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U.S. Geothermal – Still No Short-Term Catalysts On The Horizon

Summary US Geothermal continues providing decent financial results. This year the company demonstrates some progress in taking two geothermal projects, WGP Geysers and El Ceibillo, closer to their production phase. However, in my opinion, setting COD (“Commercial Operation Date”) at 2Q 2018 (El Ceibillo) and 3Q 2017 (WGP Geysers) is going to be a challenge for the company. I believe that currently US Geothermal’s shares are overvalued against its peers. On November 23, 2015 US Geothermal Inc (NYSEMKT: HTM ) published its 3Q 2015 results. Below I am commenting on these results. I am also covering the last developments at the two most advanced geothermal projects. Year to date financial results The table below summarizes year to date financial results: Source: Simple Digressions and the company’s reports As the table shows, the results reported by the company in the first nine months of 2015 were comparable to those reported last year. However, a 17.5% increase in book value is worth commenting. To remind my readers, I consider book value as one of the best performance measures of any company. Simply put, if a company is able to increase its book value in the long-term, it means that it has built its value. Let me show how HTM was building its value: Source: Simple Digressions and the company’s reports Note: to calculate HTM book value I have excluded two issues, which distort it in the long-term: 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. Because non-controlling interest is excluded from my calculations, the final figure demonstrates book value attributable to the company’s shareholders. As the chart shows, HTM increased its book value attributable to its shareholders from $0.66 per share at the end of 2012 to $0.80 per share at the end of September 2015 (an increase of 21.2%). In my opinion, it is a big plus – US Geothermal, increasing its book value in the long-term, behaves like a classic utility company. Operating results The table below presents basic operating results: Source: Simple Digressions and the company’s reports As the table shows, year to date US Geothermal reported slightly lower electricity generation and slightly higher operating expenses than in the same period in 2014. After taking a closer look at each operating facility I came to the conclusion that the main factor, standing behind higher operating expenses, was the Raft River’s performance. Raft River, located in Idaho, is the smallest HTM’s power plant, in terms of generation capacity (9.4 MW). Since the beginning this facility has been lagging behind other two plants. However, this year this underperformance is particularly striking: (click to enlarge) Source: Simple Digressions and the company’s reports As the chart shows, this year each megawatt hour, generated by Raft River, delivered only $4.94 in operating income (I call it “Netback”). Other plants, San Emidio and Neal Hot Springs, delivered $61.19 and $75.66, respectively. In its 3Q 2015 report the company explained that there were two reasons standing behind this underperformance: 371 lost hours during two unplanned outages (according to my calculations, these outages were responsible for the lost revenue of $196 thousand) Higher operating costs due to turbine repairs and wage increases – year to date these additional costs were $361.5 thousand (turbine) and $142.3 thousand (wages). I think that technical problems, experienced at geothermal facilities, happen sometimes. However, granting wage increases to the crew when the facility is in trouble is not, in my opinion, the best practice. Projects under development US Geothermal has four projects classified as “Projects under development”: El Ceibillo Phase I, San Emidio Phase II, WGP Geysers and Crescent Valley Phase I. Of these four projects, in 2015 the company was developing mainly two of them: WGP Geysers and El Ceibillo. Below I am commenting on these developments. WGP Geysers In April 2014 the company acquired the so-called “Geysers project”. To remind my readers, this project is located in the Californian broader Geysers geothermal field, the largest producing geothermal field in the world. In June 2015 the company completed a flow test program of the three production wells. These tests confirmed that wells were operational but to achieve a planned long-term capacity of 28.8 MW, two or three additional production wells should be reopened (the company does not need to drill new wells). In other words – before any geothermal company takes a decision on eventual production, flow tests have to be performed to establish resource viability. US Geothermal completed such tests and announced that two or three additional production wells were needed. In my opinion, it is an important message. It seems that the company is approaching a production decision on WGP Geysers – if such is the case it could be a game changer. However I have some doubts. The company estimates that production at Geysers should start in the third quarter of 2017. In my opinion, it will be a challenge to meet this timeline because HTM must, for example, open two or three production wells, connect its property to the grid, sign a power purchase agreement, find financing for its project etc. All these issues need time so the two-year time frame, in my opinion, seems to be very optimistic. El Ceibillo, Guatemala US Geothermal used to postpone a commercial operation date (COD) of El Ceibillo many times. Fortunately, since the fourth quarter of 2014 the company has been confident that this facility should start its operations in the second quarter of 2018. On October 13, 2015 HTM was granted the concession agreement for the El Ceibillo development. To remind my readers, the previous concession expired this year so now the company is once again formally allowed to continue development. Currently the company is in the middle of it. In 2014 it completed a nine hole temperature gradient drilling program (an initial part of any development). This year HTM is performing flow tests – one well (EC-2A) confirmed that there is a commercial resource at El Ceibillo but at least two additional wells are needed to extend the resource area (drilling at the first well, EC-3, started on October 29 ). Summarizing, the company is at its intermediate stage of development at El Ceibillo. In my opinion, setting 2Q 2018 as a COD is going to be, similarly to WGP Geysers, a challenge. Equipment purchase On November 9 the company announced it acquired equipment for the construction of three binary geothermal power plants. This equipment was acquired at a significant discount to its cost. According to the company: “We paid $1.5 million, which is approximately 5% of the equipment’s original cost, a saving of roughly $28 million. This equipment gives us the ability to expand our megawatt output at our existing portfolio of advanced stage development projects at significantly lower cost, and in much shorter construction timeframes” The equipment is supposed to be applied to the Crescent Valley and San Emidio Phase II projects. The initial market reaction was very positive – on November 9, the company’s shares closed 8.9% higher than on the previous day. Well, in my opinion, the equipment acquisition is surely a positive thing in the long-term – the company should save a lot of money and time at the construction of Crescent Valley and San Emidio II. The management did a very good job, indeed. However, in the short-term this message means nothing – the company has just bought some equipment, which will be stored as inventory, waiting a few years to be applied. Additionally, this equipment will be accounted for as inventory and disclosed at cost ($1.5 million). However, the most paradoxical thing is the fact that when both projects start their operations, the company will be allowed to recognize depreciation charges attributable to only $1.5 million. Putting it differently, an excellent managerial success, due to accounting and fiscal rules, will be converted into lower depreciation charges and higher taxes in the future. Valuation To demonstrate US Geothermal’s market valuation I have calculated the Enterprise Value / EBITDA multiples for a few geothermal energy stocks. The chart below, depicting these ratios, was taken from my article on another geothermal company, Polaris Infrastructure. As the chart shows, currently the company’s shares are trading at a multiple of 12.3, which means that they relatively overvalued against its peers: Summary US Geothermal continues to provide descent financial results. However, due to large non-controlling interest component, HTM shares are relatively overvalued against its peers. In this article I have covered two projects, which are approaching production phase – WGP Geysers and El Ceibillo. Year to date some progress towards putting these projects closer to production has been evident. However, in my opinion, to meet time frames set by the company is going to be a challenge. Therefore I am sustaining my previous thesis on US Geothermal – there are still no short-term catalysts to lift the company’s shares. 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.

Residential REITs Offer Steady Dividends With Long-Term Growth Potential

Summary REZ is a well-diversified ETF with both moderate long term growth potential and a 3.3% dividend yield, making it a great income play. REZ has ~49% of its holdings in residential REITs, which are expected to experience steady demand over the next few years as renting becomes more and more attractive. REZ also has ~29% of its holdings in healthcare REITs, which are primarily composed of different types of senior housing. As baby boomers retire, demand here is expected to skyrocket. Finally, REZ has ~22% of its holdings in self-storage REITs, a booming industry of late. They tend to follow economic trends, so I’m bullish on self-storage REITs as well. The potential risk posed to REITs from an interest rate hike is not to be ignored, as it increases the cost of financing new projects. The iShares Residential Real Estate Capped ETF (NYSEARCA: REZ ) is a popular ETF for those who wish to invest in US residential real estate without actually being a landlord. It does this by using the FTSE NAREIT All-Residential Capped Index as its benchmark index, which is comprised of many different REITs. Taking into account demographic changes, a trend towards renting instead of buying and a recovering economy, I’m bullish REZ in the long term. I view it as a great income play with moderate long-term growth potential as well. REZ Overview Offering an attractive dividend yield of 3.3% and a tolerable expense ratio of 0.48%, this ETF has been popular with investors since its inception in May 2007. It currently has about $316MM in assets. REZ can generally be looked at as holding 3 different types of REITs. The first are obviously residential REITs, which develop multifamily housing such as apartment complexes. The second are healthcare REITs, which can generally be categorized as senior housing. The third are self-storage REITs. (click to enlarge) (Source: Data for chart by iShares.com ) To find the holdings for the chart above, I went through each individual holding and categorized it as self-storage, healthcare or residential. Some that I categorized as residential may have been categorized by iShares as specialty. Due to this, my percentages are about 2% off of iShares own classification, which is between residential, healthcare or “specialty” (which I felt was too broad). As you can see, while traditional residential REITs make up 49% of this ETF, there are still significant investments in self-storage and healthcare REITs. Due to this, one has to consider many more factors than just the residential housing market when considering investing in REZ. I’ll be reviewing the outlook for all 3 of the different types of REITs in this article. Residential REITs Outlook Housing prices are just below record highs, but this time it’s not thought to be a bubble , as strong economic growth has fueled increasingly higher housing prices. This is very bullish for residential REITs, as more and more people are resorting to renting. Mortgage requirements are tighter, making it more difficult for lenders to make loans than it was pre-2008. This coupled with slow wage growth makes buying a home less feasible for many people. Additionally, new US housing starts are very low, with these high prices simply mirroring the scarcity of supply. As you can see below, builders still haven’t recovered from the recession. (Source: tradingeconomics.com ) When adjusted for inflation, housing prices are just below record highs, according to the census . The rate at which housing prices have increased has also remained at a respectable level into these highs as well. (click to enlarge) (Source: Data by S&P Dow Jones Indices) Keith Gumbinger, VP of HSH.com, dismissed the idea that a bubble is forming, stating that “Today’s rising prices are fueled by actual market forces, backed up by real money.” This couldn’t be more true in my opinion, and many economists do not believe a bubble is forming either. All of these factors, which make buying a home less and less realistic are very bullish for residential REITs, as people will naturally resort to renting. As you can see in the chart below, the trend has clearly been in favor of renting the last 5 years. The US rental vacancy rate is currently reaching lows not seen since 1985. (Source: US Rental Vacancy Rate data by YCharts) It’s thought that housing prices will continue to increase, albeit at a slower rate than they have in the past few years. I don’t see the vacancy rate significantly rising again either. So with housing prices expected to continually grow, the only risk I can see to this REIT category is the potentially negative effect an interest rate hike could have. This investment is not without its risks though, as higher interest rates increase the cost of financing the balance sheet. This makes projects more expensive for REITs, which depend heavily on debt to finance new projects. Some would disagree that an interest rate hike is net bearish for REITs, saying that increased economic growth and occupancy rates are closely linked to the performance of REITs. They say that once everything is factored in, REITs will come out at a net gain due to increased occupancy rates and inflation. So while the net affect of an interest rate hike isn’t clear, I’d recommend those interested in REZ conduct their own due diligence to decide for themselves. Healthcare REITs Outlook Healthcare REITs make up 29% of REZ’s holdings and are very well positioned to take advantage of the massive impending demographic changes in the United States. The “Baby Boomer” generation is aging, with about 10,000 turning 65 every day . As this segment of the population begins to age, healthcare REITs owning senior housing facilities will see a huge and steady surge in demand. (Source: FiveThirtyEight.com ) Investments in healthcare REITs are a long-term strategy though, so I wouldn’t recommend this ETF to medium-term investors, as nearly a third of REZ’s holdings are in healthcare REITs. As a 2005 study by Stefano DellaVigna and Joshua Pollet found one needs to wait 5-10 years before fully reaping the benefits that demographic changes bring to businesses. I think this finding applies best to healthcare REITs in the current environment. With many of them having been beaten down over the last couple years, there is serious growth potential to go along with the handsome dividends these REITs offer to those who are patient. So for those willing to wait, I view this segment of REZ bullishly in the long term. Self Storage REITs Outlook Self storage REITs, which make up about 22% of REZ’s holdings, have exploded over the last few years in both share price and popularity. With average occupancy rates around 90% and a business that tends to reflect economic trends, there are plenty of reasons to be bullish here. These REITs are extremely profitable as well. REZ’s largest self-storage holding (12% of assets), PSA, had a net profit margin of 52% last year. Most self-storage REITs have performed very well over the past few years as well, showing the sector has growth potential in addition to respectable dividends. I expect demand to grow with the economy as well, so I have a favorable long-term outlook for these REITs. (click to enlarge) (Source: San Clemente Self Storage ) I expect demand for these self-storage units to go hand in hand with demand for rental housing as well. An article by the CCIM institute noted that about 30% of the average property’s customer base lives in apartments and about 13% live in townhomes/condos. These higher housing prices are driving more people to renting or downsizing, increasing demand as they’ll need more room to store all of their “stuff.” It’s worth noting though that self-storage REITs see increased competition compared to many other types of REITs, as the vast majority of self-storage facilities are owned by local entrepreneurs. Back in 2000, REITs made up less than 10% of new development. While that was a long time ago, I expect that local entrepreneurs still maintain ownership of a sizable portion of self storage facilities. Some of the more profitable facilities are being acquired by REITs, but the large amount of locally owned facilities puts increased competitive pressure on REIT-owned facilities. In general though, I view self-storage REITs very bullishly in the medium term to long term. REZ: A Great Income Play With Long-Term Growth Potential After a thorough review, one can see that this ETF is well-diversified into many more sectors than purely residential REITs, as the name suggests. In my opinion, REZ would be a great addition to the portfolio of a long-term income investor who is interested in taking on a little bit more risk in exchange for moderate growth potential. The 3.3% dividend offers a great opportunity for steady income just as owning physical real estate would, but with much greater liquidity. In addition to the dividend, it offers a moderate growth opportunity to more aggressive income investors who believe housing prices are going to rise and want to take advantage of the drastic demographic changes taking place. I believe each of the 3 primary types of REITs that REZ holds will grow with the economy over the next decade. This investment is not without its risks though, so when considering an investment in REZ, one should weigh the immediate negative affect an interest rate hike could have with the dividends and long-term growth potential. I wouldn’t recommend investors use REZ as their primary income source, as the trend towards renting may change over time, which could have an adverse affect on share prices and dividend payments. Overall though, I think the factors mentioned above would make REZ a great portfolio addition for long-term growth investors who want their portfolio to generate additional income, as well as purely income investors who want to pursue moderate growth while not giving up their income stream. Conclusion REZ is a well-diversified ETF that is much more than simply a residential REIT. There are many factors one needs to account for and many different markets that one should research. From a fundamental perspective, though, I view each of the 3 primary REIT types that REZ holds bullishly in the long term. I think that long-term investors who believe that growth and income investing don’t have to be mutually exclusive could benefit greatly from this ETF. I think that long-term investors who are patient will see their diligence handsomely rewarded through steady dividend payments and moderate growth.

5 Broader Emerging Market ETFs Surging This Quarter

Emerging market investing has gone dour recently on slowing growth, a potential decline in foreign direct investment on a likely cease in cheap money inflows from the U.S. (post lift-off), a stronger greenback and slouching commodities. No doubt, this time around, emerging markets are more hardwearing to the Fed blows than they were in 2013 when taper talks resumed, but threats of underperformance still persist. Investors should note that several market researchers hinted at weak global growth for the coming years and cut their estimates. For example, the Organization for Economic Cooperation and Development (OECD) slashed global growth estimates twice in three months . The organization now projects that the global economy will expand 2.9% in 2015 and 3.3% in 2016, down from the prior guidance of 3.6% for both years. For the emerging markets, protracted slowdown in the largest region China has been a huge concern and its ripples in the other parts of the bloc are souring the sentiments over the region. Moreover, China accounts for a gigantic portion of the global commodity market. Thus, a long drawn out weakness in this economy has weighed heavily on commodities. This in turn dealt a blow to two other commodity-rich emerging markets, Brazil and Russia, which are now facing recessionary threats. IMF expects the Russian economy to contract 3.8% this year and 0.6% in the next, while Brazil’s economy is expected to shrink by 3% in 2015 and 1% in 2016. However, the OECD expects both the struggling economies to return to growth by 2017. Within the bunch, India seems to be a winner, though it has its share of problems in the form of political complexity and the resultant delay in application of pro-growth reforms by Prime Minister Narendra Modi. In such a backdrop, iShares MSCI Emerging Markets ETF (NYSEARCA: EEM ) has added about 6.6% so far this quarter (as of November 20, 2015) after the MSCI Emerging Market Index lost about 19% in Q3 – the largest quarterly retreat in four years – instigated by the Chinese market upheaval, per Bloomberg. But investors should note that not all emerging market ETFs have delivered lower than 10% gains so far this quarter. In fact, Chinese ETFs returned superbly after the stock market rout in Q3 when the market had a bloodbath. Several China ETFs, especially A-Shares ones, returned more than 20%. Several Latin American ETFs too have given stellar returns, some on political hopes while others on compelling valuation. However, since particular country-ETF investing looks risky in the present market backdrop, which might not sustain returns at any point of time on any single issue, below we highlight a handful of broader emerging market ETFs that have given impressive returns even in a tough operating environment. Broader market options appeared better picks as the strength of one economy often compensates the weakness of the other. Emerging Markets Internet & Ecommerce ETF (NYSEARCA: EMQQ ) – Up 23.5% The Internet and e-commerce industry is developing fast with the increased use of social networking sites and online trading as well as the growing adoption of smartphones and other mobile Internet devices. So, this product has more to do with technological expansion in the emerging markets rather than reflecting the slowing potential of those economies. In fact, EMQQ can succeed on the back of a fast-expanding middle class population of emerging nations. This $11.7-million ETF considers companies from Asia, Latin America, Africa and Eastern Europe. Country-wise, China takes the highest allocation in the fund. EMQQ charges 86 bps in fees and is up 23.5% so far in the fourth quarter (as of November 20, 2015). First Trust BICK Index ETF (NASDAQ: BICK ) – Up 16% This $8.3-million product considers securities from Brazil, India, Mainland China and South Korea. The recent rally in the Brazilian market following its Congress decision to cut on government expenditure to boost the waning economy favored the fund. The product charges 64 bps in fees. WisdomTree Emerging Markets ex-State-Owned Enterprises Fund (NYSEARCA: XSOE ) – Up 14.3% The $2.2-million fund can entice investors having less faith in the state-owned emerging market companies, but still intending to tap the region’s growth story. According to the issuer, the MSCI emerging market index generated 80% less returns than the U.S. markets over the past five years and this was due to the anemic performance of the SOE. In terms of geographic exposure, China (23.5%), South Korea (16.5%) and Taiwan (10.9%) have a double-digit exposure each. The fund charges 58 bps in fees. Guggenheim BRIC ETF (NYSEARCA: EEB ) – Up 12.9% As the name suggests, the $90.6-million fund considers BRIC (Brazil, Russia, India and China) economies. It charges 64 bps in fees and is heavy on IT (up 25.44%), while energy (19.30%), financials (17.38%) and telecom (12.9%) round out the next three spots. SPDR MSCI Beyond BRIC ETF (NYSEARCA: EMBB ) – Up 11.6% The $2.5-million ETF put double-digit weight in South Korea, Taiwan, South Africa and Mexico. The fund has returned over 11.6% so far in Q4 (as of November 20, 2015). Original Post