Tag Archives: utilities

AmeriGas Partners: Proceed Cautiously

Summary 8.5% yield is enticing for income investors, but has risks. Heritage Propane acquisition just isn’t working well; leverage up, earnings per share are down. Propane faces stiff competition from continued natural gas expansion and increasing market supply. AmeriGas Partners (NYSE: APU ) is a nation-wide propane distributor operating as a MLP. The company’s primary business model is to supply propane to rural areas where natural gas is not run due to the costs involved. To operate as a business that serves these small communities, AmeriGas has had to develop significant transportation and distribution infrastructure, helping give the company the current market advantage it holds. Propane is a multi-faceted commodity. The fuel source is plentiful, easily separated from crude oil during refining and also extracted as a byproduct from oil/natural gas wells. The resurgence of fracking in the United States has unlocked a major supply source for the fuel that is unlikely to go away anytime soon – the Marcellus and Bakken shale plays are expected to produce billions of gallons of propane annually by 2020. However, propane is less energy efficient than other sources of power generation like gasoline and natural gas. This relative energy inefficiency will continue to have propane play second fiddle to more efficient fuels. Over the past decade as energy markets have evolved, propane prices have collapsed in comparison to alternatives like gasoline and home heating oil. Toughening the market for AmeriGas, residential consumer propane use has shrunk as well, outside of years with exceptionally cold weather. The future of the fuel primarily relies on commercial uses such as use in internal combustion engines. However, commercial users have more options than residential buyers who have little to no access to alternative sources of heat production. Any sustained growth in propane prices compared to alternatives will be met by falling demand by end-users. Overall, given my views on natural gas pricing remaining low despite strong demand from utilities and chemical companies, my views on propane fall in the same category. I’m in the camp that propane prices will remain lower for longer. To offset losses, the company has to rely on continued expansion in propane cooking and water heating. This will likely at best offset the downtrend in residential heating markets. This doesn’t mean that AmeriGas is doomed, but the company does face headwinds given the environment it is currently competing in. Whatever your opinion on propane’s future, there isn’t any denying that the North American energy market, propane included, is in the middle of significant and profound change. Mixed Bag Of Operating Results *numbers in millions CAGR 2015 (est) 2014 2013 2012 2011 Total Revenue 3.76% 2942 3713 3167 2922 2538 Cost of Revenue -3.44% 1395 2121 1660 1720 1605 Operations & Maintenance 11.21% 950 964 944 889 621 Depreciation & Amortization 19.39% 193 197 203 169 95 Total Operating Expenses 2.67% 2592 3250 2774 2764 2333 OpEx as % of Total Revenue -1.06% 88.10% 87.53% 87.59% 94.59% 91.92% Investors should note that the above are fiscal year results – AmeriGas’ fiscal year ends 9/30 which means only one quarter needed my estimation. As investors can see, 2015 total revenue is set to fall over 20% primarily due to a more mild winter season compared to prior years. On the plus side, gross and operating margins have improved and operating income expanded. It might surprise investors to find out that 2011 was the more profitable year. Why? The acquisition of Heritage Propane in 2012 was incredibly expensive, paid for by nearly $1.5B in cash that had to be raised in the debt markets, along with a $1.1B dilutive stock issuance that diluted shareholders nearly 40%. Total debt now stands at $2.2B, compared to $929M in 2011 and AmeriGas now pays $100M more in interest expense annually than it used to, even in a falling interest rate environment that has improved. Debt used to finance the purchase wasn’t cheap – the majority ($1B due 2022) carries a burdensome 7% rate that cannot be refinanced due to covenants until 2017. I have yet to see much value in this purchase. While operating income has nearly doubled, shareholders haven’t seen any reward as earnings per share has moved nowhere. The estimated $2.38/share AmeriGas will earn in 2015 is less than the $2.93/share the company earned in 2011. *numbers in millions CAGR 2015 (est) 2014 2013 2012 2011 Cash From Operations 30.07% 521 480 356 344 189 Capital Expenditures 7.54% 111 114 111 103 77 Dividends Paid 20.45% 362 347 327 272 172 Resulting Free Cash – 48 19 -82 -31 -60 Additionally, when evaluating utilities I like to see how the cash is used. When looking at a utility, there are two main uses for cash from operations: capital expenditures and dividend payments. If investors in their research see continued years of negative free cash after these two items are paid, eyebrows should be raised. Utilities with healthy leftovers have cash balances they can use for acquisitions, debt retirement, share repurchases, or just setting aside cash for a rainy day. This is an area that has seen improvement for AmeriGas, although I would like to see more improvement than what I’ve seen. As another critique, historically, approximately 60% of capital expenditures have been “maintenance” capital expenditures, or capital expenditures that are done simply to maintain the current asset base. So from a growth perspective, only 40% of 2015’s capital expenditures, or $45M, is used to build new plants, storage devices, or purchase new equipment. Future growth may be curtailed if this investment remain slow. Conclusion Investors were skeptical back in late 2011/2012 over whether the Heritage Propane acquisition was a good deal. Several ratings agencies downgraded the company’s debt on questions whether the cost (11x EBITDA) and risk of failed execution high. This is part of the reason why AmeriGas’ debt issued to fund the acquisition carried such unfavorable rates. Looking back from today, it appears those fears were largely founded. Investors who are likely salivating at the current 8.5% yield should question whether that yield may remain stagnant in the years to come. Management wants to target 5% annual targets but free cash flow currently cannot support much further growth. I can see expansion if we have a string of cold years in 2016 and 2017 while interest rates remain low. Strong operating results before a debt refinance option opens up could free up some cash flow to support some future dividend raises. Beyond 2018, the source of tens of millions in additional free cashflow to fuel 5% dividend increases each year becomes murky.

New Hope Looks Good, But Is Free Cash Flow Negative

Summary New Hope is one of Australia’s companies focused on coal. It says it wants to acquire new projects with its A$1B working capital position, but it’s spending cash like there’s no tomorrow. The dividend is 7 times higher than the free cash flow is. If New Hope is serious about its expansion plans, it should reduce its dividend payments right now. Introduction After identifying Whitehaven Coal ( OTCPK:WHITF ) as a great coal company, I continued to look for other companies and was waiting for New Hope’s ( OTCPK:NHPEF ) financial results to see whether or not this is another coal company I should add to my list. Source: company presentation New Hope has a more liquid listing at the Australian Stock Exchange where it’s listed with NHC as its ticker symbol. The current market capitalization is approximately US$1.05B, so this isn’t your average micro-cap company. The company is still flowing cash Everybody knows the entire coal sector is suffering due to low prices, but fortunately the Australian producers have one advantage; the extremely weak Australian Dollar. As the Australian currency has lost in excess of 30% of its value in just one year time, the Australian companies are doing much better than their competition as even though they are still selling the coal in USD, the local expenses are a few dozen percents cheaper than one year ago, protecting the margins. (click to enlarge) Source: financial statements And yes, this seems to be proven in the company’s financial statements as even though the revenue decreased by 11%, the cost of sales fell by 17% and this would have resulted in a pre-tax profit of A$73M ($52M), if New Hope would have been able to avoid an A$97M impairment charge. This pushed the pre-tax profit in the red and even after a small tax benefit the bottom line was still showing a net loss of almost A$22M ($16M). Fortunately an impairment charge never has any influence on a company’s ability to generate cash flows, so I would think the cash flows of New Hope would remain pretty decent but the only way to find out is by checking the cash flow statements. That’s why I waited for New Hope to publish its annual report, as (unlike the quarterly reports), the company has to provide a cash flow overview as well. (click to enlarge) Source: financial statements The operating cash flow was A$88.5M ($63M) (after taxes), and whilst that’s still pretty good, considering the worsening circumstances on the coal market, you shouldn’t forget the total capital expenditures were A$115M ($82M), so New Hope was free cash flow negative. Again, that’s nothing to worry about because a) the negative cash flow is still limited and b) New Hope has a substantial amount of cash on its balance sheet. The negative free cash flow was A$26.5M ($18M), but in the next part of this article I’ll explain why I’m not really worried about this cash shortfall. But is spending more than it receives, and I don’t like that Indeed, that’s New Hope’s strength. It has a working capital position of in excess of A$1B ($700M) and a current ratio of in excess of 11 and that’s extremely high. This strong working capital position will also allow New Hope to indeed pursue the acquisitions it has been eying as this must be the only coal company in the world with such a financial flexibility. (click to enlarge) Source: financial statements The majority of its cash is being held in term deposits, and this resulted in a total interest income of A$38M in FY 2015. This was sufficient to cover the shortfall of the operating cash flow to fund the capital expenditures, but despite the free cash flow increasing to A$11.5M, it’s quite annoying to see the company has spent A$79M on paying dividends. And it won’t stop there. Together with the presentation with the company has announced a final dividend of A$0.025 and a special dividend of A$0.035 to bring the total dividend for the financial year at A$0.10 ($0.07). Using the current amount of 831M outstanding shares, this means New Hope will be paying A$83M in dividends based on its FY 2015 results. And that’s a pity. The adjusted free cash flow was a positive A$11.5M, but paying A$83M in dividends is definitely weakening the company’s financial situation. Of course, it still has in excess of one billion of Australian Dollars in working capital, but I have a firm opinion the company should NOT pay out more cash than it’s taking in from its operations. Investment thesis The shareholders will be happy with a 6% dividend yield, but I believe not a single company should pay out more cash than it’s generating. New Hope has publicly declared it wants to acquire more projects, to paying out almost A$100M ($71M) in dividends probably is one of the most stupid things the company could do. I like coal, and I like New Hope’s strong and solid financial status, but it’s not helping the company at all to spend cash on dividends instead of keeping the cash in its treasury. The working capital decreased from almost A$1.2B to A$1.1B in the past year, and that seems to be a bit contradictory to the company’s public claims it’s looking for acquisition targets. If New Hope is really serious about becoming a major player in the coal space, it should cut the dividend and cash up. Now. 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.

Abengoa Yield PLC: Diversified Global YieldCo With Attractive Dividend And Upside Potential

Summary Attractive sustainable current dividend yield of over 8 percent; expected to increase by 31 percent next year. YieldCo sponsored by global engineering giant with a substantial pipeline of attractive acquisition opportunities. Solid diversified asset portfolio with stable cash flow and global exposure. Last week we brought readers an interesting opportunity with a renewable energy focused YieldCo in NextEra Energy Partners (NYSE: NEP ). With this article, we’re focusing on another YieldCo with substantial upside potential, along with a strong sustainable high yield dividend. This time, however, the company is more nuanced and has, in our view, a different risk profile than NextEra Energy Partners. However, we believe the potential upside with this company is significant and offers a great source of low cost diversification to an income focused portfolio. Abengoa Yield PLC (NASDAQ: ABY ) is a United Kingdom registered company that trades primarily on the NASDAQ. Abengoa Yield follows the typical YieldCo model for project developers: its sponsor, Abengoa SA (NASDAQ: ABGB ), wins contracts, develops projects and then the Yieldco has the opportunity to be the first bidder on these projects as they’re sold. The sponsor benefits by freeing up capital to pursue more development opportunities and investors in the Yieldco benefit by holding onto long-term stable cash flow generating assets that can be levered to produce a high dividend yield. The sponsor, Abengoa SA, is a global engineering company based in Spain whose expertise is primarily in the development of power projects. Its market capitalization is approximately $1 billion, with 2014 revenues of over €7 billion. As of the second quarter of 2015, the sponsor held a 51.1 percent interest in Abengoa Yield, though the company is targeting this to be reduced over time to a 40 percent interest. Unfortunately for Abengoa Yield, there are conflicting views on the financial health of the sponsor, with a recent upgrade by Standard & Poor’s in July offset by the news that Moody’s has put the company on credit watch in early August. Abengoa Yield PLC does enjoy a higher credit rating from Moody’s than the sponsor, indicating limited concern about the impact of a default or bankruptcy of Abengoa SA on the YieldCo’s immediate financial situation. However, there is no doubt that a default of the sponsor would have a considerable impact on the future project pipeline that the YieldCo has access to, and we believe that this risk is captured in Abengoa Yield’s lower valuation and higher yield. With the YieldCo business model, questions around governance are common. In the case of Abengoa Yield, we believe there are adequate governance controls in place to protect the interests of its shareholders. First, a majority of its Board of Directors are independent directors, independent of both management and of the sponsor company. The board must vote on any acquisition of assets from the sponsor and determine that the terms are set “no less favorable than terms generally available to an unaffiliated third-party under the same or similar circumstances.” These terms would be determined based on a market analysis of what similar projects would be priced at in the market. While the risk remains that the board could be swayed by influence of the sponsor, it would be at great legal risk to the independent directors and so we believe that this level of control is adequate. Further, there is an inherent control in the business model as the sustained ability for the YieldCo to raise equity in the market is based upon its ability to generate attractive cash flow returns. A poorly priced deal could hamper the YieldCo’s ability to attract equity financing in the future, harming the very purpose of the fund for the sponsor. Finally, in the case of Abengoa Yield, the sponsor does plan to dilute its interest over time to only 40 percent of the outstanding shares, handing majority shareholder ownership over to the public. In terms of its asset portfolio, Abengoa Yield is a highly diversified YieldCo, with assets ranging beyond just renewable energy on long-term contracts. In addition to solar and wind generation assets, the company also owns a conventional 300 megawatt gas plant, 1,100 miles of electric transmission lines and two water treatment facilities, along with a financial interest in a Brazilian electricity transmission project. The diversified nature of its assets is attractive, with many other YieldCo type models more focused on generation specific projects. All of these assets are backed by long-term contracts, most with investment grade counterparties, allowing Abengoa Yield to apply a significant degree of leverage through project financing. The average remaining contract life for the assets is 23 years. (click to enlarge) Source: Abengoa Yield PLC’s June 2015 Investor Presentation Along with the long-term, stable cash flow contracts, Abengoa Yield has also locked down O&M costs for all of its assets. This has generally been done through long-term inflation linked O&M agreements, primarily with Abengoa SA as the contractor. This provides cost certainty not only on the revenue side but also on the cost side, offloading operating and maintenance risks to the O&M services provider. This is a common practice in the YieldCo space, and Abengoa SA certainly has the skills and global reputation to be a strong operator of these assets. Abengoa Yield is still exposed to capital maintenance expenditures for its assets, however, and increasing capital maintenance costs could pose a risk down the line. In the medium term, however, we review this risk as small as most of the assets are fairly new in vintage and won’t be facing substantial overhauls for decades. In many cases, much of the return on and return of capital for a project is captured in its initial contract term, making maintenance and renewal of future contracts an option that the company can decide, or not, to exploit down the road depending on market conditions. Beyond the diversification in the types of assets of the company, the firm is also significantly geographically diversified. Its solar projects are split between the United States, Spain and South Africa, while its wind generation is located in Uruguay, its gas generation is in Mexico and its transmission assets are in Peru and Chile. Finally, the firm’s water treatment projects are in Algeria. Some of these jurisdictions certainly add risk to the company’s profile, but we also find the diversification to be encouraging in an industry where political and regulatory risk threaten companies with over-concentrated positions. We would expect further diversification of the company’s assets geographically due to the nature of potential push down projects from the parent, which truly operates in every corner of the globe. The firm’s assets are generally supported by long-term contracted cash flow arrangements. This enables the company to pay both a high dividend and maintain a significant amount of leverage. The firm’s cash flows are based 61 percent on availability, rather than production, and 93 percent of the cash flows are in US dollars, or hedged to US dollars through a swap arrangement with the sponsor. Further, less than 4 percent of contracted cash flow is from counterparties that have less than an investment grade rating. The combination of these factors provides a very stable cash flow base from which the company can support its high payout ratio dividend. In terms of future projections, the company has published some attractive but well supported numbers, with a projected 2016 exit dividend of $2.10-2.15 per share annualized. This would be a significant increase from the $1.60 per share paid today. The company then projects ongoing growth at 12-15 percent per year based primarily upon further acquisitions of Abengoa SA projects, potential third-party acquisitions and efficiencies. We think the long-term trend might be on the aggressive side of attainable and we reflect that in our valuation analysis further on this report. Source: Abengoa Yield PLC’s June 2015 Investor Presentation The YieldCo’s primary source of expansion projects is completed projects with contracted cash flows purchased from the sponsor. The firm has a Right of First Offer on all projects that Abengoa SA offers for sale, giving it the opportunity to participate in any potential acquisition from Abengoa’s substantial project list. The sponsor had a backlog of €8.8 billion, according to its first half 2015 presentation, with significant power and infrastructure projects under development that would be ideal assets for inclusion in Abengoa Yield PLC’s portfolio down the road. Previous asset sales occurred at a 15 percent IRR, which is a significant discount to Abengoa Yield PLC’s current return on equity as calculated in our valuation, offering the potential for accretive acquisitions at its current price. Positives Diversified Geographical Exposure: The variety of geographical locations represented in Abengoa Yield’s holdings is an attractive feature for a company of this nature. Having a variety of jurisdictional exposure limits the impact of any one country’s political or regulatory changes, which can have a significant impact on these types of assets. Despite the geographic diversification, the contracted cash flows for the company are primarily in US dollars or are hedged to US dollars and therefore the firm has limited foreign exchange exposure risk. Diversified Portfolio of Asset Types: The variety of assets held by Abengoa Yield is attractive for investors. We believe that the lower risk conventional gas generation and electric transmission assets act to reduce required equity returns for the firm overall and underpin the company’s stable cash flow profile. The renewable assets are well diversified themselves with a split between solar and wind projects of varying sizes. ROFO Agreement with Abengoa SA: The firm’s Right of First Offer arrangement with Abengoa SA is highly attractive on the basis that the sponsor has a significant pipeline of developed and in development projects that could be sold down to the YieldCo at an attractive price. We expect that Abengoa SA will overcome its liquidity crunch in the medium term and this project pipeline will be realized at its full value for the YieldCo. Conservative Leverage at Hold Co Level: The firm currently reports a net debt to cash flow available for distribution of 1.8x versus its target level of 3x. This offers some ability for the company to finance future acquisitions through additional debt, rather than the dilutive equity offerings which are too common in the YieldCo space. Risks Many Assets in Higher Risk Jurisdictions: Many of Abengoa Yield PLC’s assets are located in jurisdictions that pose higher business risks than assets in North America or Western Europe. While a concentration of assets in any one high-risk jurisdiction may pose a concern for us, having small exposures to numerous jurisdictions seems to offer a higher potential return, with minimal incremental risk on a portfolio basis. That said, if future acquisitions continue to build exposure in an existing asset location, or if the risk profile of future asset locations was significantly higher, this would materially impact our required equity return and valuation. Financial Health of the Sponsor: The conflicting views on the financial health of the sponsor, Abengoa SA, are certainly weighing on this stock. We believe that Abengoa SA has taken steps to address its financial situation but the outcome of this is uncertain. Further deterioration in the financial health of the sponsor may have a material impact on the availability of projects for Abengoa Yield to acquire through the ROFO agreement. Valuation One attractive aspect of a company that is primarily driven by its dividend and distributes nearly all available cash to shareholders is the ease in analyzing and comparing its relative value along with assessing its implied cost of equity capital. In the case of Abengoa Yield, our baseline assumptions are the lower end of 2016 dividend guidance of $2.10 per share, a 90 percent payout ratio and an 11 percent annual growth rate. Why do we reduce the expected growth rate below the guidance provided by the company? Our concerns about the sponsor’s financial health are not insignificant and any major liquidity crunches at the sponsor could impact the available project pipeline for future acquisitions by the YieldCo. We do believe that the higher growth rate could be obtainable, as demonstrated by the company’s ability to beat that growth rate in 2016, if the sponsor company can maintain an adequate pipeline of projects at a reasonable cost. Into the details of the valuation, based on the September 18 share price of $19.34, these dividend, payout ratio and growth assumptions produce an implied cost of equity of 23 percent on a free cash flow to equity basis, nearly on par with the equity cost of capital determined in our analysis of NextEra Energy Partners, but still significantly higher than Brookfield Renewable’s (NYSE: BEP ) 16 percent cost of equity. Importantly, this is also a significant discount to the typical sale price of these types of assets, with the recent purchases from the sponsor occurring at a 15 percent IRR. This is reflected in Abengoa Yield PLC’s current price to book of 0.88. Arguably, the lower risk transmission assets held by this YieldCo should reduce its cost of equity compared to a firm like NextEra Energy Partners, who has a more concentrated asset exposure. Over the longer term, we believe that these YieldCos will trend towards a more reasonable 15-18 percent return on equity. This is the basis of our base case scenario for Abengoa Yield PLC of $30.00 per share (at an 18 percent return on equity). This would represent an even 7 percent dividend yield in 2016, which is much more generous than the yield on the firm’s stock earlier in 2015, illustrating significant upside potential beyond our projection. Summary Overall, we believe that Abengoa Yield offers an attractive valuation and potential upside for a set of high quality power and infrastructure assets located in geographically diverse locations. Current drag from the financial situation of its sponsor has weighed on this price but we do believe that this simply offers an attractive entry point for long-term investors. We view Abengoa Yield as having a unique risk and return profile and offsetting highly attractive qualities that together make for a bargain priced addition to a diversified portfolio. Disclosure: I am/we are long ABY, NEP. (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.