Although the reported numbers were in the red (due to factors that were known and expected) the quarter was an exceptional one nonetheless as reflected by a 40% increase in the share price.
Electricity prices are booming both on the short and on the long end of the curve. On the short end due to water reservoir levels being low, and on the longer end, which is perhaps more significant, due to rising demand and carbon emission quotas increasing steeply because of an increasing focus on the environment from governments.
The impact of carbon emission quotas on electricity prices
To give an idea of the impact carbon emission quotas have had: Quotas have risen from 7 to 16 EUR since January 1st. For every 1 EUR in quotas the impact on the price of electricity is 90 cent. On a SEK/MWh basis this translates to about 85 SEK of sustained improvement. Given that the forward curve for 2020 indicated a price of 280 SEK/MWh one year ago (when large impairments were taken by Arise!), this now sits at 360 SEK/MWh – a significant boost upwards that is mostly the result of the carbon emission quotas move. The two electricity analysts I’ve been speaking to recently both expect the quotas to go higher still.
The impact on rising e-certificate prices on cash flow
On top of that we have had a boom in the forward prices of e-certificates for 2018-2020 since the start of the year. I’ve created a spread sheet to calculate how much this means in terms of the net present value of the increased cash flows to equity holders when comparing to the outlook at the beginning of the year.
Given that my assumptions on their current hedging percentages are correct (and their slides today indicate it is in the right neighborhood) I estimate the value to be 80 MSEK. To put this in relation to equity and market cap those are 800 MSEK and 580 MSEK.
See the spread sheet here. Admittedly it is a bit messy (did it for myself initially) and so you may need to have looked at the case in some detail for this to make any sense at all.
Why is this important?
Because their debt level at 1,000 MSEK is relatively high in relation to their past cash flows and now that both e-certificate prices AND recently also electricity prices look to contribute much more cash the debt can be reduced at a much faster pace than previously believed which means the stock has started to reprice. This effect is what makes highly levered stocks go bananas, as has been the case for Arise these last few months. Note that the 80 MSEK number is for e-certificates only. Add to that the impact of the rising electricity prices as well as the increased capacity (and increased willingness of potential buyers) for project sales.
The pipeline is more robust than ever
On top of that the pipeline is looking more robust than ever. With projects of 180 MW, 150 MW, 45 MW and 35 MW ready or close to ready to be sold from now and until the end 2019 (potentially providing 1 MSEK/MW on the bottom line). The Kölvallen project, which initially failed to get environmental permissions, is another 150 MW that could potentially be brought online by 2020/2021.
One of few downsides that I see is that the market could get ahead of itself believing that current electricity prices are likely to stay as high as they are now. While I do think we will see much higher prices than we’ve seen in the last 3-4 years the current 550 SEK/MWh (excl e-cert) in the warmest months of the year is perhaps at an extreme – and if not shareholders will have very nice ride going forward!
Another downside is that the forward prices for e-certificate prices are very low from 2021 and onwards due to the construction of the current system. There is some expectation from industry players that this will be fixed to ensure that the long term build out goals will be reached but this is in no way a certain outcome. There is also some chance that institutional players will invest even without the subsidy from e-certificates if the current electricity pricing environment trends continue via support from carbon emission quotas.
Take profits or hold for the longer term?
I am personally retaining a core position for the longer term but I have been reducing my holding by about half this past week. I still see the stock as under valued but not by the same extreme amount as when I last wrote about it in my post of April 30th when the price was 12,30 SEK. I tend to be quite aggressive in my sizing when opportunities like that come along and the risk appear low but the flip side is I am forced to reduce earlier than I would have had my position size been a more standard one.
So I think much of the upside has been realized but that there is still some way to go when having a two year+ time horizon. Given current fundamentals my estimate of fair value two years out is 22-24 SEK per share, equal to 0,9-1,0 of book value (the price is now 17,30 SEK). I arrive at that number partly because I see potential for a reversal of past impairments now that fundamentals have improved and partly because I think the chance of project sale success in the coming two years is high.
I’d appreciate any feedback on what your current view of the stock is and if I have overlooked anything!
I do not accept responsibility for losses that are a result of buy/sell recommendations I make. I encourage you to do your own reserarch before making an investment decision.