Category Archives: Company analysis

Wilhelm Wilhelmsen Holding, the Bear Case

In my first post on W. Wilhelmsen Holding published yesterday,, it was established that the stock is exceptionally cheap right now, based on both Price/Book and Price/Earnings.

Why is it cheap? The Bear Case
This question ought to be the main focus when we dig into the fundamentals of a company, which on the surface appears to be especially cheap. There is always the risk that it is a value trap and that the market knows about things that we don’t. As we slowly peel the onion that is the company and get closer to the core of it, reasons will start to appear. The main question is if those reasons are rational or not.

So far I have spotted the following possible reasons:

  • Antitrust investigations
  • Uncertainty about contract renewal
  • Fear of increase in local car production?
  • Conglomerate discount
  • Shipping market discount
  • Norwegian market discount (following the current oil crash)
  • The founding family controls more than 50%
  • Dividend payout ratio is low (12%)
  • No share buyback
  • Cyclical, low liquidity, boring

Let’s look at those one by one.

Antitrust investigations
WWASA and three Japanese competitors are all being investigated for price fixing from 2008-2012. The investigation started in the fall of 2013 and has already led to fines from Japanese authorities. Two Japanese competitors have also been fined by US authorities and it is expected that WWASA will be fined as well. It is also expected that the EU, Canada, Mexico and Chile will seek to fine the major of players in the industry. This creates uncertainty in the market. But it can also be a source of opportunity and lead to mispricings if that fear is irrationally overblown. WWASA expects a clearer overall picture on this issue during 2015.

Having spoken to analysts who have followed the process more closely, the expectation is that the total fines for WWASA will be in the USD 100-120 million range, and USD 200 million being a worst case scenario, in their opinion. Translating those numbers to the balance sheet of the holding company means a reduction of between USD 70-140 million in equity. If that turns out to be the case the effect will be in the 0,02-0,03 range in terms of Price/Book, ie. it will jump from 0,49 to 0,51/0,52 – still a far cry from P/B 0,84 of 2013 and 2012. In other words, while a serious matter, this alone cannot be the reason for the heavy discount – if we suppose investors are rational.

The liquidity position of WWASA is solid enough to counter fines of this size. On top of that WWASA has a 12,5% share in the logistics company Hyundai Glovis, and that share is currently worth approximately USD 1 billion. So if things get tough, they can sell a portion of that.

Uncertainty about contract renewal
Eukor, which is 40% owned by WWASA, has a contract renegotiation with Hyundai and Kia coming up in 2016. Eukor currently transports 60% of Hyundai’s and Kia’s exports and there is uncertainty whether this will continue or whether it will drop into the 50% or 40% range. WWASA has stated that they expect volumes to remain the same. Perhaps the market views this as overly optimistic.

Fear of increase in local car production?
I have not been able to find information on whether there is a trend in this direction currently. But if it is indeed the case, or if it happened in the future, it would result in a smaller market, so it is a potential threat to keep in mind and to look out for.

Conglomerate discount
There has always been a discount compared to a sum-of-parts valuation in WWI. As I wrote in the first part of this analysis, I don’t completely agree with it, but it will probably stay that way in the foreseeable future. Should the company decide to spin off some of their holdings, this will come down and the share price will go up.

Another reason for the discount might be a very simple one. Both WWI and WWASA consist of a myriad of companies and joint ventures, which makes it harder and more time consuming to analyze. Perhaps many potential investors stay away for that reason. However, none of those two reasons address the increasing discount gap.

The general shipping industry has been hit hard
The Baltic Dry index, which measures the transport activity of commodities by sea, is at an all time low – due to a combination of overcapacity and declining demand. As a result of that many players in the shipping industry are struggling. However, WWI’s main operations are in the car carrier and high & heavy markets, which are both unrelated to Baltic Dry. The revenues for the Ship Service part of the group has declined slightly – but profits are up and EBIT-margin a healthy 10%. However, these numbers are relatively small compared to the overall numbers for the group.

You could argue that if the market is viewed to be in a slump now and the current P/E is at 3,4 what happens to the share price once profits start to really take off?

Norwegian market discount
Norway is to a very large extent synonymous with the oil and shipping industries. As both have witnessed brutal declines recently some investors in the region may have withdrawn funds from the overall stock market out of fear regardless of the industry that the individual companies are in. A lot of stocks on the Oslo stock Exchange are traded at historically cheap prices. For some the fear is warranted, for other much less so. I believe the latter to be the case for WWI.

The founding family controls more than 50%
Some investors don’t like to be at the mercy of one group controlling 50%+ of the outstanding shares. However, it is very well documented that founding families tend to be more focused on long term value creation than your average CEO. And generally speaking, you get rewarded handsomely for owning shares in family owned businesses. However, there is also another side to this story and that is that the company (Tallyman), which controls the majority of shares in WWI, is owned by about 15 family members, I am told (as a side note, many of those are on this list of Norway’s richest people, among them the group CEO, Thomas Wilhelmsen: What happens if there are disagreements with regards to the overall strategy within that group. Can it hamper decisive action?

Low dividend payout ratio
WWI is expected to pay out NOK 3 to shareholders in May and NOK 2 in November, this equates to only 12% of earnings (3,3% dividend yield). Compare that to the more normal 50% payout ratio of other companies. I think this is one reason why WWI is usually cheap compared to its earnings power. In the current low interest environment the market is hungry for dividend yield so I have no doubt the share price would explode if the company suddenly decided to payout 50% of its profits. Very unlikely to happen though. The company does not strike me as one that changes its strategies to satisfy the market.

No share buybacks
If the primary aim of a company is to increase shareholder value one expects that company to invest its profits in ways that maximizes the return. New capex investments might be expected to produce a return on investment in the 10-15% range. However, there is another low hanging fruit waiting to be grapped now that the company’s asset are for sale at only 49 cents on the dollar and that is to buy back its own stocks. If Price/Book were to increase to the more normal (but still cheap) levels of 2012 and 2013 the stock would increase by about 70% in value. That seems like a no brainer investment to make. And personally, I would much rather see this happen than increased dividends.

I don’t believe it will happen though. The company has no history of doing so and it may prefer an organic growth strategy. If that is the case, perhaps the stock market is punishing the company for preferring empire building rather than shareholder maximizing initiatives.

Cyclical, low liquidity, boring
I don’t care in what shape or form they present themselves but I like value propositions. Paying much less than the expected value of an asset is all that interests me. But many investor groups need an investment to fit into a certain box in order for them to invest and in many ways WWI doesn’t fit the bill.

Dividend investors tend to be defensive and shy away from businesses that are cyclical in nature, which WWI certainly is.

Institutional investors want a minimum of liquidity otherwise their very buying and selling will move the price too much to be worth it for them. On many days the volume in WWI is less NOK 1 million, which is surprising for a company of this size.

Gamblers want bigger day-to-day movement than WWI provides, being in a mature business segment and with a low gearing ratio and solid balance sheet. The later also scares away growth oriented investors.

Personally, I am indifferent to those reasons. I just want the gap between price and value to be huge. I also don’t mind volatility from year to year as long as value is created and compounded over time.

Bear Case conclusions
Of the above mentioned 10 possible reasons for the discount, I believe the first three are somewhat rational. I am the most uncomfortable with the second and third reasons as I find those the hardest to assess both in terms of the likelihood of them occurring as well as the possible impact they can have. The rest are not really rational in my book.

I hope there are skeptical investors out there  who would like to share their thoughts if they have found holes in my analysis or have additional information or questions/thoughts to bring to the table.

You can read the third and final part, the Bull Case, here:

Wilhelm Wilhelmsen Holding – Quality at Bargain Prices?

Everyone and their neighbor has been participating in a mad rush to buy quality companies (earnings wise) for the past year or so. This has led to bloated, pumped up prices and I want no part in that race even though the participants have been rewarded nicely – so far. Value investors typically look a little dumb in the latter stages of bull markets, but Seth Klarman and the like often remain with their clothes on unlike many others investors a couple of years later. As I have said repeatedly in my blog: Quality is not a safe haven. Price is king when it comes to evaluating risk, not quality. But, if I can have it both ways, I am open to suggestions!

I might just have stumbled upon such a company: Wilhelm Wilhelmsen Holding, listed on the Oslo Stock Exchange, stock ticker WWI. It has in fact been on my radar for some time I just hadn’t gone down and dirty with analyzing it due to its complexity which meant it would be a time consuming exercise if nothing came up. Below is a diagram of its structure:

WWI overview

The 25% drop in share price since July has triggered my curiosity and I thought it would be an excellent time to take a closer look and dig into whether the drop was warranted or whether it has provided an opportunity for investors. Especially since the share prices of the three main competitors have gone up in the same period of time, indicating a low probability that it is the future prospects of the market they are in that is at fault.

Wilhelm Wilhelmsen Holding, WWI, has an immaculate value creation record since 1861. In the last 15 years WWI has returned 12% annually (semi-annual dividends + increase in share price) to their shareholders, which equates to 4,5x their money, beating the general market by a wide margin.

The company’s biggest asset is the daughter company WWASA (to the left in the diagram above), of which it owns 72,73%. The company’s primary market is transportation of cars and so called “high & heavy” equipment (mainly mining and agricultural machinery) by sea. They also have a lot of subsidiaries and joint ventures in related markets. In other words, it is a conglomerate, and investors typically crave discounts for those. However, unlike many other conglomerates WWI’s businesses intertwine creating synergies, so perhaps it would be more appropriate to award a premium to the share price instead. This probably won’t happen any time soon. However, it is my belief that the current discount will come down as it is rather large.

Key valuation figures, WWI (holding company)

Today 2014 2013 2012
Price/Earnings 3,4 4,2 5,9 4,1
Price/Book 0,49 0,55 0,84 0,83
Solvency ratio 48% 48% 46% 42%

Key valuation figures, WWASA (daughter company)

Today 2014 2013 2012
Price/Earnings 7,3 8,2 7,6 4,9
Price/Book 0,80 0,79 1,22 0,77
Solvency ratio 51% 51% 48% 45%

At the time of this analysis the price for WWI was NOK 149,50 (for the B share, the A share was slightly higher at 150,50 – if I was buying, I’d buy whichever is cheaper on the day). Price/Earnings is extremely low at 3,43 based on 2014 numbers and the company guides for 2015 to be similar to 2014. Price-to-Book is at 0,49, down considerably from 0,84 in 2013. Curiously, in the heyday year of 2007 Price/Book was at 2,2 (4,5 times higher than today).

These first two numbers generally don’t go together. Either you have excellent earnings and pay a high price-to-book for it, or you have poor or negative earnings prospects and are compensated by getting what is on the balance sheet at a discount.

What’s the catch?
Why both? What are the dangers lingering out there in the horizon? Well, according to my analysis there are a few but in my opinion they are relatively minor in proportion to the heavy discounts the market is providing.

  • Antitrust investigations
  • Uncertainty about contract renewal
  • Fear of increase in local car production?
  • Conglomerate discount
  • Shipping market discount
  • Norwegian market discount (following the current oil crash)
  • The founding family controls more than 50%
  • Dividend payout ratio is low (12%)
  • No share buyback
  • Cyclical, low liquidity, boring

Follow-up post
In my next post, I will take a closer look at each of those bear case arguments and following that I will then proceed to the bull case arguments:

Arise Windpower – a Quantitative Analysis (Part 2)

Back in October I wrote a qualitative analysis on Arise Windpower ( – 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.

Polarcus – a Short Analysis

P/B: 0,17. Equity ratio: 40%. 2013 P/E: 2. An unlikely combination and too good to be true?

Polarcus is a company that trades on the Oslo Stock Exchange. It is in the seismic industry supplying oil companies with geophysical maps of the underground to aid their search for oil. To do this Polarcus has a fleet of specialized ships with streamers attached that pick up the data like in the illustration below.


The industry is dependent on the Exploration & Production budgets of oil companies. Those have been hit hard recently by a combination of shareholders wanting to cut costs and return more to shareholders via dividends – as well as the decline in the oil price. As a result almost all seismic stocks have taken a hit – and in the case of Polarcus to an extreme degree: 78% down since the beginning of the year.

Price-to-Book, Nov 18th
()=May 30th
Stock performance
since Jan 1st
Polarcus 0,17 (0,60) -78%
Dolphin 0,77 (1,34) -32%
PGS 0,77 (1,15) -39%
TGS 2,36 (2,50) 11%

I believe the extreme differences in those numbers relate to the market’s view of the riskiness of their balance sheets. Polarcus has the newest fleet in the industry and thus has higher leverage while TGS is an asset-light company in that they don’t own any ships.

A closer look at the balance sheet

Currently you can buy shares in the company for 0,99 NOK while the Price-to-Book value is 5,72 NOK per share. This is insanely cheap and indicates that the market believes there is an imminent risk of Polarcus going bankrupt or in need of large injections of cash. If this risk is low and Polarcus survives the current downturn in the industry the upside potential is very large, possibly in the 200-400% range. The stock traded in that range only five months ago.

When analyzing the balance sheet we see that the loan-to-book ratio is 55%. For a bank that would seem a safe loan. Now there are market participants, Fearnley Fonds among others, who argue that as there are no buyers of ships in the current market this ratio is irrelevant. I personally don’t understand this logic. 1) You want to look at the whole business cycle and not just at a moment in time when the market is depressed. 2) With a margin of safety of 55% loan-to-book ratio would the banks not want to extend the loans if Polarcus’ cash position gets into troubling territory? I would think so.

Debt Service Ratio-terms

There is also another aspect of the financing that needs a closer look and that is the Debt Service Ratio-terms that Polarcus has agreed with the banks. In 2014 Polarcus has been in breach of covenant twice and this has resulted in some minor fines of USD 15,000 so it hasn’t been a big issue in the past. However, it is never nice to be dependent on the good will of banks as that can change. With a loan-to-book ratio of 55% it does seem to me that the banks have an interest in keeping the relationship afloat though.

The DSR is defined as EBIDTA/debt service (ie. interest+loan repayment). For Q4 this is 1,6x, Q2 2015: 1,75x and Q4 2015: 2,0x. The debt service on Polarcus’ books are at USD 86 million on a 12-month rolling basis and so for Q4 the EBIDTA needs to be above:

Q4 2014: 86 x 1,60 = USD 138 million on a 12-month rolling basis

Q2 2015: 86 x 1,75 = USD 150 million on a 12-month rolling basis

Q4 2015: 86 x 2,00 = USD 172 million on a 12-month rolling basis

EBIDTA for recent quarters have been as follows:

Q1 2014: USD 40 million

Q2 2014: USD 50 million

Q3 2014: USD 43 million

Q4 2014: ? – probably below USD 20 million given company guidance (lots of multiclient work this quarter)

Note that on Oct 6th Polarcus launched an equity private placement where they secured USD 35 million – probably pushed through by the banks in exchange for better DSR terms. In the DSR agreement the proceeds counts as EBIDTA. Therefore Q4 is no problem in this respect. Fearnley Fonds, who have been selling the stock heavily for the last 30 days, have argued that there is risk of covenant breach in Q2. To me that seems very unlikely. For that to happen the three quarters of Q4, Q1 and Q2 combined would have to be below: 150-35-43 = USD 72 million, which translate into an average of only USD 24 million per quarter and the company has already secured a large backlog for the coming quarters. For Q4 of 2015 it will be trickier. And if the current market conditions persist for much longer I think a breach of covenant is likely in Q4. The question is how much it matters. That we don’t know. So far there have been no serious consequences.

Here is Polarcus’ backlog as of mid November (the numbers in parenthesis are for the same time last year):

USD 325 million (USD 150 million) backlog:

Booked capacity Q4 2014: 100% (75%)

Booked capacity Q1 2015: 70% (30%)

Booked capacity Q2 2015: 45% (20%)

Booked capacity Q3 2015: 50%   (?)

Booked capacity Q4 2015: 25%   (?)

It is worth noting that the CEO has said that Polarcus has been aggressive in their price bidding recently. But now, given the record high backlog, it would seem to me that to fill the rest of the backlog they don’t need to be as aggressive going forward possibly resulting in higher margins.

Future earnings and conclusion

So far I haven’t even touched on what drives stock prices: earnings and cash flows. While very impressive in 2013 they are much less so for 2014. The bottom line will probably result in a small deficit. The free cash flow will be positive though – for the first 9 months it was at USD 18 million adjusted for changes in working capital (market cap USD 98 million) – and after loan repayment and interest.

2015 will no doubt be a challenging year with regards to earnings. But if Polarcus can get through the current depression in the market reasonably intact, the 2013 results showed that the company has fine earnings potential.

As I believe the market is being too pessimistic with regards to Polarcus’ financial health and is giving too good a price for me to pass up, I have chosen to invest in the company. I do not recommend for others to do so if they are risk averse, however. And for those who do, a bet on the smaller side might be a wise option. In other words: don’t risk the house on Polarcus – it could come crumbling down!

Arise Windpower – Traded at a Historically Large Discount, part 1

(Note to the reader: What follows is an analysis of Arise Windpower. Part 1 will contain a qualitative analysis – the why without a lot of numbers, while part 2 will focus more on the quantitative aspects of the case, ie. the numbers in the annual reports, discounted cash flows, etc. If it is too long winded for you there is a summary at the bottom of the page.)

As an investor I am always on the lookout for stocks that are traded at a discount to their intrinsic value. Bargains in other words. Those have become harder to find in the current market where optimism is running rampant and stocks have risen sharply the last five years in spite of a rather bleak world economy. So I have started looking in depressed sectors out of the spotlight of most investors. One such sector is the wind power industry in Sweden. This sector has been hit by low electricity prices the last few years as can be seen here:

2008 2009 2010 2011 2012 2013 2014
Elspot SEK/MWh 491 392 542 378 280 340 320
E-certificates SEK/MWh ? 317 255 187 167 196 180
Total SEK/MWh 709 797 565 447 536 500

The bolded numbers, Total SEK/MWh, are what renewable energy producers (such as wind power producers) receive per MWh and the Elspot prices are what conventional energy sources (such as nuclear power producers) receive per MWh. The prices change every day, so these are averages.

These are unsustainable levels if Sweden is to renew its energy base since very few producers of energy are willing to make the necessary investments in the sector at these prices since they are all bleeding money (except those that have hedged prices in advance when times were better, ie. 2009 and 2010). As a consequence stock prices in the sector have been hit hard since the summer of 2011. Some perhaps way too hard. I believe Arise Windpower, listed on Swedish Stock Exchange in the small cap category, is such a case. Below we can see the development of the Price to Book Value from 2010 when Arise was listed on the Stock Exchange to today, October 9th 2014.

2010 2011 2012 2013 2014
Equity per Share 38,99 37,18 34,46 37,09 34,91
Share Price (yearly average) 48,80 39,70 31,40 24,30 17,20 (cur)
Price to Book Value 1,25 1,07 0,91 0,66 0,49

At the time of writing, Oct 9th 2014, the share price was 17,20. 

“For the price of 49 SEK you are currently getting 100 SEK of value”

The market cap of the company is currently priced at 585 mio. SEK while the book value of equity is at 1,167 mio. SEK. Discounts this large are not unusual for companies in declining industries where the company shows deficits year after year slowly (or in some cases, quickly!) depleting its assets. However, Arise has actually shown a combined profit in the tough years from 2011 to 2013 of 60 mio. SEK. And the cash flows from operations are approximately +200 mio. SEK per year. This is mainly due to successful hedging of prices though and not results that can be expected longer term if electricity prices remain subdued at current levels for the long run.

So what gives? Well, before I get into possible reasons for the large discounts (and whether I think the heavy discount is warranted), let’s take a look at what Arise Windpower actually does…

Arise Windpower’s business model
This is their own brief description of their business model found on their website, “Arise is a leading player in the Swedish wind power market. The company’s business idea is to operate as an integrated wind power company managing all stages of the value chain, from project development to sale of green electricity from company-owned onshore wind turbines. Arise´s target is to have completed construction of and manage 1,000 MW of onshore wind power by 2017, of which 500 MW is owned by the company.”

At present wind farms in operation are at 368 MW (of which 102 MW are co-owned), which is quite far from their 2017 goal. The original goal for 2014, set back in 2009 when electricity prices were significantly higher, was to have 700 MW in operation. However, new investment decisions were put on hold because of market conditions. When prices rise above 600 SEK/MWh the company has stated that the expansion plans will resume.

The developments in the energy sector in recent years and the political situation
As of 2013 the total electricity production in Sweden was 150 Terawatt hours (TWh). The power sources were as follows:
Nuclear power 42%
Hydro power 41%
Wind power 7% (9,9 TWh)
Other energy sources 10%

In only a few years wind power production has gone up quite dramatically from 2% to 7% of the total national production. This is due to decisions by the political establishment relying less on nuclear energy and instead shifting more towards renewable energy. The E-certificate system is the instrument the politicians have available to make investments in the sector more attractive.

In February 2014 the Swedish Energy Agency put forth a recommendation for the adjustment of the E-certificate system which would result in higher prices if an agreement is made among the parties in the Swedish Parliament. A decision will be made in 2015. There is usually agreement across the aisle to follow recommendations of the Swedish Energy Agency.

Since the Social Democratic Party and the Green Party came to power the pace toward renewable energy has become even more pronounced. Before the election last month Sweden’s stated goal was to reach 25 TWh from renewable energy (currently at 18 TWh) by 2020. Now the left leaning government has raised the bar and proposed a new goal of 30 TWh by 2020.

Nuclear power
At the same time there are proposals from the government for extra taxes on nuclear power making a shut down of one or two nuclear reactors (of a total of ten) within the next four years a possible outcome. This would increase the spot prices of electricity as there will be less supply.

There are lots of ifs and buts in the discussions so the overall picture is not entirely clear. The right wing parties, along with many industry associations, are sceptical of the pace of which the new government wants to phase out nuclear energy. They fear unstable energy supply and higher prices.

One key question is whether the Green Party can survive as a party and as a member of the government unless they get a win in this, for them, major issue. Before the election they promised voters that at least two nuclear reactors would be shut down if they came to power. Having followed the debate quite closely (from the outside, admittedly), it looks to me like an almost certainty that the E-certificate prices will be raised, possibly by double what it is now (ie. in the 350 SEK/MWh range) as a few independant energy experts have called for. Perhaps the right wing would accept this in exchange for a slower phasing out of the nuclear reactors than what has been proposed.

Being comfortable with uncertainty
A lot of guesstimates and uncertainty here but isn’t that what always comes along with the investment territory? Being comfortable with uncertainty and being able to perform unbiased, coolheaded calculations of different scenarios is what investing is all about after all. Perhaps the best sources of opportunities lie in the fact that most would rather steer clear of uncertainty even when the odds are stacked in their favor?

Back to Arise
Now let’s get back to Arise and the possible implications for the share price for each scenario.
I first became aware of Arise back in May of this year when I learned that Peter Gyllenhammar had bought a stake worth 13 million SEK in the company. I had read a great deal about him in the book Free Capital by Guy Thomas and he is someone who likes to go for deep value (there is an excellent portrait of him in Swedish by a fellow blogger here:

However, I never got down and dirty with the annual reports figuring it would take too much time to really figure out the inner workings of this complex industry to be worth my while. Since then the Arise stock has plummeted a whopping 35% from 26,00 to now 17,20. I started reading more about the company in September when the price was around 18,50. At the time it looked like a certainty that the red/green side would win the election which would possibly be giving tailwind to the wind power industry and so I started digging for reasons that stock had tanked so heavily.

So far I have not found anything that could justify shaving off 285 mio. SEK from the market cap. Sure, the numbers in Q2 were a bit worse than expected mainly due to less wind in the quarter and the refinancing of loans might have been a tad more expensive than the market expected but again we are talking very small numbers in comparison to the dive.

No change in long term story
From my perspective the long term story has not changed in any significant way and so the 35% dive seems unjustified. After all, electricity is not a product that is ever unsellable. You don’t need a marketing department, and once wind turbines are erected there is little capex maintainance. So there is a certain safety attached to the investment.

The only major issue that I can see is the uncertainty of the price of electricity and while this is a huge one, and one that fluctuates quite wildly, electricity is tied to the survival of the nation. A bit like the too big to fail banking sector in 2008. If prices dip even further the long term supply of electricity is threatened. So when investments in the sector start to dry up, I believe the politicians will wake up and press a few buttons in order to make investments attractive again.

A few numbers
First, let’s take a look at the downside. I tend to focus on potential catastrophes first. Preservation of capital is vital in the long run and much more important than chasing that extra percentage here and there.

According to my calculations, the point at which cash flow from operations goes in the red occurs when the total price (elspot + E-certificates) falls below 400 SEK/MWh. Net income would be -100 mio. SEK. Even two years like that would spell trouble when it comes to refinancing their loans. Arise might have to liquidate some of their assets at discounts that are larger than the current price indicates. For that to happen two things would have to occur simultaneously. 1) No political agreement is reached on adjustments of the E-certificate system and 2) the economy enters into a recession. The chances of both happening at the same time is extremely low in my opinion.

The point at which Arise net income goes in the red occurs when prices are below 570 SEK/MWh. Still cash flow from operations would be +100 mio. SEK. Due to Arise’s current price hedges 2014 and possibly 2015 look like years in that price range. Not great years at all, and not ones that make Arise overly attractive as an investment. The reason to enter would be because of what, in my opinion, is almost bound to happen from 2016 and beyond.

Political decision in 2015
Parliament will have made energy decisions reaching well ahead into the future in 2015 and the new adjusted E-certificate prices will come into play from 2016 and onwards. I don’t see the combined prices falling below 650 SEK/MWh as that could jeopardize the overall investment plans. And it is quite possible that prices will be a lot higher than that. At 650 SEK/MWh cash flow from operations will be 140 mio. SEK and profit after tax around 40 mio. SEK. At 800 SEK/MWh cash flow from operations will be 220 mio. SEK and profit after tax around 120 mio. SEK.

I will dive deeper into the numbers from the reports and perform a cash flow analysis in part 2. I expect to post it shortly (probably within a week or two after the Q3 report).


The Bull Case
Significantly higher E-certificate prices on the horizon according to experts. Judging from the political debate it seems almost a done deal across the aisle. Arise, with its portfolio of projects, is well positioned for a quick expansion plan if this was to occur.

– It is difficult to imagine the price of electricity fall below what it is now if Sweden is to reach its long term renewable energy goals. Investments in the sector has come to a halt as a consequence. This cannot go on for much longer and judging from the political debates it won’t.
– 100 SEK of book value is currently selling at 49 SEK. This is historically low. If Price to Book increased modestly from 0,49 to 0,70 as is more normal in the sector currently, the Arise share price would be in the 25,00 area – an increase of 45%. If electricity prices were to rise to average levels a share price around book value seems within reach, which would double the price from current levels. The long term potential is much higher.
Insiders are buying. The CEO bought 60,000 shares (amounting to 1 mio. SEK) in September around the time of the election. Board member Peter Gyllenhammar added to his 500,000 shares position by buying another 250,000 shares on Oct. 2nd (4,3 mio. SEK).
– Will the Green Party survive as a party if nuclear reactors are not being shut down in the near future? If reactors are shut down, the price of electricity will be boosted.

– BlackRock, the world’s largest asset manager, recently entered into an agreement to purchase Bohult windpark (46 MW). This can prove to be very beneficial relationship for the years to come releasing capital to either lower debt, pay out dividends to shareholders or for new projects.

Less important and more short term, but factors nonetheless:
– The water supply for hydro power is below the historical mean currently. Short term this ought to support the elspot prices.
– Will Russia increase the pressure in Ukraine by cutting the gas supply when the winter comes? This could potentially raise elspot prices in Sweden.

The Bear Case
– Forward prices of E-certificates do not agree with my assessment that we will see significantly higher E-certificate prices going forward ( in which case the current price to book discount is fair.
– A worsening of the world economy would put pressure on the demand for electricity potentially driving elspot prices down even further. It is my belief though that E-certificate prices would provide a cushion, at least to some extent.
– A reversal in political sentiment towards nuclear power. I really don’t see that coming – the momentum away from it seems way too strong on both sides of the aisle. But perhaps the market sees this question differently than I do, hence the low stock price.
– Rising interest rates at or around the time the loans are to be refinanced. The flip side to that is that it would indicate a stronger world economy and thus almost certainly higher elspot prices.

Part 2 of my analysis can be found here: