Category: Equity

Atlantic Power – on the nature of power generation

James J. Moore Jr. has done an incredible job with Atlantic Power – it is unfortunate the IPP industry as a whole has faced significant headwinds over the past decade. In what is (hopefully) his final letter to shareholders, he writes the following (underlining is my emphasis):

What about the new green energy policies? Shouldn’t they have a positive impact on Atlantic Power?
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I have said in the past the power business is cyclical, capital-intensive and commodity-priced. I also have cited the Warren Buffett adage that when a management team with a reputation for brilliance tackles an industry with poor economics, it is invariably the industry that survives with its reputation intact. More money has been lost in the energy space by investing in themes (surfing green waves, combined-cycle gas plants in the late 90s, YieldCo’s, peak oil, etc.) than any other way I have witnessed. I have repeatedly noted to shareholders the challenging markets for power and the poor fundamental outlook. Public policies pushing green energy and electrification have not pushed demand up as much or as quickly as taxpayer subsidies, state Renewable Portfolio Standards and corporate commitments to green energy have pushed up the supply of generation. Our hydro portfolio contributed 24% of our 2020 Project Adjusted EBITDA, but that EBITDA was generated under PPAs which were signed in the pre-fracking era when power prices were substantially higher. Market prices today are a fraction of those PPA levels. Green policies in places such as New York may provide some uplift in demand or power prices. However, the continual extension of tax subsidies at the federal level is likely to continue to incentivize the addition of supply to power grids that don’t require more intermittent generation but will get it, needed or not.

Before making a decision on the value of your shares, you may want to consider the fundamentals, such as: What are prices today for new PPAs or for projects without PPAs? Is more supply being added to the grid than there are retirements? Where is demand headed? Will demand for things like electric vehicles grow nearly as quickly as new supply is added to the grid? Be aware that new technologies can be very destructive to commodity prices. Fracking was truly an energy revolution, but it also killed the natural gas market in the United States for a decade, as was predicted by Mark Papa (the brilliantly successful CEO of EOG Resources) about a decade ago.

The stumbling block for this transaction is most likely going to be the preferred shareholders – when this acquisition was initially announced, there were those that claimed they should hold out for par ($25) but even they I think are starting to realize that it is the common shareholders that got (mildly) the short end of the stick in this transaction – the value that accrued to the preferred shares should have gone to the common shareholders. Indeed, this is one of the rare times where pronouncements of “fairness” actually appears to be the case.

The last decent preferred shares left on the market

Long-time readers here should remember that I referred to a specific security as cash parking vessel. I didn’t make it much of a secret, but I was referring to DREAM Unlimited’s preferred share, which has been redeemed at the end of 2019.

There has been a lot that has happened since then and now! During the COVID crisis, there were a lot of good opportunities for fixed income investors in the form of bonds, preferred shares and income-bearing equity (in addition to others). Today, however, when scanning my fixed income lists, it is a total wasteland – generally the reasonably safe returns will give you a 5% dividend, while marching up the risk spectrum (e.g. Bombardier’s BBD.PR.B) will get you about 7.3%. It is slim pickings.

The next nearest cash-parking vessel is Birchcliff Energy’s (TSX: BIR.PR.C), which I have written about during the COVID crisis. Unfortunately, it, along with its twin cousin, (TSX: BIR.PR.A) is likely to get called out over the next 1.6 years – I am expecting the company to redeem the latter for par on the September 30, 2022 rate reset date.

It is very tempting to leverage up on “safe” preferred shares yielding 5% or so and finance it with 1.5% margin debt, but as the market instructed people 12 months ago, doing so can be very financially hazardous in the event of a collapse in asset prices.

BWX Technologies – year-end

BWX Technologies (NYSE: BWXT) has a huge competitive advantage – their primary business is the engineering and production of nuclear reactors for US Navy vessels (including aircraft carriers and submarines). Here’s the amusing movie clip that comes to mind:

The company is undergoing a significant capital expenditure which will end in 2022 that will facilitate future projects. The nuclear vessel business is stable, but the ability for the company to branch off in other industries (nuclear medicine, power generation and nuclear space technologies) make them appear to be a fairly cheap entry for a very limited number of investments in this domain (most of which are very diluted with other businesses, such as GE).

I’ll skip the financial analysis. I’ve performed it, but do not wish to write about it.

I do not know why they sold off this morning (they released earnings and Form 10-K yesterday evening), but those nimble got a mild discount. I originally took a position in them during the Covid crisis and still am holding onto it. Percentage-wise, it has not performed nearly as well as the rest of the portfolio, but the risk-reward ratio is very acceptable. They also raised their quarterly dividend from $0.19/share to $0.21/share, but this is not relevant in the investment decision.

GFL Environmental year-end

No positions after the Spruce Point debacle, but reviewing the year-end GFL Environmental (TSX: GFL) statements, they are still a huge train wreck.

Income statement, with some colour commentary:

The gross margins are exceedingly thin (and indeed in the last quarter, negative). We can’t make money per unit of revenue, so we’ll make it up on volume!

The balance sheet tells more of a story:

From the end of 2019 to 2020, the company:

Raised $4.1 billion in equity financing (and another slab of money in “Tangible Equity Units” which trade as GFLU; these will be converted to equity).
They also were able to pay down a net of $1.46 billion in debt with the above line.

However, on the outflows we have the following:

Cash: negative $550 million
PP&E, intangibles, goodwill: $3.8 billion net

So about $4.3-$4.4 billion out the windows in a year. These were to complete the WMI acquisitions. This is a lot of money out the door. I’m also ignoring the $1 billion or so in the increase of the deficit, which I’ll very generously dismiss and chalk up to one-time contract adjustments, foreign currency translation, and operational issues. Presumably the prior expenditures went for the purpose of building a return on equity it would be a good expenditure of capital.

Management claims guidance for an “Adjusted Free Cash Flow $465 million to $495 million” for 2021 and an “Adjusted EBITDA $1,340 million to $1,380 million”.

The question for an investor is whether they can produce an un-adjusted free cash flow, full stop. The historical financial statements are at complete odds with what management is saying. It doesn’t mean they won’t be able to produce positive financial results in 2021 and beyond.

I truly don’t know.

They still appear to have a very good ability to raise capital. On December 2020, they closed another US$750 million financing of senior secured notes at a 3.5% coupon, good until 2028, and also sliced another 50bps off their $1.3 billion credit facility. Their common stock is also near their all-time highs, about CAD$38/share.

Again, I’ll just leave this one up to smarter people than myself to evaluate, but this is one fascinating case study.

Just Energy heading towards another recapitalization

Failing to predict a changing climate, the global warming armageddon consumes another victim. The Texas Winter Freeze has impacted Just Energy (TSX: JE), which announced today:

The financial impact of the Weather Event is not currently known due to challenges the Company is experiencing in obtaining accurate information regarding customers’ usage from the applicable utilities. However, unless there is corrective action by the Texas government, because of, among other things, the sustained high prices from February 13, 2021 through February 19, 2021, during which real time market prices were artificially set at USD $9,000/MWh for much of the week, it is likely that the Weather Event has resulted in a substantial negative financial impact to the Company. Based on current information available to the Company as of the time of this press release, the Company estimates that the financial impact of the Weather Event on the Company could be a loss of approximately USD $250 million (approximately CAD $315 million), but the financial impact could change as additional information becomes available to the Company. Accordingly, the financial impact of the Weather Event on the Company once known, could be materially adverse to the Company’s liquidity and its ability to continue as a going concern. The Company is in discussions with its key stakeholders regarding the impact of the Weather Event and will provide an update as appropriate.

Just Energy is in the business of selling fixed price energy contracts. For instance, if energy is selling at $2/GJ at spot, they will typically offer a 5-year fixed energy contract where they will sell it to you at $3.5/GJ. The same thing goes for electricity sales.

Presumably they hedge these contracts using energy future swaps or some other mechanism, but there are long-tailed events that you can’t possibly hedge for. Similar to those that sold call options on Gamestop, Just Energy is now caught in one hell of a margin squeeze. The only difference is that their “accounts payable” is not instantly due from their brokers, but rather due on their next payment installments to the local utility provider, which doesn’t really care about Just Energy’s predicament other than the fact that they can’t pay the gigantic bill owing.

The shares are still trading at a market capitalization of $250 million, so clearly the market is anticipating that perhaps not all is lost.

Will be interesting to see how this one resolves itself!