PORTFOLIO PURCHASE POLARIS INFRASTRUCTURE PIF – TSX; RAMPF – PINK
I’ve said many times I don’t know (and neither does any other human) where the oil price is going. I’ve got lots of cash to buy oil stocks, and I’m willing to miss the first 15-20% off the bottom.
In the meantime, I look for out-of-the-box energy stocks that can potentially give me 50% plus gains in a year.
Polaris supplies about 50 MegaWatts (MW) of geothermal power to Nicaragua–about 6% of the country’s use. There’s only 15.5 million shares out, and they have a long term deal to supply power. The government owns part of the utility buying the power. Several technical studies show there is only 3-4% overall decline rate in power. So I have:
- a long lasting, steady cash-producing asset (with positive EBITDA!)
- that needs almost no mainentance capital (i.e. has almost no decline rate; one well every three years to hold steady–three years!)
- with price certainty–long term contract
- and in US dollars
- in a tight share
A lot of my boxes get ticked there. And a dividend IS coming in Q3. So I bought 3000 shares today at $6.76
It’s funded, and it has immediate growth prospects–a three well drilling campaign that are all step out wells…but relatively low risk. The Market will know the results of the first well in the first or second week of February 2016, and any new power from that one well can be put online almost immediately–like, by the end of March (because it’s being drilled from a pad that already has a producing geothermal well; the other wells–if successful–will have to wait until Q4 2016).
Management says each new MegaWatt of power is worth US$1 million in
annual EBITDA. Wells range from 2-14 MW–huge variability. arger step out) will be known late March, but again, even if successful, logistics won’t let it get online until Q4 2016. The location for the third well will be decided after the first two are done. Management is hoping for 14-15 MW between the three wells.
Polaris is a re-cap (formerly called RAM Power) from May 2015–at 2000:1; a two-thousand to one rollback. Equity shareholders were wiped out. Debt holders were able to get 80% of their money put into equity at $8/share. (As you can imagine, former shareholders HATE this company.)
Most of the restructuring was done by CEO Marc Murnaghan, who as an investment banker at a Toronto firm, and he funded the old RAM Power. Some of the principals from the former Salida Capital out of Toronto were also helping with the restructuring.
The company is generating USD$50 million in annual revenue and it’s doing US$40 million EBITDA right now. The reason for looking at the stock now is that this drill program–IF successful–COULD justifiably value the stock 50% higher than where it is today in 18 months–and pay a dividend.
This is a drill punt, but one with limited downside. About US$10 million of that EBITDA is Free Cash Flow (Interest Expense is HUGE; lots of debt held by the World Bank). A complete miss on all three wells (highly unlikely) puts the stock at $6/share IMHO. (But if the first one is a duster, it will go close to $6 quickly.)
I’ve spoken with CEO Marc Murnaghan several times over the last five months, and met with CFO Shane Downey over dinner to discuss the company. I talked to one of the funds who owns a major position. I talked to former contractors. I talked to an analyst who covered RAM (but not Polaris) and knows the story well.
(This is actually the fun part of my job–getting excited and calling people to investigate–I’ll call anyone and I meet new people and make great contacts this way. It’s fun; it’s sleuthing; putting together a puzzle.)
I’ve been following the stock closely since mid-September. The stock had a big run then; just after one fund put out a very bullish piece on it, and then Canadian brokerage firm Salman Partners initiated coverage (Salman no longer exists, so nobody covers it except me and my good colleague Fabrice Taylor at The President’s Club.)
But I knew the stock wouldn’t hold after that big pop from $8-$11. And it has come back to $8. It won’t even hold these levels if the first well is a bust (unlikely IMHO)–BUT if successful, a high enough dividend could be installed–that even at double digit yields–could drive the stock higher from here.
The stock started getting attention in mid-September as the $8 re-cap financing came free trading September 1, and the Toronto institutions who bought that could then sell it–and it’s these brokerage firms’ job to find retail buyers for their institutions!
I just bought stock today…I’ve been waiting for the overall market to bottom…but there are some intriguing fundamentals as you will read– especially if they can get at least 15-19 MW out of this 3 well program.
Management just issued news on Dec. 30, 2015 that the first well was completed and guided the Market to it being a small to medium well, with the remote possibility it’s a duster. So I’m thinking a 3-6 MW well.
The second well should spud late this week, maybe Monday. The results from the second well (a little bit l
QUICK FACTS (they report in USD)
Trading Symbols: PIF-TSX, RAMPF-OTC
Share Price Today: $7 CAD
Basic Shares Outstanding: 15.5 million
Market Cap: $108.5 million
Net Debt: (roughly, I used FX 1.3) $170.5 million CAD Enterprise Value (EV): $279 million CAD
2015 Estimated EBITDA : $ 52 million CAD
Enterprise Value / EBITDA: 6.0 times
The recapitalization involved $54.6 million (Canadian) of secured debt being exchanged for 5.5 million common shares and another 9.25 million shares being issued for $74 million (Canadian) in cash. After the recapitalization the newly issued shares account for 60% of the total outstanding and the converted debtholders who are now shareholders another 35%.
For those of us looking at the company for the first time we see a new name (Polaris Infrastructure) new Board of Directors and management, and a cleaned up balance sheet.
Polaris’ main asset is in Northwest Nicaragua called San Jacinto. Geothermal power is a clean and renewable energy source where the
Earth’s heat produces molten rock which warms underground water. Wells are then drilled to bring the superheated water and steam to the surface which drives turbines that generate electricity. The water (or brine at this point) are then re-injected underground to replenish the reservoir and thus making the geothermal energy source renewable.
San Jacinto is near several young and active volcanoes that are part of the Maribios mountain range. Currently San Jacinto is generating 50 MW of power from 8 wells, and 5 re-injection wells.
Capacity is 72 MW–so whatever new production can be brought on with this new drill program will have very low capex associated with it–as in, almost free–that low a capex. REPEAT: Management says each new MW is worth about US$1 million in annual EBITDA.
By re-injecting the fluids back into the reservoir allow for low total production declines currently trending at only 3% per year.
This brings up another, much more lower-risk growth–what’s called a binary unit. My (very limited) understanding of this industry is that there is wet and dry geothermal–steam with water and just steam. San Jacinto is wet, and has 1,500 tonnes an hour of hot brine that comes up that gets re- injected back to the resource.
Were the Company to complete the Binary Unit project, it would first run the hot brine through a heat exchanging unit before being re-injected back down into the ground. That extra heat from the exchange unit is generally worth 10% extra MW.
Assuming that Polaris gets 15 new MW–taking production to 65 MW–that extra heat would equal 6.5 MW to get a total of 71 MW–or very near full capacity.
After the 3 well program, management will likely go build a Binary Unit–it’s proven, simple technology and CEO Murnaghan is confident they can get at least 2/3rds debt for that, if not 100%. (He’s had pretty good success negotiating so far…)
Production from San Jacinto is sold under a long-term power purchase agreement with Disnorte-Dissur which operates the Nicaraguan electricity distribution system. Disnorte-Dissur is 16% owned by the Government of Nicaragua with the rest of the company in the hands of Spanish utility TSK Melfosur.
Under the agreement, Disnorte-Dissur is required to purchase all electricity from San Jacinto through 2029, up to 72 MW. The current purchase price in 2015 is $115 per MWh with an annual escalation of 3% through 2022 and 1.5% thereafter.
(After watching the bottom fall out on oil producers it is nice to look at a company that knows the price it will be receiving for its production!)
Not only is the selling price known, but production has also been stable following a 2013 production remediation project.
Technical consultants estimate that capital spending required to maintain that 3-4% decline rate is only $5.5 million per year–$2 million on maintenance and $3.3 million a year into a sinking fund so that every 3 years, a new $10 million well gets drilled to bring production back up to close to 72 MW.
At the current production level of around 50 MW Polaris is expected to generate EBITDA of just under US$40 million and free cash flow of roughly US$12 million.
There is a near term opportunity to significantly boost those numbers IF this new drilling program is successful. As I said, the first well has been been drilled and results will be known mid-February–and potentially be online by the end of March. The second well will spud early January with results known by mid-March. But it needs $7 million in tie-in costs, and won’t be ready to produce revenue until late Q4 2016.
So as Polaris drills these three additional wells which have the potential to increase power generation significantly–but what does that mean for cash flow and dividends?
If the wells add a combined 15 MW each as suggested, San Jacinto could be producing 63 MW by the beginning of 2017 after considering the 3% annual decline of existing wells.
In my talks with management, they said that for these wells to produce steam, they have to hit a permeable zone at a geologic fault, meaning that steam and water would come to surface prior to a full power measurement could be taken (that takes a month). That’s what’s happening now with the first well.
But IF the 3 well program hits expectations and can bring 15 new MW of power production online (remember the selling price is known), that could generate US$55 million of EBITDA and more than double free cash flow to US$25.7 million. That’s the reason to take a punt on the stock today.
Now, the company has told me they WILL do a dividend in mid-2016 with whatever cash flow they have. Their deal with the debt holders during the restructure was no dividend until the 3 wells were drilled.
If the three wells hit medium or two wells hit big and one’s a duster, then that dividend would likely be a double digit yield on the current share price by Q1 2017–only 15 months away.
Let me do the bear case–if all three wells miss. (And to be honest, if the first well now being tested is a duster, the Market will not wait for the other two–this bear case (in this market) will play out quickly.)
There is US$12 million or CAD$15 million available to be paid out in dividends once the 3 wells are done. Assume a 70% payout ratio for distributable cash of CAD$10.5 million.
Divide that by 15.6 million shares for a per share # of 67 cents a share. An 11% yield on that is $6.11. So arguably, that’s your downside if all 3 wells (or the first one) miss.
And the stock today is $7. That’s a 15% or $1/share downside. If you want to put a 13% yield on that dividend, the downside stock price is $5.17–or $2 downside. Let’s call that rock bottom downside.
Base case is–this first well delivers 3 MW, which translates into an extra CAD$4 million EBITDA, for a total of $19 million. Seventy percent of that is $13.3 million for an annual dividend of 85 cents, and at 11% yield gives a stock price of $7.75.
That tells me the current $7/share price is pricing in a mildly successful MW well on the first well.
What’s the uber bullish case–if they hit 19 MW total over the 3 wells this year, and have a 70% total payout? That works out to $1.75 dividend, which makes for a $15.91 stock at 11% yield. But it’s a 25% yield on today’s price of $7.
I say the stock trades at 11% because despite the long-life, low-decline power (bullish), this is a single asset (bearish) in Nicaragua (somewhat bearish). Maybe that’s for a bull market. In a bear market the yield would be higher, which means the stock price would be lower.
Nicaragua is a true democracy, but current President Daniel Ortega is centralizing power. Nobody is really worried about democracy in Nicaragua (Hey, he lost twice in a row and never did a coup.) yet–but I don’t see the Market ever giving this stock better than an 11% yield. It likely is more like 12-13% until they have a year of flawless operations–hitting wells, getting them online etc.
But I’ve only used 1.3x FX here, and today it’s 1.4. So that likely makes up a bit of the difference.
I think there is big leverage here if these wells hit, and I think 10-15 MW is reasonable. Incremental production of each additional MW will provide roughly $1 million of EBITDA, virtually all of which will add to current free cash flow since maintenance capital is so low.
The $70 million of cash on the balance sheet from the recapitalization will be used to fund $35-$40 million of spending directed at those additional wells plus working over four injectors and some additional investments into the San Jacinto facility.
It all sounds great, but The Big Risk here is that the results from these geothermal wells tend to be quite variable. The eight existing wells at San Jacinto produce an average of 7 MW, but have a huge range from 2MW to 14MW. They don’t say what each well is declining at, but they did say the big 14 MW well is actually increasing right now. That’s kind of important, as this company relies heavily on that one well for now.
Now, the good news is that the big wells, including the 14 MW, were actually drilled later, as knowledge of the asset increased. The bad news is that those wells still needed some very expensive remediation work. This asset has a long history of cost-overruns.
Most cost over-runs happened above ground, so the previous problems were…um….not geology, if you catch my drift.
I know NOTHING about this industry. (But I didn’t know anything about ethanol either 😉.) My network tells me drilling a deep geothermal well is much more complicated than drilling for oil and gas or mining–and CEO Marc Murnaghan agrees.
Technically, investors should know These three wells are “minor” step-out drills; there are actually no in-fill drilling in the way they are drilling this geothermal play (in-fill being generally NO-risk wells, step-out or delineation wells being slightly higher risk; pushing the known boundaries of the deposit).
The wells have to be a certain distance apart so they don’t communicate, roughly 400-500 metres, and these wells will step-out that far. It’s pretty much impossible to guess what rate these wells will produce at. One well will be 500 metres east and one will be 1 km north from current production. The placing of the third well will be decided after the first two.
FWIW, I checked with some former technical consultants at the project and they think the locations are chosen wisely. After a 2000:1 rollback, they are not long-biased.
Management believes that despite the variability in wells, it has a much better understanding of the project than it did when the earlier wells were drilled.
The World Bank holds much of the debt here at the project level, and is getting paid regularly–they’re happy. This is a long-term cash flow project that is established and even if these wells miss completely, there’s only a 3% annual decline, and the pricing mechanism for electricity allows for a small annual increase.
The debt repayment schedule still gives PIF some Free Cash Flow even at today’s 50 MW production level:
Similar companies in the renewable energy sector currently trade at a forward EBITDA multiple of 11.5. Polaris is a smaller company with less liquid shares which might suggest a more conservative valuation of say 8 times EBITDA.
Putting that multiple onto the projected $55 million of EBITDA for Polaris would suggest an Enterprise Value of $440 million. Back out the net debt of US$131 million and I get a share price (in USD) of $20 versus US$5 today.
So why isn’t the stock closer to that?…likely because (besides basically being a new issue with no research) investors should remember that Interest is a BIG EXPENSE here (debt is half the Enterprise Value) so EBITDA multiple is not likely the best method of valuation.
I think I have accurately outlined the rewards and the risks. This is Murnaghan’s first time as a CEO. This is Downey’s first time as a CFO. But the heavy lifting is over for the pubco side of the play, and
they’ve done a great job. They’ve set the company up to succeed for shareholders. Now the technical team has to do its job.
Polaris is an out-of-the-box idea, unloved by former shareholders. I like that. The Market now knows the first well will NOT be a huge success (10- 14 MW) but rather a muted one (0-6 MW) and has already priced in the mid-range of that muted scenario.
SO HERE IS MY STRATEGY. At this $7/share, I’m willing to own a small position and see what this first well delivers. I think one of the two best strategies for 2016 is to have a list of dividend payers over 6% yield and lots of coverage for their debt–which this company has. Then, on bad days in the Market–and the first week of trading so far says that investors will get a lot of those in 2016–these yields could spike up to 10%, and then I buy the stock.
(There is a second asset here I have chosen to ignore for now, because getting it producing is at least a couple years away and not relevant to the short term share price.)