Summary In 3Q 2015 Alterra delivered decent financial results. Very soon the company should commence operations at two new renewable energy projects: Shannon Wind Farm and Jimmie Creek hydroelectric power plant. In my opinion, Alterra’s shares are still underestimated against its peers. Alterra Power ( OTCPK:MGMXF ) runs five renewable energy power plants with a total capacity of 553 MW (megawatts). Apart from operating facilities, the company holds a portfolio of energy projects, of which two are at their advanced stages of development. In my first article on Alterra I made a statement that the company’s shares offer an impressive upside potential. Since that time Alterra’s shares went up from $0.31 to $0.41 (August 17) and then retreated. Now they are trading at $0.34 (up 9.7% since my first article). I am not impressed – Mr. Market still underestimates these shares ignoring the fact that Alterra is quickly strengthening its position as a provider of green energy. In this article I am trying to defend my earlier investment thesis on Alterra. Time is appropriate – the company has just announced its 3Q 2015 results . Business philosophy. Alterra is focused on growing its business through construction of new renewable energy power plants. Apart from HS Orka, at which Alterra holds a majority stake, all power plants are constructed as partnerships with strong financial partners: Toba Montrose – a partnership with Fiera Axium, with Alterra holding a 40% economic stake Dokie 1 – partnership with Fiera Axium (a 25.5% stake belongs to the company) Jimmie Creek – another partnership with Fiera Axium, with Alterra holding a 51% stake Shannon Wind – partnership with Starwood Energy Group Global (Alterra holds a 50% stake) The philosophy standing behind this approach is simple – Alterra wants to grow its power plants portfolio as quickly as possible and partnerships are one of the best methods to finance the company’s development. These partnerships are accounted for using an equity method of accounting – that is why the analysis of the company’s partnership stakes is crucial to have a thorough perspective on Alterra’s performance. 3Q 2015 results Alterra is quite a complicated company to analyze. For example, although it runs five power plants and two advanced development projects, only two of them are accounted for using a consolidation method of accounting – the rest is accounted for using an equity method of accounting. In my analysis I am firstly presenting the overall results of the company and then the results reported by each plant / project, most of which are accounted for under an equity method. The overall results The table below shows basic financial measures, reported in the first nine months of 2015 and 2014: (click to enlarge) source: Simple Digressions and the company’s reports As the table shows, in the first nine months of 2015 the company’s revenue decreased 18.3%, compared to the same period in 2014. However, this revenue is attributable to two geothermal power plants, Reykjanes and Svartsengi, located in Iceland. Alterra controls these plants holding a 66.6% stake in HS Orka, a mother company to those two geothermal facilities. Similarly, other lines in the earnings statement, apart from “Share of results of equity-accounted investees”, are attributable to HS Orka and the overall corporate issues. Note: I have to remind my readers a crucial accounting rule. Although Alterra holds a 66.6% stake in HS Orka, the earnings statement considers all (100%) operations carried by HS Orka. To exclude a 33.3% stake held by other stakeholders, an appropriate correction is made at the bottom line of the earnings statement (in the line called “Net income attributable to non-controlling interest”). Therefore, during the first nine months of 2015 Alterra printed a net loss of $7,128 thousand, but the other HS Orka stakeholders, classified as non-controlling interest, booked an income of $1,566 thousand. In this way a net loss attributable to Alterra increased to $8,694 thousand. This quite poor picture of the company, presented in its earnings statement, would be much poorer if it was not partly mitigated by an item called “Share of results of equity-accounted investees”. This line shows the results reported by power plants and projects, which are accounted for under an equity method. As the table below shows, in the first nine months of 2015 these entities reported a profit of $21,251 thousand (87.5% up, compared to the same period in 2014). Let me break down this figure: (click to enlarge) As the table shows, the results, attributable to five plants / projects, are accounted for using an equity method. Three of them: Toba Montrose, Dokie 1 and Blue Lagoon are plants in operation. The other two, Shannon and “Geothermal development projects” are projects under development, of which one project, Shannon, is at an advanced stage of development. As the table shows, the biggest part of an increase in “Share of equity income” is attributable to Shannon. For a better comparison, this project should be excluded (last year Shannon was accounted for using a different method of accounting – full consolidation). However, after doing it, “Share of equity income” is still higher than last year ($13,813 thousand against $11,333 thousand). Simply put, Alterra’s power plants, other than HS Orka, are doing better than last year. In my opinion, it confirms a thesis that Alterra’s business is in good shape. Now, let me analyze the company’s plants / projects separately. Currently Alterra is a company under development. It means that it is a mix of a number of active power plants and projects at various stages of development. Let me take a closer look at these facilities and projects: Plants in operation HS Orka HS Orka consists of two geothermal power plants: Reykjanes and Svartsengi, both located in Iceland. In the first nine months of 2015 HS Orka reported revenue of $41,664 thousand (down 13.0%, compared to the same period in 2014). This decrease was attributable to the exchange rate between the Icelandic krona and the US dollar because revenue, if reported in the Icelandic currency, went up from ISK 5.31 billion in the first nine months of 2014 to ISK 5.39 billion in the same period in 2015 (an increase of 1.5%). Note: as a matter of fact, Alterra owns operating facilities located in Canada and Iceland. While the company’s reporting currency is the US dollar, Alterra’s operations are measured in the Canadian dollar and the Icelandic krona. Therefore to catch a full picture of the company, I recommend studying statement of comprehensive income (which measures the impact of exchange rates, cash flow hedges and other issues on the company’s bottom line). The HS Orka EBITDA and cash flow from operations followed revenue, expressed in ISK. EBITDA went up from ISK 1.96 billion to ISK 2.1 billion and cash flow from operations (excluding working capital issues) went up from ISK 1.9 billion to ISK 2.0 billion. Due to an increase in non-cash line called “Embedded derivatives in power sales contracts” HS Orka reported a decrease in its net income from ISK 1.2 billion in 2014 to ISK 0.3 billion in 2015. In my opinion, fluctuations in the value of embedded derivatives are standard features of this business and should not be taken as a risk. Toba Montrose Toba Montrose comprises two hydro power plants located in British Columbia, Canada. In the first nine months of 2015 Toba Montrose generated 704 thousand megawatt-hours of electricity (8.2% up, compared to the same period in 2014). The plant delivered net income of $18,403 thousand (1.9% down, compared to 2014), of which $7,417 thousand was attributable to Alterra (the company holds a 40% stake in Toba Montrose). Dokie 1 Dokie 1 is a wind farm located in British Columbia, Canada. Year to date Dokie 1 delivered revenue of $20,515 thousand, slightly above revenue reported in 2014 year to date. Due to lower costs (mainly costs of sales and financial expenses), year to date the farm showed a net income of $2,158 thousand (last year Dokie 1 incurred a net loss of $1,380 thousand). Of this income, 25.5% ($647 thousand) was attributable to Alterra. Blue Lagoon Blue Lagoon operates the legendary Blue Lagoon geothermal spa in Iceland. HS Orka owns a 30% stake in this company (Blue Lagoon) therefore this stake is reported directly in Alterra’s books using an equity method of accounting. In the first nine months of 2015 Alterra recognized net income of $6,241 thousand (up $2,057 thousand, compared to 2014). Summarizing, in the first nine months of 2015, all Alterra’s power plants operated with no major problems. Power plants, accounted for using an equity method, brought $14,305 as “Share of results of equity-accounted investees” (compared to $11,577 thousand in 2014). In my opinion, these figures confirm that Alterra’s power plants are heading for the right direction. Projects under development Currently Alterra has two projects under advanced development: Shannon and Jimmie Creek. Shannon Shannon is a wind farm project located in Texas, USA. It is owned by a partnership between Alterra (50%) and Starwood Energy Group Global (50%). Shannon is accounted for under the equity method (previously it was fully consolidated in Alterra’s books). The project is fully financed through a mix of an equity contribution (delivered by Starwood) and project financing ($286.8 million in credit facility). According to the company, commercial operations should start before the end of 2015. Jimmie Creek Jimmie Creek is a hydro power plant project located in British Columbia, Canada. It is owned by Alterra (51%) in a partnership with Axium (49%). Similarly to Shannon, this project is fully financed. In the beginning of 2016 Jimmie Creek should start delivering electricity to BC Hydro, under a 40-year power purchase agreement. The excerpt below, taken from the company’s 3Q 2015 report, summarizes Alterra’s stakes in all plants and projects (excluding HS Orka): (click to enlarge) As the picture shows, at the end of September 2015 the company was holding $186 million in various issues accounted for under the equity method. The company’s long-term performance Before writing this article I was wondering how to show the company’s long-term performance. After second thought, I have chosen book value as a leading measure. I think that any energy producing company should increase its book value in the long term. Calculating Alterra’s book value I have excluded two issues, which distort it: Accumulated other comprehensive income (AOCI) – it is part of the equity section of the balance sheet, representing accumulated unrealized gains and unrealized losses, such as cash hedges or currency translation adjustments. Every year or quarter this item fluctuates, very often quite much. What is more, AOCI depends on exchange rates, interest rates and other issues, which the company does not control. Therefore I have eliminated AOCI from my calculations of book value. Non-controlling interest – because non-controlling interest represents the stakes other entities hold in the company’s consolidated assets I have excluded this issue from my calculations. Now, let me take a closer look at this issue, taking Alterra as an example: (click to enlarge) source: Simple Digressions and the company’s reports The chart shows Alterra’s book value per share starting from 2011. It is not a nice picture – the company’s book value decreased from $0.69 per share (at the end of June 2011) to $0.33 per share at the end of September 2015. Someone would even say that the company was destroying value in the long-term. Well, it would be a half-truth. Since its beginning Alterra was trying to explore / develop quite a large number of projects. Part of expenditures on project development was accounted for as costs – in that case these costs were disclosed in the statements of operations. However, much larger part of development expenditures was capitalized in the balance sheet as “Development costs”. According to the company: “The Company capitalizes direct costs associated with its hydro, wind and geothermal development projects. Such costs include acquisition costs, exploration and development costs (including materials, direct labor, directly attributable overhead costs and borrowing costs), net of any recoveries and grants. Costs associated with successful projects are amortized over the useful life of the projects upon commencement of commercial production. Costs of unsuccessful projects are written off in the statement of operations in the period the project is abandoned or impaired” The last sentence is particularly important – unsuccessful projects are written off in the statement of operations. In 2013 and 2014 Alterra recognized impairments charges of $120,504 thousand and $22,439 thousand, respectively. On the per share basis it was $0.26 and $0.05, respectively. If the company did not recognize these charges, its book value at the end of September would stand at $0.64 per share, a little bit below its book value at the end 2012. Of course, it still means that the company has not built value in the long-term but every investor should remember that Alterra is at its initial development stage. At that stage a number of projects is doomed to failure. Alterra is no exception and it will take some time before the company starts to create value. Debt Alterra holds relatively high debt: (click to enlarge) According to the company (3Q 2015 Report, Note 13, page 20): “The Company currently plans to retire the holding company bonds (Sweden) through refinancing in 2016, for which the Company is currently in negotiations ” As for HS Orka loans of $81.7 million, though they are disclosed in the company’s consolidated balance sheet, they are non-recourse to Alterra – it is HS Orka, which has to pay this debt down. A holding company loan facility of $64.6 million will mature in 2023; till that time no principal payments are scheduled (the loan facility will be paid down on expiration). I believe that HS Orka will be paying down its debts so in the short-term there is only one small question mark – the company’s negotiations aiming at refinancing the holding company bonds (Sweden). Valuation To demonstrate Alterra’s market valuation I am using an Enterprise Value / EBITDA multiple. Including a non-controlling interest in the company’s valuation, currently Alterra’s shares are trading at a multiple of 11.7. The chart below shows valuations of a few renewable energy companies (as of November 20, 2015). In my opinion, Alterra’s shares are not overpriced, compared to its peers: (click to enlarge) source: Simple Digressions Summary In my opinion, Alterra is going in the right direction. Its current power plants operate with no major problems. In the coming future the company should increase its capacity through completing two additional, fully financed, energy projects. The first one, Shannon Wind, is a wind farm facility with a nameplate capacity of 204 MW. Shannon should be in operation at the end of this year. The second project, Jimmie Creek, is a hydroelectric power plant with a nameplate capacity of 62 MW. This project should start its operations in early-2016. After commencing operations at these new power plants, the company’s capacity will increase from 553 MW to 819 MW (an increase of 48.1%). Despite these positive developments, the market is valuing Alterra’s shares at an EV / EBITDA multiple of 11.7. I think it is relatively low valuation, compared to other renewable energy stocks. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.