Arise Windpower – a Quantitative Analysis (Part 2)

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)

In terms of free cash flows my estimates for a normal year are as follows – based on previous years and based on a price of 650 SEK/MWh:
Screen Shot 2014-12-28 at 23.03.22

– 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.

10 thoughts on “Arise Windpower – a Quantitative Analysis (Part 2)

  1. Thanks for the analysis, very interesting. Maybe you have some thoughts on these questions

    Are there no price hedges after 2015? I find that worrying since Arise enjoyed prices well above spot in recent years. And I assume that’s because of successful price hedging? Or can you see another reason why they received well higher then spot prices on both Electricity prices and e-certificate prices?

    I would say the succes or not in this investment lies in the development of prices to a larger extend then in the hands of the company (of course that is important as well)

    Again thanks for the work
    // Fredrik

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    1. Hi Fredrik, thanks for your comment. Yes, Arise has been skillfull/lucky when it comes to price hedging in recent years. And they have hedged much less from 2016 and onwards. You can see the 2016 price hedges here: (see page 10: http://arise.se/sites/default/files/cmd/arise_capital_market_day_october_9th.pdf ). As you can see it is mostly for the co-owned Jädraås wind park and almost none for the wholy owned. I see that is a good thing as I believe the odds of higher prices in 2016 are good. But yes, it does provide some risk.

      And yes, I think you are right. Electricity prices is the all important aspect of the succes of this investment. Prices right now are very low compared to historical averages and I personally believe in reversion ot the mean and that prices will go higher. But that is not a given at all. It could take many years, we will see. They will have positive cash flow all the way down to around 430 SEK/MWh though.

      Apart from prices, project sales will be very interesting to follow. It seems to me as if the market is giving zero value to this. If Arise is able to sell 75 MW per year as is their plan, the bottom line after tax from this alone will be SEK 35 mio. And then there may be management deals on top of this.

      It isn’t a risk free investment, but I like the overall odds as I see them. Perhaps I am missing something that the market is seeing though.

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  2. Excellent with link and even page number 🙂 thank you.

    I must say that it’s risky to say what “low” elspot prices are. between 2000-2005 there is actuallly just one year with higher prices then the low prices of 2014
    http://www.nordpoolspot.com/Market-data1/Elspot/Area-Prices/ALL1/Yearly/?view=table

    I also think it’s a good buy at 0,5P/B, don’t get me wrong. I’m just trying to see the risks. And I agree the Green party should be helpful even though I don’t like to be dependent on politic decisions.. But with positive cashflow I guess it’s just a waiting game for elspot to rise and with it share price.

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    1. Thanks, Mads. As always there are pros and cons. Overall, I am very bullish though.

      The cons: Since the article electricity prices have come down more than I expected – so violently, in fact, that the owners of four nuclear reactors (13% of the total Swedish capacity) has decided to shut down them down before 2020.
      Write-downs can be the result if prices don’t come up. However, with capacity being taken out while there is very little investment going on in other energy sources I think price increase is very likely. Hydro levels have been extreme in 2015 so this has been part of the reason for the low prices.
      If you believe electricity prices will remain subdued – or go even lower, Arise will not be immune to a further decline even if it is priced very cheaply currently (P/B = 0,46). The cash flow break even point is around 400 SEK (elspot + e-certificate) so if prices fall below that for an extended period of more than two years the company could be in trouble if they don’t sell projects at decent prices on the side to cover it. A highly unlikely scenario in my opinion.

      The pros:
      – As expected the politicians recently decided to raise e-certficate quotas and this will almost certainly lead to higher e-certificate prices in the short to mid term. After 2020 is another story. There is increasing political pressure for the e-certificate system to be dismantled after 2020. If that happens there is a counter: landbased wind has now become the cheapest source of energy, so investment in the sector is likely to continue longer term.
      I think the decision will result in more investments in the sector.
      – Price. Arise has closed deals resulting in profits of about 100 mio SEK on a 12 month rolling basis (and all of them were closed at above book value). Market cap is 560 mio SEK.

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  3. Thanks, illuminating!

    I personally think elspot prices are going to stay depressed, with the low marginal cost of wind and the problem of cogeneration (many farms producing at the same time). Better links to high-price areas can help, but that might be a temporary measure too. So I think it’s down to a question of subsidies.

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    1. Thanks for the comments, Ole. You bring up some great points. Cogeneration is indeed the curse of weather dependant electricity production and it has an especially harsh effect on prices when there is over capacity which was the case in 2015 mainly due to hydro power producing about 30% more than the mean due to an abnormally wet season. But cogeneration would be the major reason I probably would not hold this stock if it was priced above price-to-book of 1,0 unless electricity prices were extremely elevated.

      Are the current low prices here to stay? Perhaps. But there is one thing working in favor of wind and that is that onshore wind power has become the cheapest way to produce energy. In a depressed environment it is the higher cost producers that get knocked out first. And we may see a movement in that direction. 4 out of 10 nuclear power plants will be removed by 2020. One of those has already been taken out and the owners of the rest are currently debating shutting down all 10 prematurely due to taxes and continuing low prices making production unsustainable. Also, hydro power is threatened by low maintainance which could potentially reduce capacity there as well – again due to the pricing environment. So that is the beauty of being the lowest cost producer in a supply/demand world. I actually see the main threat from offshore wind, an area Arise has not entered into.

      The problems here and now are very real but there is also the question of valuation. Arise has succeeded in selling off assets at prices above book value, even quite recently. Still their assets are valued at Price-to-book of 0,5 (while competitor Eolus is valued at 0,75 – less debt, but still a huge gap that doesn’t make much sense).

      Added to that, the market may not fully realize that about 30% of their production is hedged at very reasonable prices in the 630-640 SEK/MWh range for the next three years (elspot+e-certificate). This means Arise is able to buy time when others are suffering more – increasing the chance of more capacity being knocked out before Arise potentially would get into trouble – and with a current cash position above 200 million and a conservative approach that seems unlikely to me.

      I see offshore wind as the biggest threat out there. Especially if this sector is granted special subsidies higher than those granted to onshore wind and solar because all of a sudden that segment would become a very serious tor.

      That got a bit longwinded, sorry about that 🙂 Do you invest in the energy sector yourself?

      Like

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