer base, and an inherently flawed business model. Flawed Business Model One of my favorite financial quotes is from famed investor Jim Chanos. “A business model that relies on deceiving customers is an inherently flawed model.” No sentence more accurately describes Just Energy. The services offer no value to consumers. In fact, one study found that the average JE customer pays more for their utility service than those who pay for their utilities through a traditional utility provider. If your business model is built on saving customers money by switching them to your service, shouldn’t your service actually be less expensive? It appears that in 98% of cases , it is not. According to a lawsuit in Illinois, “there is no reasonable person who could market this product by suggesting that a customer would ‘save’ money.” The lawsuit also noted that “almost all of [Just Energy’s] plans have cost customers far in excess of what [utilities charge].” This could partially explain the aggressive sales practices. If your services cannot deliver as promised, why not just bend the truth? The company’s profits rely on selling long-term contracts to customers at rates higher than can be achieved in the marketplace. Essentially, the company locks customers into 5-year contracts and hopes that energy rates decline. The only way it makes a profit is by overcharging customers. Again, a business model marketed as a less expensive alternative to utilities that can only make a profit when it is, in fact, more expensive, is deceptive and fundamentally flawed. Legal Concerns There is a litany of formal complaints filed against the company, so many in fact that it has had to change its name and buy new brands in an apparent attempt to hide the past misdeeds. Among the most notable concerns are lawsuits brought by the Attorneys General of Illinois, Massachusetts, Ohio and New York. Complaints filed by the Canadian Energy Board and consumer watchdog groups have also caused reason for concern given the repeated allegations of misconduct. The company has an almost unheard of F rating by the Better Business Bureau . The BBB cited “a large volume and pattern of complaints concerning misleading sales practices.” (click to enlarge) Source: Internet review websites Just Energy could arguably have received more complaints per customer than any other publicly listed company in North America. The Illinois Attorneys General lawsuit found that the company received about 30,000 complaints annually in the state of Illinois alone. So what caused so many formal complaints against the firm? As most lawsuits describe, the company’s sales team goes door-to-door soliciting homeowners to purchase energy contracts. It also utilizes telemarketers in its sales process. The fraud complaints stem from thousands of sales reps purposely lying about rates, and in some cases, signing up customers without their permission. Source: News articles The unbelievably poor compliance at JE is a cause for future concern, as the practices are systemic of the organization and do not seem to have been curtailed. In fact, they are getting worse. In July 2015, Just Energy partnered with an alleged pyramid scheme to distribute its products. Lyoness is a MLM firm with a long history of pyramid scheme accusations. Think Herbalife (NYSE: HLF ), but worse. If the company’s former sales team was so inadequately trained that hundreds had to be laid off after defrauding clients, why would the distributors for a company under numerous fraud investigations be any better? According to an Australian regulator, Lyoness’ distributors “lie about every aspect of the business they are promoting.” These people will now be the face of Just Energy. Cue the forthcoming onslaught of Attorneys General investigations that are likely to emerge. Declining Customer Base While the company has largely weathered the past concerns, that luck seems to be eroding. As customers are coming out of their five-year contracts, they do not seem to be re-enrolling. Additionally, the company is failing to find new customers. Perhaps the years of negative reviews, multiple fraud investigations, and bad press coverage have dissuaded customers from trying out the company’s service. Or perhaps they can just do math and do not want to pay more for a service they already receive. For the first time in years, the company had a net loss of customers in the most recent quarter. Additionally, the number of new customers was the lowest since 2012. In red below, we can see that new customers are down 31% from Q1 2015 and down 15% from Q1 2014. The company is not growing the customer base enough to offset those leaving the business. (click to enlarge) Source: Investor presentation (with Q1 info added by author) How This Will Impact Earnings With a clear downward trend developing, investors should prepare for a future decline in sales. The average Just Energy contract is 3.5 years. The decline in new customers is not directly felt on the income statement just yet. As customers leave (about 1.15 million per year), the inability to replace those customers will cause revenues to decline. For the first time in years, JE is losing more customers than it is gaining. Customers leaving today locked into a temporarily low point in natural gas prices, thus new customers that replace the customers being lost are “higher margin.” While management has spun this as a positive, in reality it is a massive headwind. As noted, the average customer contract is 3.5 years. In early 2012 (exactly 3 ½ years ago), natural gas prices bottomed at nearly $2. So yes, the customers leaving are being replaced by new customers with higher margins, but it is short lived. In the coming quarters, as more customers leave, the new customers will be lower margin than those customers lost. Source: NASDAQ The next two years are going to be a massive headwind as the company loses customers that signed up under much higher natural gas prices than today’s prices. Recognizing this impact, the company began diversifying the portfolio over the past several years. In 2009, debts were zero. Today, debts are in excess of C$677 million. The decision to buy electricity suppliers has cost the company in a time when profits and margins are going to begin eroding. Impact On The Stock Predicting JE’s EPS is a challenge. The company often swings between massive losses and equally massive profits. Over the past three years, the company has posted net profits from C$602 to losses of C$579. With customer attrition likely to increase over the next year, it will be virtually impossible to produce a net income. While Q1 saw an EPS of C$0.67, that figure was due to asset sales. That is not a long-term means of growth. Had the company not sold off a unit for C$505 million, it would have posted a loss for the quarter. For FY2016, expect a significant loss (unless JE continues selling off assets). While management is correct that margins are improving, that effect will fade in Q2 and reverse in Q3. New customers will begin to constrain margins beginning in November. That is because 42 months ago (3.5 years) natural gas prices fell to levels below current levels. That lasted from December 2011 to June 2012. Every customer who signed up after June 2012 is a higher-margin customer than the ones the company is acquiring today. JE requires volatile gas prices for profits. In 2015, natural gas has been flat. In order to turn a profit, gas prices would need to drop. At $2.7 today, that seems unlikely. With all of this in mind, the company could post continuing revenue growth, but will still report losses. Management does not provide earnings or revenue outlook, instead it only focuses on EBITDA outlook. For FY2016, the company expects C$193-C$203 million in EBITDA. The excessive focus on EBITDA is alarming from an investor’s standpoint. Multiple forensic accounting firms have highlighted red flags in relation to how JE calculates its EBITDA. Additionally, it is always alarming when a company with no tangible cost structure (JE does not own any hard assets) only points to EBITDA. In 2015, the company generated sales of C$831 per RCE (residential customer equivalents). This is the non-GAAP figure used to calculate the number of customers. The actual number of customers is around two million. The C$831 per RCE is higher in 2015 because margins are increasing. As margins decline (as I have suggested will be the case in the second half of FY2016), the revenue per RCE should normalize to figures from previous years. About ⅓ of Just Energy’s customers leave each year. In past years that decline was offset by adding more customers, creating a net gain. That trend reversed in Q1. If the rate of decline experienced in Q1 continues throughout FY2016, total RCE will decline to 4,390,000. Using the C$831 figure (which I feel is very generous), total revenue for the year will come to C$3.6b, a 7.7% decline from 2015. RCE Sales per RCE Sales (in millions) Q1 4,609,000 C$202.4 C$933 Q2 4,535,000 C$202.4 C$918 Q3 4,462,000 C$202.4 C$903 Q4 4,390,000 C$202.4 C$889 Total – – C$3,643 Source: 10-Q The exact nature of any declines are subject to a number of factors including the timing of margin contraction, the severity of the contraction and the ability of the company to aggressively increase marketing to obtain new customers. All of these factors could impact the above calculation. At the end of the day, things do not look good for Just Energy. It is hard to imagine how the company will grow EBITDA by 5.5% (as it predicts) when the business is facing declining customer growth, increasing attrition and declining margins for 2016. Long term, there are too many headwinds to keep this electricity and natural gas reseller from being an attractive investment. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.