Australia | Feb 28 2008
By Greg Peel
Around this time last year there was a real focus in Australia and around the globe on the issue of greenhouse gas emissions. The Howard government was refusing to sign the Kyoto agreement, but had commissioned a report on a potential national carbon trading scheme. As the task force included only the country’s heaviest polluters, and no environmentalists, it was seen as a farce. But at the same time a bloke by the name of Kevin Rudd was beginning to soar in popularity, and he was talking tough on Kyoto, emission reductions and trading schemes. It just might be that he could win the election.
Either way, companies had begun to take a realistic view of their own emissions, and had begun to prepare for the inevitable. In the meantime, companies which would prove to be net winners out of emissions trading were proving popular investments on the market. One such company was renewable energy provider Energy Developments ((ENE)).
Energy Developments controls over 60 power generation facilities in Australia and around the world which are fuelled by either renewable energy sources or very low carbon emission sources. The company boasts 20 landfill gas power plants in Australia, as well as two coal seam gas plants and four remote area plants. It also controls landfill gas plants in the US, UK, France, Greece and Taiwan. And then it has numerous further projects in development, including the West Kimberely Power Project, which will provide LNG-derived power to all those remote northern WA towns, and the Moranbah North project, which will extract CSM from a Queensland coal mine.
When the credit crunch hit, the market began to be focused on other matters rather than green concerns. This impacted on ENE’s share price as a member of the broad market, but further problems were to come. Apart from ongoing project delays that managed to keep analysts frustrated, the NGAC price collapsed.
The NSW Greenhouse Abatement Certificate scheme has proven to be similar to any other projects the NSW government has been involved in recently – shambolic and ill-conceived. To be fair, however, NGAC’s were one of the first global prototypes for a carbon credit system, predating even the forward-thinking Europeans. The Europeans rushed ahead with their Union-wide system, only to have Phase I collapse under weight of over-enthusiastic exemption hand-outs. Phase II is much stricter. The NGAC system fell foul when the Coalition government failed to endorse it as a national benchmark, trading was lacklustre, exemptions were, again, prolific, and then the NSW government started talking about privatising the state’s electricity industry, which threw everything into confusion.
The NGAC price subsequently collapsed from $14 in early 2007 to under $6 in October. Despite the fact there had been minimal trading anyway, the NGAC was always seen as a proxy for the fate of ENE’s bottom line. As important as the power ENE would generate were the rebates it would receive in a carbon trading scheme, given energy could be produced more cheaply using dirty coal. An already suffering ENE share price subsequently fell further.
It fell further again yesterday, when the company posted a poor profit result. Guidance was also downgraded. The stock has now fallen to below $3 from a high of over $5 in early 2007.
Analysts have thus been frustrated again. Nobody denies that in the carbon-traded world the future will ultimately bring, ENE will stand as a first-mover beneficiary. However, the company still has to perform in order to justify valuation. NGAC’s aside, it doesn’t help that power generation margins have fallen on increased operation and maintenance costs. The WKKP continues to be delayed, but hopefully will be running by May. Moranbah North is thankfully still on track for late this year. Performance in the UK was strong, but the US continues to run at a loss.
And now to top matters off, ENE’s gearing levels have drawn attention. Gearing stands at 57%, which is in the middling risk range, and $118m of short term debt needs to be refinanced by December. Total net debt of $405m means any further significant acquisitions will need to be put on hold so that credit can be addressed in the midst of the credit crunch. It may be that further capital will need to be raised.
The response from analysts was generally downbeat, with ABN Amro downgrading from Buy to Hold to provide a 1/4/1 B/H/S ratio in the FNArena database. Earnings forecasts reductions were fierce, and the average target has fallen from $4.00 to $3.25 on a range of $2.56 (Macquarie, Underperform) to $4.00 (Deutsche Bank, Buy). Last trade was $2.86.
Macquarie just can’t see anything positive at the moment, particularly as the stock is trading on an expensive 18x and failing to deliver. Deutsche, however, comes up with a discounted cash flow valuation of $5.10 which thus supports its Buy rating. But Deutsche also warns of uncertainty ahead.
Uncertainty is exacerbated by the Rudd government’s plans to move to a national emissions trading scheme which, in theory, will be born of the various state government schemes already underway, including NGACs. But a national scheme is still a drawing board proposal, and specific valuation of ENE will not be clear until the details emerge.
ENE could well be one to put away in the bottom draw for the carbon trading world that will evolve some time around 2012. However, there may be little need to rush in until the debt situation is addressed and/or another capital raising occurs. ENE may not decide to raise capital in the current weak environment, however, but prefer to have faith in refinancing which analysts suggest will take its cost of funds to 8%.