Renewable On Sale With High Dividend Yield To Come In 2016
By Extract Capital :
C$144.9 million$108.9 million
Adjusted EV 1
Polaris Infrastructure Inc. ( OTCPK:RAMPD ) which trades primarily on the Toronto Stock Exchange under the symbol "PIF", is the operator of the San Jacinto-Tizate Plant, a geothermal plant located in Nicaragua. Polaris is the reincarnation of its predecessor, Ram Power, which failed with too much debt. However, with its recapitalization, Polaris has become an underfollowed opportunity to invest in a stable geothermal asset that is both absolutely and relatively inexpensive with the potential for a stable double-digit yield dividend and increased cash flow through new wells and a binary unit.
Nicaragua, which PIF's asset produces power for, has been heavily reliant on fossil fuel imports. The Nicaraguan government has been promoting construction of renewable sources of energy such as geothermal and hydroelectric, setting a goal of 94% of electricity needs being met by renewable sources by 2027. B2Gold Ltd. (NYSEMKT: BTG ) operates its La Libertad and El Limon mines in Nicaragua and has been paying $219 per MWh.
YTD Nicaragua Power Production by Fuel Type
Nicaragua has the highest electricity rates in the Central American region, averaging $240 per MWh. To this end, the Nicaraguan government is working actively to encourage new private power generation in cheaper, renewable resources in the region (such as the San Jacinto project) to reduce costs and build energy capacity so as to reduce dependence on imports.
Nicaragua has large untapped potential to develop renewable energies through its access to large geothermal sources as well as its development of wind, solar and hydroelectric power. With this in mind, and with the support of the World Bank and International Finance Corporation ("IFC"), Nicaragua has made substantial commitments in developing its renewable energy resources. In 2005, the government passed a law giving renewable energy companies a tax holiday for ten years and permitting them to import equipment and machinery free of duties.
Energy consumption in the region is also set to grow as lagging infrastructure leaves potential for an increase in residential and commercial demand. Grid coverage was estimated to be around 69% in 2009, with only 40% in rural areas, and the government is working to increase coverage towards a goal of 84% coverage in rural areas with the assistance of international development funds.
The San Jacinto asset represents the single largest private investment in the history of the country, producing more than 10% of energy needs and replacing almost 900,000 barrels of imported fuel each year.
History of PIF
Developed by PIF's predecessor, Ram Power, the San Jacinto-Tizate Plant grew its capacity in phases. However, the development process that was designed to simplify and keep costs low was riddled with cost overruns and resultant liquidity issues. Having accumulated $246.5 million in debt and with no further capital available, the Company entered into a reorganization with creditors.
Annotated Share Price Graph of PIF (prices adjusted to prior to 2000:1 share consolidation)
The Company was recapitalized in May 2015 and raised $60 million at C$8.00 per share. The recapitalization plan included 1) the conversion of C$53 million of convertible debentures into equity at 80 cents on the dollar, 2) the cancellation of all outstanding warrants, 3) a restructuring with the project finance lenders to create a longer principal repayment schedule, thereby lowering annual debt service costs, 4) an agreement with the project finance lenders to allow a dividend to Polaris' shareholders upon a completed drilling program to increase its power output, and 5) the reduction of the percentage of EBITDA payment due to subordinated loan holders to 3% annually.
With total capex of $425 million spent from 2005 to present, the recapitalization assumed a project value of only $320 million for San Jacinto-Tizate based on current book value as of the September 30, 2015 financial statements.
Interest ($000) 3
Though PIF has reduced its debt load through the recapitalization plan, it still has $186.2 million in debt, or $146.1 million in net debt, representing net debt/current EBITDA of 3.6x. Its senior debt portion is $153 million and has an interest rate of LIBOR+ 6.5%. $32.4 million is subordinated debt and has a rate of 6% and a return enhancement of 3% of EBITDA, but cannot exceed a 13% interest rate. Strangely, the Company also has $0.8 million due to a deceased previous shareholder, and the Company plans to extinguish that debt. Approximately half of the subordinated debt is due 2024 and the other half is due 2028.
The San Jacinto-Tizate Plant is currently producing 50MW of power as of September, though its generators have capacity to generate 72MW with adequate steam input. The power being produced is sold on a contracted basis at $115 per MWh and escalates at 3% per annum in 2023, and 1.5% per annum thereafter, until 2029, in which case the Company may enter into a further agreement or sell on a merchant basis. The agreement is with Disnorte-Dissur, owned by Spanish companies TSK and MELFASOUR and the Nicaraguan government.
With 50MW of power production, the plant is expected to generate $49.0 million in revenue and $40.0 million of EBITDA annually. The Company generated $38.0 million of EBITDA over the last twelve months with $10.1 million posted in the latest quarter. The direct costs of running the geothermal plant are relatively minimal; with low requirements for sustaining capex (such as general maintenance of steam pipes and turbines) and corporate overhead. Based on conversations with management, we estimate $5 million of maintenance requirements and $2.5 million of corporate overhead in Canada. At its current valuation, Polaris is trading at 6.4x current EBITDA. After interest and maintenance capex, free cash flow is expected to be $21 million, or a FCF yield of approximately 19.3%. After principal repayment, the Company is expected to retain $12 million, or 11.0% FCF yield.
There are prospects for significant growth in FCF and EBITDA. With eight production wells producing 50MW of power but turbine capacity of 72MW, the Company hopes to increase its production by adding additional sources of steam from new wells. As stated in Figure 3, 72MW of production could increase its revenue to $70 million and EBITDA to $55 million while free cash flow would increase to approximately $36 million, or $2.32 per share.
Two plans exist to increase steam production. First, the Company plans to drill three additional wells for $30 million to potentially increase production towards the plant's capacity. The eight current production wells produce 2MW to 14MW each with an average production of 7.2MW per well. Extract believes that the new wells should be able to achieve +15MW in production with the assumption that one well is not successful. An increase of power production by 15MW to a total production of 67MW would increase the Company's EBITDA to $51 million and free cash flow to $32 million.
Less: Principal Repayment
Dividend per Share
The Company also plans to install a binary unit system, a system that extracts power by recycling steam which can provide 5MW to 8MW in power. The system should cost $20 to $25 million. IFC has been mandated to finance 100% of the cost of the binary unit. Timing of this binary unit is uncertain and we have not included it in our base case.
The Company plans to institute a dividend program mid-2016 once the drilling program has ended. According to management, the initial plan is to set the payout ratio at 75% which implies 15.8% yield in the base case, and 18.6% yield in the 72MW case.
In Nicaragua, PIF is enjoying a 10-year tax holiday incentive and has approximately eight years left in the tax holiday. In addition, the parent company in Canada has tax losses in Canada that should allow the Company to not pay cash taxes for many years, our analysis gives zero value for the favorable tax situation.
Valuation and Conclusion
Not only is PIF absolutely cheap but it is also materially undervalued compared to its renewable peers. Small caps such as US Geothermal (NYSEMKT: HTM ) and Alterra Power ( OTCPK:MGMXF ) trade at 10.5x and 10.6x 2016E EBITDA, respectively. Larger renewable independent power producers trade at 11.8x 2016E EBITDA. Those which pay a dividend are trading at a 5.7% dividend yield. Polaris deserves a discount relative to its peers due to its single country risk, but we believe the discount is too high and believe it will decrease as investors discover the new company and execution is demonstrated by new management.
Per Share Value
C$18.02 (92.7% upside)
C$30.89 (230% upside)
Peer Valuation @ Current Production
C$20.07 (115% upside)
Peer Valuation @ 72MW Production
C$32.30 (245% upside)
Based on its current production of 50MW, Polaris is inexpensive. Although risk remains in increasing the power plant output, we believe that the Company's plans will increase cash flow meaningfully due to higher production. We also believe that Polaris would be an accretive acquisition to multiple different renewable entities and the market would value the Polaris assets in a larger company at a higher valuation due to the elimination of Nicaragua jurisdictional risk. Even without the additional output, Polaris is meaningfully inexpensive compared to peers and regardless of its success in drilling wells, should be paying a meaningful dividend by the end of 2016.
1 Cash balance reduced by remaining capex spend for new wells.
2 PIF can distribute cash to its parent from the project if the project has a 1.3x Total Debt Service Coverage Ratio and 1.5x Senior Debt Service Coverage Ratio on a quarterly basis. DSCR is calculated by Cash Flow from Operations at the project level divided by Debt Service Costs including principal repayments.
3 Includes the 3% EBITDA payment for the subordinated loan.
4 Before principal repayment.
5 Free cash flow after debt principal repayment.
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