Arise Valuation – 50% Target Reached, Now What?

In March I set a 50% year-end price target for the Swedish windpower company Arise and this has now been reached. So is now the time to sell?

In my opinion no. I estimate the risk/reward to be roughly the same as back in March when the price was 12.50 SEK/share (now 19 SEK). Granted, the risk has increased but the upside is also significantly higher now as my calculations further down will show.

And by the way these calculations are based on current market conditions and are not dependent on blue sky scenarios, which would only provide further upside not accounted for here.

The reason for the greater downside is that the price has further to fall in case the electricity market reverts back to the unprecedented slump that plagued it in the period from 2015-2017.

So how have market conditions changed? The basic drivers are:

  • The project sales market is stronger than ever. For the last three years projects were generating 1.0 MSEK/MW of profits or less while recent sales ranged from 1.5 MSEK/MW for a project of average quality to 1.1 MSEK/MW for a project of below average quality. And I expect the hunger from institutional investors to result in increased sales of at least 100 MW per year – and more likely closer to 150 MW per year.
  • Electricity prices are much higher. Short-term in part because of weather conditions (this effect is excluded from my calculations further down) but more importantly due to what I believe is a sustained trend in CO2 emission quotas. The two electricity analysts I have spoken to believe this trend is set to continue because of rising environmental concerns.
  • E-certificate prices have gone up dramaticallyThis impacts years 2018 and until 2020. Post 2021 is more of a question mark but in prior periods politicians have stepped up to secure a system that favors a continuation of the renewable build out.

As a result of the above I estimate EBITDA to more than double within the next couple of years from currently 135 MSEK to 275 MSEK. A word of caution though: Other analysts have much lower estimates in the 160-180 MSEK range. Not exactly sure why but I assume this is due to lack of updating to reflect the new reality.

Let me split up how I arrive at that much higher number:

  1. 40 MSEK additional EBITDA from e-certificates. Here are my calculations for the years 2018-2020 (results in grey cells). Hedges are accounted for. Post 2021 the numbers are currently uncertain.
  2. 40 MSEK additional EBITDA from electricty prices. This is based on current CO2 quotas alone resulting in 140 MSEK/MWh higher prices (15 Euro higher * 0,9 Euro = price). Per 100 MSEK/MWh in price EBITDA increases/decreases by 34 MSEK. Lots of other factors influence electricity prices but most of those are weather dependent, and others are impossible to predict and model out due to their complexity so this and forward curves are all we can rely on in my opinion.
  3. 60 MSEK additional EBITDA from project sales. (100 MW * 1.2 MSEK/MW vs. previously 60 MW * 1.0 MSEK/MW)

The above number is a conservative estimate in my view. I actually think they will sell closer to 150 MW on average per year but I have discounted the number to account for possible permitting/construction problems that may come about. Note though that in its short 10-year history Arise has not encountered construction problems before and only once, with Kölvallen in 2017, have run into permitting problems.

When will the effects kick in?

#1 and #2 have started to kick in but the full effect ought to be evident from the full year 2019. #3 will take effect from late 2019 and onwards and I expect EBITDA to gradually arrive at 275 MSEK for the full year 2020 and be in the range in the yeaers following.

Despite the above mentioned effects starting to kick in from now on my base case for 2018 is only 160 MSEK in EBITDA due to low winds in H1 – and as a kite surfer I know this spring to be an unusually disappointing season! In addition to this project sales that are being delivered this year were sold in 2016/2017 when they had a lower value than those that can be expected going forward.

Valuation and some key metrics

EBITDA 2017: 135 MSEK

Estimated EBITDA going forward: 275 MSEK

Current enterprise value: 1628 MSEK

Estimated EV/EBITDA: 5.92

Price-to-book: 0.82 (Asset-light competitor Eolus Wind: 1.58)

Since 2011 Arise has traded at an EV/EBITDA multiple in the 11-15 range. Companies trading near 5 are often takeover candidates.

As a result of the above estimates I believe the current fair value of Arise to be in the 30 SEK range +/- 5 SEK.

Note that the above is my base case scenario and all of the above numbers are based on current market conditions and prices. Be aware that the volatility has been quite extreme for all three factors historically and that the risk is significant. For that reason I have erred on the side of caution in my estimates, especially when it comes to project sales.

Post Mortem

Let’s say two years from now the above thesis has been proven wrong and the numbers above did not materialize. What killed the case?

  • Project sales volume was lower than expected due to institutional investors finding other ways of deploying their capital at a higher rate of return, perhaps helped by higher interest rates. The realized prices were lower than expected because the energy market went into a slump, perhaps as the result of an abundance of natural gas hitting the market from Russia and the US. Also, the politicians failed to move ahead to squeeze out coal via increased CO2 emission quotas.
  • The E-certificate system that was widely expected to get fixed was not fixed and as a result e-certificate prices post 2021 were too low to attract enough institutional investor resulting in lower sales.
  • Permits for projects were delayed and/or not granted at all which created holes in the pipeline as happened with the Kölvallen-project in 2017.
  • EBITDA Bear Case Scenario: 120 MSEK. If this happens two years out I think the effect on share price will be limited to a downside of approximately 15 SEK per share as debt repayment until then will have decreased the overall risk.

3+ years out:

  • Grid connections are being planned to continential Europe and the UK. This will likely lead to Sweden being able to export electricity generated from wind and solar at higher prices.
  • Arise may divest some or all of their own windfarms down the road. This would bring down debt dramatically and likely result in a repricing as I believe the debt level is the primary drag on the share price. While this is likely to boost the share price short term I am unsure whether it is the optimal move long term as these assets, especially those in the southern part of Sweden, are becoming increasingly valuable in the current pricing environment. Arise CEO have recently stated they believe their wind farms are likely to have a longer lifespan than the 25 years that are reported in the books.

Never time frame forecasts again!

And by the way let me end this post by apologizing for that 50% year-end target I made in March even though it panned out.

I believe all we can comment on is our estimate of fair value and not what the markets will do, especially short term like within nine months, and for that reason I will refrain from commenting on that going forward. I never do this in written form but on video it slipped out in a moment of uncertainty and regretably I didn’t bother with the editing.

Disclaimer: 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. I own shares in Arise.

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