Back in October I wrote a qualitative analysis on Arise Windpower (https://hammerinvesting.wordpress.com/2014/10/09/arise-windpower-traded-at-a-historically-large-discount-part-1/) – before reading this quantitative follow-up I recommend that you read part 1 first.
I have been hesitant making calls on future electricity prices due to political uncertainty regarding a possible re-election. Since it has now been cleared up that there will be no re-election I feel somewhat more comfortable making these estimates. However, it is important to realize that there still is a lot of uncertainty in the assumptions below.
Since October, there has been some interesting developments:
1) A project with a capacity of 46 MW was sold to BlackRock, one of the largest money managers in the world. The company will receive a healthy profit of SEK 46 million as well as management fees going forward.
2) Due to the current low electricity prices the company has decided to reduce risk by selling three wind parks with a total capacity of 25 MW (total portfolio is 266 MW). They expect to sell these wind parks at prices above book value. On December 3rd the first of those were sold at a price that was 15% above book value. It was the small Stjärnarp wind park with a capacity of 5,4 MW which was sold for SEK 83 million and which had a book value of SEK 72 million (cost 75 million, depreciation 3 million).
Projects sold above book value, while the stock is traded at a 48% discount
The above sales show that even in the current challenging environment where electricity prices are at historically low levels, customers are willing to buy at prices that are above book value. This is not reflected in the current stock price, which is selling at a 48% discount to book value. After these sales the risk in the stock has been reduced significantly and the upside ought to be apparent for investors.
Let’s now take a closer look at the net present value of future cash flows and convert the number to price per share. Below are my assumptions.
Discounted cash flow analysis – assumptions:
– The previous expansion strategy has been put on hold due to lower electricity prices and therefore I will assume no building of new farms. This means Arise will rely on the cash flows generated from existing wind farms as well as projects sold to external parties. Should total energy prices rise to above 700 SEK/MWh it can be expected Arise will again look into expansion. This is an added upside but also one that is impossible to quantify, and so for this analysis I will focus on the current strategy only.
– Arise has sold 5,4 MW recently and aims to sell 20 MW more at a price above book value. This will lower debt from SEK 1,6 billion to around SEK 1,2 billion. Whether or not these sales will materialize, it will not affect the intrinsic value of Arise Windpower by much. It might be slightly higher if these sales do not materialize, however, the investment will also be somewhat riskier.
– Yearly average production: 715 GWh (current) – 87 GWh (sale of 25 MW) = 628 GWh after sale of 25 MW.
– Life span of a wind farm is 25 years. E-certificates are received for 15 of those years. On average Arise’s total wind farm capacity has been in operation for 3 years. That means on average they have 12 years left to receive E-certificates. For the remaining 10 years only elspot prices will be collected.
– For 2015 we already know Arise will receive around 600 MSEK/MWh due to forward price hedging. Very little is hedged after 2015.
– From 2016 and onwards I make the following assumptions as to prices and the likelihood of them occurring:
Scenario 1: Total elspot + E-certificate prices from 2016 and onwards: 450 MSEK/MWh. 2% price increase per year. Probability: 15% (No e-certificate hike + prolonged lower e-spot prices)
Scenario 2: Total elspot + E-certificate prices from 2016 and onwards: 650 MSEK/MWh. 2% price increase per year. Probability: 60% (normalized e-certificate prices + slightly higher e-spot prices but still below historical average)
Scenario 3: Total elspot + E-certificate prices from 2016 and onwards: 800 MSEK/MWh. 2% price increase per year. Probability: 25% (global recovery above expectations)
– On top of revenue from own wind farms Arise expects project sales of 75 MW on average per year. After the BlackRock deal this seems a reasonable assumption. Total profit after tax for those sales is estimated to be SEK 35 million. Added to that approximately SEK 5 million in management fees per year per project. We don’t know for sure whether Arise will succeed in making these project sales, but due to the recent sales I estimate there is a 75% chance of this happening – so for the numbers I have discounted with this factor.
Given an 8% discount rate, I have calculated the intrinsic value per share to be as follows:
Scenario 1: 13,60
Scenario 2: 31,50
Scenario 3: 44,20
Weighing the different outcomes I arrive at the following numbers:
Intrinsic value: 13,6 x 0,15 + 31,5 x 0,60 + 44,2 x 0,25 = SEK 32,00 per share
The current share price is 16,90. And the current book value per share is 34,90. In other words, the above estimate is still below book value. Considering what recent customers have been willing to pay for Arise’s wind farms it is possible my guesstimates are too conservative. I’d be interested in hearing yours.
Note that when it comes to discounted cash flows it is a case of garbage in, garbage out. And since there is a lot of uncertainty in almost all of these numbers, take it for what it is: Lots of guesses as to possible future outcomes.