Australian renewables group Infigen Energy is another example of a company where everything that could go wrong, did. The equity market abandoned the share price and it fell away. Then there was a catalyst, in this case the increase in REC prices and the share price has picked up.
It’s gone from a low of $0.22 in August 2015 to $0.74 today. Today if we looked at the briefest possible summary of what an investor might see it would look as follows:
Four years ago, Infigen had many disadvantages as an investment:
– It had a lot of debt, so much so that compliance with its financial covenants was an important issue.
– It was complex; each US asset had a separate financing structure, and those financing structures split the cash flows into three parts. In some wind farms, there were also minority interests to consider. Because of the way numbers are reported under generally accepted accounting principles, the reported numbers did not provide an easy to understand presentation of what was actually happening to the cashflows of the parent company.
– Performance of the portfolio was (well) below expectations of analysts at the time it was put together. Specifically, capacity factors were consistently below the original expectations.
Wind modelling and understanding has much improved in recent years. We all underestimated the operating cost of a wind turbine. Since the wind was free the natural expectation was that the variable operating expenditure [opex] of a wind farm would be very low. In fact it turns out that gearboxes break down and that these big powerful pieces of equipment cost a lot to run. It works out to be about $20/MWh, that’s more than a brown or black coal generator. That’s right, the open for a wind farm is probably higher than for a coal generator.
And it’s not just wind. According to data released earlier in the year by ARENA, PV solar farms also cost around $20/MWh. It’s a mystery to me where that money goes. The PV solar panels on my roof get washed by the rain and that is the maintenance cost. Still, its not the analyst’s job, particularly, to understand why something is the case.
It’s more a matter of understanding what it means for profits and the share price – and in this case, it meant that the profits of the wind farms underperformed initial expectations. Electricity prices were lower than initially expected both in the USA and in Australia. In Australia the REC prices fell at the wrong time.
Over the past four years Infigen has worked hard to steady the ship. Initially management tried to change as little as possible and an early attempt to sell the US portfolio didn’t succeed due to inability to agree on price. Infigen sold off its European portfolio for good prices, though, and disclosure gradually improved. Still the company remained in a financial straight jacket with the vast majority of cash flow “swept” through to the debt providers. Iinfigen’s only flexibility was in assets that were held out of the “debt group”. Over the past year, though, self help and external events have combined to once again create some enthusiasm.
Specifically, the USA portfolio was sold in July 2015 for $US272 million. The price wasn’t great, relative to earlier expectations (and in fact resulted in a book write down of $US225 million) but was at market and at a stroke some debt was repaid. The complexity was dramatically reduced and Infigen now became a company with a portfolio of operating wind assets in Australia together with some development options. This meant that the leverage to conditions in Australia had increased strongly.
Right now, that’s great because: (i) REC prices have increased from $35 to $85 dollars; (ii) South Australian pool prices have increased although wind takes a sharp discount.
We can see the size of the discount in the attached chart. For the 12 months ended March 31, wind received about $39/MWh in South Australia.
Now and then
The following table compares financial results, and balance sheet extracts taken from the Dec 14 (H1 FY15) and Dec 15 (H1 FY16) presentations. The numbers are a bit simplified but in our view contain the essence of the “scoreboard”
When we look at the numbers what we see is:
- Ebitda – net interest is about $30-$35 m per half and will improve while REC prices stay high. That’s the cash available to pay down the $900 m of debt.
- Net debt: Ebitda, Ebitda margin and Ebitda:Net interest ratios have all improved
- There is about about $135 m of cash that is held outside of the “ring fenced” assets. All cash flow from assets inside the ring fence has to go to paying down debt. IFN can do what it likes with the remainder of the cash. If it wants it can put some of the cash into debt repayment each half and if it does so it qualifies to reduce the denominator in the debt covenant test. The debt covenant test only applies to debt within the ring fenced group and IFN does not disclose the price debt or calculations around the covenant.
However Infigen has disclosed that Net debt/Ebitda must be < 8.5x through Dec 16; < 6.0x from Dec 2016, to Jun 2019; < 3.0x from Jul 2019 to Jun 2022 (when the facility expires).
Infigen states the test was satisfied at December 2015, still the overall reported net:debt ebitda ratio of 5.6 on our estimate means that investors have to continue to see some risk in the overall debt level. More simply, the quantity of debt including the derivative liability exceeds the book value of the property plant and equipment [PPE]. We’ve focused a bit on the debt because high financial leverage is a significant factor for equity investors.
Infigen has about 550MW of operating assets of which about 400MW are exposed to changes in the REC prices. The merchant (uncontracted) assets are mostly in South Australia and so the average pool price they receive is around the $40/MWh.
On average those assets and indeed the Woodlawn asset should be getting something like a total of $120/MWh at present. Infigen states that ebitda increases around $0.8 million for every $1 increase in the combined pool and REC price. The table below shows the commodity prices as disclosed by management and our (rough) estimate of the six months to June 2016.
The table shows that, despite the excellent increase in REC prices over the past year, Infigen’s bundled spot prices (REC + pool electricity) were still a touch below the original hedged prices. The table shows average over the period prices.
Since Dec 31 2015 REC prices have been consistently around $75-$80 but the pool price received by wind in the June quarter to date in South Australia is just $30 (that may improve). So we don’t expect a massive improvement in the bundled price for the June half. Still our numbers could be conservative.
Beyond the current year production volumes will likely stay relatively constant. The outlook for pool prices is unclear but the futures curve remains modestly supportive. REC prices may rise further as there is still not too much sign of new supply. Most of the Australian wind farms are still on manufacturer warranty agreements and there will be a change in costs and risks once these expire (mostly over the next 12-18 months).
In short, we don’t see the overall ebitda outlook from the existing portfolio changing in a significant way from here. Infigen’s Development portfolio is a relatively large 2GW, but there is little sign that Infigen itself wants to build any more capacity.
Assuming 50 per cent debt funding, and using all of its $130 million of spare cash – and assuming about $2.4 million/MW of capital expenditure for wind – Infigen could finance around 100-120MW of new merchant development, most likely in NSW. Infigen, like every other player in the renewable space, is happy to take advantage of high REC prices but unwilling to bet that these will continue indefinitely.
The development portfolio has a value, but not one that is easy to identify. Origin Energy’s large (300MW+) Stockyard Hill site in Victoria is presently for sale and that will give a good indication of value if the sale proceeds. We’ve allowed about $40,000 per MW.
David Leitch was a Utility Analyst for leading investment banks over the past 30 years. The views expressed are his own. Please note our new section, Energy Markets, which will include analysis from Leitch on the energy markets and broader energy issues. And also note our live generation widget, and the APVI solar contribution.