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Northland Power – A Renewable Energy Giant In The Making

Summary Northland is an independent power producer with a total capacity of 1,356 MW. The company has two giant offshore wind farm projects under construction. These projects should turn the company into one of the world’s biggest renewable energy producers. Currently, Northland shares are undervalued. Northland Power (OTCPK: NPIFF ) is a Canada based independent power producer. As of March 31, 2015, the company owns or has a net economic interest in power producing facilities with a total capacity of approximately 1,356 MW. Northland’s facilities produce electricity from natural gas and renewable resources. Apart from that, the company is developing a few renewable energy projects, which, in a few years, should transform Northland into one of the biggest green companies in the world. In this article I am trying to provide a short description of these projects; in the final section I will try to assess the value of the company’s shares. Capacity As of the end of 2014, the company’s facilities had a total capacity of 1,356 MW, of which the biggest share belonged to thermal facilities (62% of total capacity). The chart below shows the capacity breakdown: source: Simple Digressions and the company’s reports In a few years this situation is going to change. The company has four renewable energy projects under construction (discussed below), which should commence their operations in the next three years. Therefore at the end of 2017, when these projects are finished, the overall company’s capacity should stand at 2,428 MW with renewable energy facilities generating as much as 58.1% of the electricity (chart below). source: Simple Digressions and the company’s reports Northland is turning from thermal generation to renewable energy Looking at the company’s electricity sales it is easily spotted that Northland perceives renewable energy as its main growth driver. Since 2009 the electricity sales generated by thermal facilities have been rising at the rate of 24.7% a year. But in the same time span the electricity sales generated by renewable energy facilities have been rising at much higher rate of 65.8% a year. This trend is going to strengthen in the next three years because all projects under construction are renewable energy ones (wind and solar). Let me discuss these projects in detail. Gemini Gemini is an offshore wind development project located 85 km off the North East coast of the Netherlands. The project will consist of 150 Siemens wind turbine generators, each with a capacity of 4 MW (600 MW in total). Gemini is one the biggest offshore wind projects in the world – the total capital expenditures are expected to be €2.8 billion. Despite these large expenditures, Gemini is an example of a successful non-recourse project financing where expenditures of €2.2 billion will be financed by debt (senior debt of €2.0 billion and subordinated debt of €0.2 billion). The Northland stake in Gemini accounts for 60% – it means that the company’s portion of the equity and junior debt is estimated to be €288 million. The project was awarded up to €4.4 billion of public funding to supplement market revenues from electricity sales. This 15-year award is called SDE Grant and has been issued by the government of the Netherlands. Simply put, the SDE Grant is a contract-for-differences, which supplements market electricity prices traded on the Amsterdam Power Exchange. In order for Gemini to earn the market based component of revenue, a power off-take balancing agreement has been signed with Delta Energy BV, a subsidiary of a Dutch utility company. Currently the financing is closed and Gemini entered its construction phase. The project is expected to be finished in 2017. Northland estimates that Gemini will be producing 2,600 giga-watt hours per year. The company also estimates that the annual EBITDA generated by the project should stand at C$560 – 570 million. Nordsee One Nordsee One, similarly to Gemini, is another offshore wind development project. It is located 40 km north of Juist Island in the North Sea. The project will consist of 54 Senvion wind turbines generators, each with capacity of 6.15 MW (332.1 MW in total). The Nordsee One capital costs are estimated to be €1.2 billion – similarly to Gemini, these expenditures will be financed by non-recourse debt and equity. According to the company’s announcement on the financing close: “Approximately 70% of the project’s required costs will be provided from an EUR840 million non-recourse secured construction and term loan and related loan facilities from ten international commercial lenders. Reflecting the strength of Nordsee One, the financing was oversubscribed. The lending group includes ABN AMRO, Bank of Montreal, Commerzbank, Export Development Canada, Helaba, KfW IPEX, National Bank of Canada, Natixis, Rabobank and The Bank of Tokyo-Mitsubishi” The Northland’s stake in the project accounts for 85%, which means that the company’s portion of equity is estimated to be €288 million. As in the case of Gemini, Nordsee One qualifies for a revenue subsidy. This time it will be a subsidy from the German government granted for 9.6 years (called EEG). It is once again a contract-for-differences, which guarantees a fixed electricity sale price over the subsidy duration. Northland estimates the Nordsee One average annual energy production at 1,200 giga-watt hours; the annual EBITDA generated by the project should stand at C$300 – 310 million. The project is expected to be finished in 2017. Grand Bend Wind Project It is a jointly held (with a 50% stake belonging to the Aamjiwnaang and Bkejwanong First Nations) wind project with a capacity of 100 MW located in Grand Bent, Ontario, Canada. Northland is a developer, construction manager, co-owner and operations manager. The project has a 20-year power purchase agreement with Ontario Power Authority. Project financing is completed and all construction contracts have been signed. The company expects the project to commence operations in spring 2016. The project budget is estimated at C$384 million. Ground-mounted Solar Projects The project consists of 4 individual ground-mounted solar projects with a total capacity of 40 MW. This is a third phase of a partly finished operation, which should be completed in 2015. Northland estimates the project costs to stand at C$329 million, which is around C$83 million higher than previously estimated (this increase is due to legal claims against the former project contractor). The annual EBITDA generated by the project should stand at C$ 22 million. Financial results Since its 2011 conversion from an income trust to a corporation, Northland has been steadily improving its financial results. The company has been increasing its revenue and operating income. On the other hand, due to a very ambitious investment plan realized by Northland, the company’s bottom line looks worse. Finance costs and unrealized losses on derivative contracts are the main contributing factors. For example, in 2014 Northland reported finance costs (interest on debt, borrowings and bank fees) of C$119.9 million. Additionally, Northland reported a loss of C$296.6 million on foreign exchange hedges (these losses were non-cash issues). Therefore, in 2014 the company showed a net loss of C$177.7 million. Now, let me discuss an issue, which is one of the most important metrics in evaluation of any dividend-paying energy company, namely its free cash flow. The chart below evidences free cash flows and dividends paid by the company: (click to enlarge) source: Simple Digressions and the company’s reports As the chart shows, since 2010 Northland has been increasing its dividends. Unfortunately, in the period 2010 – 2012 these increases were not backed by higher free cash flows – the company was over paying its dividends, which was evidenced by the so-called payout ratio, which was higher than 100% (if a payout ratio is higher than 100% a company is paying higher dividend than its free cash flow allows – in the long term such a situation is unsustainable). But since 2013 the company’s dividends have been backed by its free cash flow, with payout ratios of 70 % and 76% in 2014 and 2013 respectively. In the coming years the company expects that its payout ratio will rise over 100% once again. Till 2017 Northland will be involved in construction of two large wind projects (Gemini and Nordsee One). This process demands a lot of money therefore the company, which is determined to sustain its dividends, will have to increase its payout ratio above 100% once again (free cash flow, due to higher investment, will decrease). When both projects are in operation (in 2017) the payout ratio should go well below 100% (due to the increased free cash flow from Gemini and Nordsee One) – please, look at the slide below: (click to enlarge) source: the company’s presentation (page 84) Valuation To estimate value of Northland shares I am using the ratio of EV / EBITDA (enterprise value / earnings before interest, taxes, depreciation and amortization). Because it is quite difficult to find current and reliable EV / EBITDA ratios reported in the renewable energy sector, I am calculating the Northland value using two available ratios: multiple of 9.2 assumed by the Ernst&Young report for base-load independent power producers in the Americas multiple of 14.32 assumed by Aswath Damodaran for Green and Renewable Energy sector In my opinion, the multiple published by professor Damodaran seems to be more appropriate for Northland because this company is currently in a transitory period, which should bring it from a base-load energy producer to a renewable energy company. Another assumption – my calculations are divided into two blocks: Value calculated for current operations Value calculated for two the most important wind projects: Gemini and Nordsee One. Total value is calculated through adding up value of current operations and value of Gemini and Nordsee One. The tables below show the way I have calculated value of Northland: source: Simple Digressions and the company’s reports As the last table shows, I estimate that one share of Northland is worth between $19.9 and $44.6 . Currently the Northland’s shares are trading around C$16 per share, which means undervaluation. 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.

Centrica’s Dividend Cut – How Should Shareholders React?

This week I was mildly surprised to see that Centrica ( OTCPK:CPYYF ) ( OTCPK:CPYYY ) (which I’ve owned since 2012) had cut its final dividend as part of a plan to rebase the dividend some 30% below its previous level. It wasn’t a complete surprise given the recent collapse in the price of oil, but it’s the sort of event which demands some sort of reaction. As I see it, shareholders have three main options: Panic sell: Break out in a cold sweat, curse Centrica’s management and place a sell order immediately. Do nothing: Be mildly miffed, but do nothing with the intention of holding the shares “forever”. Weekend review: Wait for the weekend and then review the company again in order to decide whether to keep holding, start selling or perhaps even buy more if the price drops enough. Reaction option 1: Panic sell If you’ve been reading this blog for a while, you’ll know that I am not a fan of panic selling, especially when it relates to an established, successful company like Centrica . Sure, panic sell an AIM-listed micro-cap mining company that operates in some country you’ve never heard of, but Centrica? I’ve written about this before, but in my view panic selling a defensive dividend payer like Centrica is like selling a buy-to-let property because its rental income drops for a year or two. Typically, rent will drop because there’s a void period, i.e. a period where one tenant leaves and another can’t be found immediately. The property sits empty for a few months and so rental income for the year is lower. Panic selling in that situation would mean putting the house up for sale immediately at a knock down price, perhaps 20% below its true market value, just to get rid of the place. To me that is just crazy. It locks in a massive capital loss just because income has dropped a little bit for a little while. The property is still there, its basic ability to generate an income is no different, and in time the income may well bounce back to where it “should” be. The same could easily be said of Centrica or any other defensive dividend payer. The same sort of situation led investors to sell Aviva (NYSE: AV ) after it cut its dividend in 2013, causing them to miss out when the share price rebounded massively shortly after (a roller coaster ride which I went through myself). Reaction option 2: Do nothing Now, this is much closer to my heart. I like to be efficient, i.e. to minimise the amount of work I need to do (which my wife describes as “lazy”). The minimum amount of work in this situation is to simply do nothing at all. In fact, this is a popular strategy which generally falls under the banner of “buy and hold”. A good example of the buy and hold approach is the High Yield Portfolio strategy (HYP) developed by Stephen Bland, which has its spiritual home on the Motley Fool bulletin boards. With HYP, defensive dividend payers are bought with attractive yields and then left untouched for all eternity, and “tinkering” with the portfolio is a definite no-no. While this sounds more attractive to me than panic selling, and is for the most part a fairly sensible strategy if you’re buying the right sort of companies, it isn’t for me. I don’t like the idea that I would buy a company in 2010 and still be holding it in 2030 without ever having thought about whether it was worth holding on to. When a company is first bought, it is analysed to make sure it’s a defensive dividend payer. At the same time, its share price is analysed to make sure the yield is sufficiently good. So, if it makes sense to check those things when the shares are bought, why does it make sense to never check them again? What if the company goes down the pan, never to recover? Surely, at some point it makes sense to move on and buy another company that is far more successful? Or what if the company does okay, but the share price doubles or triples, dropping the dividend yield to well below the market rate? Wouldn’t it make sense in that case to lock in those excess capital gains by selling? The proceeds could be reinvested into another, equally solid company but with a more attractive valuation and dividend yield? That’s not to say buy and hold isn’t a good strategy. It can be, but only for those who really do never ever want to make any investment decisions ever again, or at least no more than once every few years. For me that is far too boring and leaves far too many potential returns on the table. So, while I think doing nothing is probably much better than panic selling, I’m not going to stick with Centrica forever and ever, regardless of how it performs. I want something in between those two extremes. Reaction option 3: Weekend review And so we come to my preferred approach, which is the weekend review. The idea with a weekend review is to take the middle path between an emotionally driven knee-jerk reaction on the one hand and a complete absence of reaction on the other. It may seem odd to wait for the weekend, but there are good reasons for doing so: The markets are closed so you can’t see the price ticking lower ever few seconds and you can’t execute a trade immediately, which means you can concentrate on doing a good review without distraction It will usually be a day or so since the original unpleasant results were announced so you will have had time to calm down (although if you get upset by bad news, you’re probably not diversified enough), which should help you to think more clearly Once the weekend rolls around you would just sit down and do a thorough review of the company (Centrica in this case) using its latest results and its latest share price (using this investment spreadsheet if you like). In my case, as a defensive value investor I would be looking to see: Defensiveness: Is Centrica still a relatively defensive dividend payer (despite the dividend cut), with reasonable medium- and long-term growth prospects? Value: Is the valuation still attractive, given the company’s slower growth rate and reduced dividend? Here are Centrica’s results up to and including the dividend cut: The profits are a bit jerky but the general trend is upward, although of course there are no guarantees for the future. At 255p, the company and its shares have the following metrics, which I have compared against the FTSE 100: Growth: 10-year revenue/earnings/dividend growth rate = 8% (FTSE 100 = 1%) Quality: 10-year growth quality (consistency) = 79% (FTSE 100 = 54%) Value: PE10 ratio (price to 10-year average earnings) = 11.3 (FTSE 100 at 6,850 = 14.4) Income: Dividend yield = 4.7% (FTSE 100 = 3.4%) Profitability: ROCE = 12.4% (using post-tax profit) (FTSE 100 = 10%) By those metrics, the company still has a better track record than the market average and its share price is still more attractively valued than the market by a considerable margin. After looking at the numbers, I reviewed the company’s operations and its market, and I think it is by no means clear how Centrica will perform in the medium to long term. The oil price is uncertain, the political situation is uncertain, and the economy is uncertain. However, this degree of uncertainty is entirely normal as the future is almost always uncertain. Rather than try to predict an uncertain future, my approach is to defend against it instead. I think the best way to defend against an uncertain future is build a highly diversified portfolio of successful, established, dividend paying companies, and then for the most part to let them get on with it. On that basis, I will be holding on to Centrica for now, despite the dividend cut. Editor’s Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks.