|Shares Out. (in M):||146||P/E||NM||NM|
|Market Cap (in $M):||1,023||P/FCF||NM||NM|
|Net Debt (in $M):||919||EBIT||45||0|
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Summary Timeline and Business Description
Before we discuss Just Energy’s business in greater depth, the following is a brief history on the company and a summary description of each business segment:
2001: Just Energy comes public as a Canadian Income Trust called Energy Savings Income Fund (with the ticker “SIF”) as a door-to-door seller of residential retail gas marketing services in the Ontario region
2001 – 2008: The company grows rapidly through organic growth, small tuck-in acquisitions and expansion outside of their core Canadian markets into the United States and into residential electricity (through the $34 million acquisition of Just Energy). The company would later change the corporate name to Just Energy in 2009.
2009: The core business starts to deteriorate (for numerous factors discussed below), and the company begins doing large debt-financed acquisitions to keep growing. In April 2009, the company acquires Universal Energy Group for $250 million in cash and stock.
2010: Just Energy acquires Hudson Energy for $289 million.
2011: Just Energy acquires Fulcrum Energy for $79 million.
2012: Just Energy raises C$105 million from Canadian Pension Plan Investment Board
2013 March: Just Energy cuts its dividend from $1.03 to $0.84.
Business Segment Summary
Energy Marketing (94% of sales)
The Gas Marketing and Electricity Marketing segments are relatively simple businesses that generally offer consumers and businesses a fixed retail price for natural gas or electricity, compared to the fluctuating price they can get from their local utility. The company hires independent contractors who go door-to-door selling their services and in the last few years, the company began marketing through other channels as well such as the Internet, telemarketing and network-marketing.
Home Services (2% of sales)
The Home Services segment came as part of the Universal Energy acquisition and provides water heater and other appliance rental services in Canada. Most homeowners in Canada actually don’t own their water heaters, but instead they rent them from companies like Just Energy, Enercare Inc. or Direct Energy (a subsidiary of Centrica PLC). The business is pretty straight forward – a water heater that costs ~$1,000 is placed into a customer’s home and the customer pays a $19.99 per month rental fee; the company is responsible for maintenance and repairs for the heater and the customer is locked into a 15 year contract.
Ethanol (4% of sales)
The Ethanol segment also came with the Universal acquisition and consists of a single 150 million litre capacity plant that is unlikely to be worth more than the debt securing it. The debt is non-recourse and Just Energy will likely default on the debt and part with the asset.
Other (1% of sales)
The Other segment includes a few new ventures such as Just Energy’s network marketing company called Momentis and their Solar business. Momentis is a “multi-level marketing” (MLM) company started in 2010 essentially to provide another sales channel for the energy marketing business. The Solar business was part of the Hudson Energy acquisition and installs solar systems on residential and commercial sites, maintains ownership and provides maintenance and monitoring services for 20 years while selling the energy to the customer and retaining the tax credits and renewable energy credits.
Just Energy’s core energy marketing business is deteriorating due to its flawed business model, unsustainably high margins, difficult industry conditions and intense competition
For many years, Just Energy was a simple company that appeared to have healthy growth, clean, transparent financial statements and a strong balance sheet. The business consisted of independent contractors going door-to-door and signing up customers to switch from their local utility (where they receive a fluctuating price for natural gas or electricity) to Just Energy’s fixed price contracts (as the company puts it – “it’s like having a fixed mortgage instead of a floating mortgage”).
The product offering, however, is of dubious value. Just Energy does offer a fixed price contract, but the fixed prices are generally much more expensive than the fluctuating price from the local utility. Just Energy naturally has no competitive advantage in either predicting natural gas prices or securing lower-cost supply than others, so there is no way for them to create any value for consumers. Moreover, the retail energy marketing business is extremely price competitive with zero barriers to entry. A Con Edison customer in New York has no less than 42 alternative providers of electricity and gas, another seven electricity-only suppliers and another 19 gas-only suppliers. There is virtually no competitive advantage among any of these suppliers as they all source the same commodity (natural gas or electricity in the New York region) from the same market and provide it to the same customer via Con Edison.
For that reason, the only factors that differentiate one supplier from another are price and marketing. Just Energy’s growth has come not because they offer a valuable business service at a great price, but very aggressive and deceptive selling practices. Just Energy pays the independent contractors 100% on commissions, with the sales reps getting ~$160 per customer they sign up. These sales reps naturally respond to incentives so they do and say anything to convince customers to sign up.
First, Just Energy’s reps present a very disingenuous comparison of a consumer’s natural gas utility cost with unrelated costs such as a gallon of gasoline. Most consumer don’t know the difference between natural gas on a $ per therm basis compared to gasoline on a $ per gallon basis, so they are misled into thinking they are saving money.
Additionally, the independent contractors represent themselves as agents of the local utility or imply that the new contracts are somehow mandatory. There are numerous instances of consumer complaints about Just Energy’s marketing practices with regulatory agencies and consumer advocacy groups finding their practices to be deceptive and misleading.
Lastly, Just Energy’s contract terms are meant to be deceiving and opaque. As noted in the table below, Just Energy “appears” to offer the lowest price fixed contract, but there’s a catch. Just Energy’s prices are fixed only for two months – despite the 5-year term – and after two months, the contract reverts to a fluctuating price based on “business and market conditions.” Just Energy then gives you the option of locking in this new, variable and unknown price. The company tries to reassure consumers that the rate won’t fluctuate that much by guaranteeing that the variable rate won’t increase by more than 30% per month. Just Energy also allows consumers to cancel their contract free within 30 days (before the misleadingly low introductory price expires) but there is a $50 fee thereafter. Of course, most consumers don’t even find out about these deceptive terms because Just Energy’s reps are by far the most aggressive and divert customers’ attention away from the fine print by dangling gifts in front of them, such as a $150 VISA gift card as a reward for signing up for the service. The offer seems too good to be true . . . because it is.
It was these aggressive and deceiving marketing tactics that fueled Just Energy’s early growth. However, Just Energy’s results began to deteriorate in the past few years due to a combination of factors including increased customer awareness about their business practices, increased regulatory scrutiny and deteriorating market conditions:
Industry conditions for natural gas marketing have become more difficult as natural gas prices have decreased substantially over the past few years. Since Just Energy sources natural gas in the market and (deceptively) adds a margin to it before selling it to their customers, lower commodity prices mean that as existing contracts expire, they are replaced with lower margin contracts. Additionally, the lower (and less volatile) commodity prices create less of an incentive for consumers to switch to a fixed price contract.
As illustrated below, Just Energy’s Gas Marketing margins have begun to shrink as high-priced contracts have rolled off and are replaced with lower margin contracts:
Lastly, the retail supply business has become more and more competitive with smaller companies increasingly disadvantaged against larger companies – especially those with generation assets. For example, one Wall Street analyst commented:
“Retail supply businesses on a standalone basis have significant financial risk due to asymmetric collateral requirements. Providers are required to post collateral if the market price of power falls relative to the forward contract price; their customers do not have a similar obligation. To mitigate this risk, companies must own or contract for merchant generation (providing a natural hedge against the load obligations) or maintain a strong balance sheet to protect themselves from liquidity events.
The market’s inclination to place a low multiple on retail businesses is warranted for providers that don’t own generation to back load. The business risks associated with a “pure retailer” are much more severe.” (emphasis added) 
Just Energy has managed to grow through their deceptive marketing practices, but they must now compete with larger, well-capitalized and better-positioned peers in an increasingly competitive market.
In summary, given the deceptive nature of its marketing and the increased regulatory scrutiny it attracts, the unsustainably high margins and the increasingly competitive nature the industry, Just Energy’s energy marketing segments are likely to be further impaired. It is not surprising that Just Energy has sought to quickly diversify away from energy marketing.
Just Energy’s desperate attempt at diversification is likely to destroy value as they overpay for acquisitions or invest in businesses that consume (rather than generate) cash
As Just Energy’s energy marketing business began to unravel, the company went on an aggressive, debt-fueled acquisition spree to diversify the business and maintain its growth rate. However, the acquisitions that were done likely destroyed value because the company overpaid for the assets, burdened themselves with debt and required substantial additional capital to grow.
The Home Services business segment that was acquired with Universal Energy in 2009 is an example. As mentioned, most Canadian residents rent their water heaters instead of owning them and companies such as Direct Energy, Enercare and Just Energy go door-to-door selling their rental services. Similar to the energy marketing business, this business is marked by deceptive and aggressive selling tactics which have now come under the radars of consumer advocacy groups and regulators.
An additional twist to the Home Services business is that it is very capital intensive – as the company needs to purchase the water heater upfront and install it in the customers’ residence before receiving the monthly rental fees. Given that Just Energy had promised its investors a healthy dividend and its balance sheet had become levered, the company did not have the capital required to grow this business, so they contracted with a Canadian non-bank lender named Home Capital Group to provide the financing for this business. Home Capital Group provides debt financing to Just Energy, which then purchases the water heater equipment and installs it. Home Capital provides an amount equal to a fixed period of monthly rental cash flows (typically 5 years, but also 7 and 10 years) discounted back at an 8% imputed interest rate. In return, Home Capital Group receives all of the monthly rental cash flows from the customer until their interest and principal has been fully amortized.
In effect, Home Capital Group makes a secured loan at 8%, backed by customer contracts, on a growing business, while Just Energy does all of the marketing, installation and maintenance. Just Energy retains ownership of the asset and all of the cash flows once the Home Capital debt is fully paid off.
The interesting aspect about the Home Services business is that while Just Energy reports substantial growth in customers, revenues and EBITDA, the business is deeply cash-flow negative and won’t generate any cash flows for several years until the Home Capital debt is repaid (see Appendix).
Likewise, the company’s other large acquisitions (Hudson Energy for $289 million in 2010 and Fulcrum Retail Holdings in 2011) have failed to deliver any growth and have burdened the company with nearly $400 million in additional debt.
Lastly, the “other” businesses like the Momentis MLM and the solar business are both likely to be substantial cash-flow drags for years to come and are unlikely to be worth much. Despite all the marketing that has gone into Momentis, it is doubtful that this business has substantial value. Momentis, as mentioned, is a network marketing company where independent representatives are compensated for both selling services and recruiting other representatives. Currently, there is tremendous controversy surrounding the business practices of MLM companies, however Momentis deserves particular skepticism because, unlike some consumer products MLM’s where the companies claim that many independent reps sign up so they receive discounts on the products, Momentis reps cannot “consume” extra contracts for energy marketing. The FTC recently shut down a MLM called Fortune Hi-Tech Marketing for basically running an illegal “pyramid scheme” in which reps were recruited based on aggressive and deceptive marketing practices, were required to pay an upfront and ongoing monthly fee to participate in the program and virtually none of them made a profit selling the products. Unfortunately for Just Energy, Momentis is a virtual replica of Fortune Hi-Tech:
The company’s debt-financed growth strategy has met its limits as the over-levered balance sheet has no more capacity at 5.9x debt / EBITDA
The combination of expensive debt-financed acquisitions and an overly generous dividend has left Just Energy with a precarious balance sheet. At near 6x debt / EBITDA, Just Energy does not have additional balance sheet capacity. Any incremental debt is likely to be extremely costly and come with the stipulation that the company reduce its dividend rate.
Management is extremely promotional, employs aggressive and misleading accounting and has not be realistic in acknowledging the challenges facing the business
Instead of acknowledging the challenges, management has continually sought to downplay them, to highlight any positive aspect and to divert attention to newly created metrics that hide the company’s true state.
For example, in 2011, a forensic accounting firm in Canada issued a negative report on Just Energy’s ability to fund their distribution. Immediately, the company put out a press release reaffirming their guidance and dividend “in light of inaccurate market rumors which it believes have adversely impacted the Company’s share price.” After several paragraphs of reassuring investors about the safety of the dividend, about the accretion of the recent Fulcrum acquisition, about the company’s strong results during the difficult economic conditions of 2008 and 2009, Chairwoman Rebecca MacDonald added: “Today, our stock has a dividend yield of over 12%. Combining this with our reconfirmed growth guidance, Just Energy should be one of the first places investors look for protection in light of troubled capital markets.” Not only did the company indeed cut their dividend, but the stock has generated a total shareholder return of negative 20% (including dividends) since then compared to a 14% return for the TSX Composite.
Likewise, in July 2012, the company issued a press release in “response to unusual trading activity in its shares.” After noting that “the company ordinarily does not comment on market activity or market rumours,” the company insisted that its $1.24 dividend was secure and that the company was “not aware of any adverse change in any aspect of its operations or prospects.” The shares have lost 37% since.
Even after the company’s hand was forced and they cut the dividend, the company still worries about “the unusual trading volumes and decline in the Just Energy share price.”
Lastly, the company’s accounting and reporting metrics have become more opaque and misleading over time. Instead of acknowledging the cash flow deficiency, management has resorted to using aggressive accounting to make the dividend appear secure. For example, the company reports its distribution coverage based on “Adjusted FFO” which adds back some items to cash flow from operations. In 2005, the add-back items were relatively benign and the dividend was roughly covered by Adjusted FFO. As the business conditions deteriorated and the company began incurring substantially more recurring, cash expenses, the company began excluding “growth & sales marketing” expenses from Adjusted FFO. While the true cash-paying ability of the company was decreasing, the company presented their results as if the dividend was securely covered:
The company will likely have to cut its dividend again which will cause the income-oriented shareholder base to sell
Even at the current reduced dividend rate of $0.84 per share, Just Energy does not generate enough cash to cover its dividend. Indeed, given its balance sheet woes, it would be prudent for the company to eliminate its dividend entirely but the company is wedded to the dividend and so are its shareholders. Many of the current shareholders are longtime holders since the IPO who enjoyed steadily growing dividends during the good years in the company’s early history. Few of these investors will want to own the shares for the fundamental value of the businesses in absence of a dividend.
Valuation is stretched and a dividend cut or additional capital raise is required
Given the disparate assets the company owns, a sum-of-the-parts valuation may be appropriate.
Ethanol: The ethanol facility is very likely worth less than its secured debt and provides no value to the equity holders.
Home Services: The Home Services business could have some future value for the company but given the financing agreement with Home Capital, the business will not generate any cash flow for Just Energy for years. Ironically, the faster Home Services grows, the worse the FCF is and the longer until any cash flow reaches the company (see appendix). A DCF valuation shows very little value for the segment given substantial upfront negative FCF. Likewise, an earnings or EBITDA shows no equity value given the low earnings level currently and the debt on the business. Therefore, the most appropriate method may be a steady-state unit-multiple based on the enterprise value of pure-play Canadian water heater rental company Enercare.
Other: The Momentis network marketing business and the solar business are likely to generate losses for the foreseeable future and are unlikely to worth much given the secured, project debt on the solar projects and the regulatory and business model risk of Momentis.
Energy Marketing: The only segment that could have value is the Energy marketing segment, but this segment is on a downward treadmill and something that the company is trying to rapidly diversify away from. The segment’s value is likely decreasing given the core challenges of the business:
The closest public comparable to Just Energy is a smaller competitor called Crius Energy that recently came public in Canada. The decision to come public as a Canadian Trust is an interesting one for a company headquartered in Stanford, CT and with operations and management entirely in the US. The reasons, we have been told, that Crius chose the Canadian public markets was a) because of the receptive audience for “yield” retail energy companies, b) for tax avoidance purposes (based on cross-border income trust laws) and c) because of the “high” valuation of Just Energy at the time of Crius’ November 2012 IPO. Crius is now valued at 5x EBITDA with a 15% yield.
It is difficult to see how Just Energy could be worth its current valuation and the need for additional capital – either equity or debt – and a further dividend cut will serve as a catalyst for a more appropriate re-rating of the company.
 We encourage readers to call the competing companies and listen to the sales reps. The difference in attitude and aggressiveness is astounding: Con-Ed Solutions (888) 320-8991; Constellation (800) 375-1277; Spark Energy (888) 877-7569; Greenlight Energy (888) 453-4427; US Gas & Electric (888) 947-7880; Just Energy (866) 587-8674.
 We believe that retail energy marketing – in general – adds very little value to the consumer. See appendix.
 Just Energy’s disclosure (purposefully) does not include traditional metrics such as gas or electricity usage (on an mmbtu or MWh basis), making it difficult to compare with competitors who provide these common metrics. The analysis above is based on Just Energy disclosure (residential customer equivalent or “RCE” units) and estimates to derive traditional margin metrics.
 Morgan Stanley research report on NRG Energy, dated October 6, 2010.
 Just Energy’s smaller peer Crius Energy has no long-term debt on its balance sheet and has a $200 million procurement facility with Macquarie to provide credit and collateral for their marketing business. Investors will also recall how Reliant Energy nearly became bankrupt in 2008 because of the credit and collateral requirements for their retail business and Reliant had 15 GW of generation capacity and an enterprise value of $5 billion with $1 billion in cash on its balance sheet.
 EBITDA calculated as EBIT plus D&A, without the adjustments management makes for recurring cash expenses.
 Anecdotally, we have heard that when the company was looking to raise capital last year, most Canadian lenders asked for a 10% interest rate and demanded a cut in the dividend. The company was able to finally raise unsecured debt from the Canadian pension fund at a 9.75% rate without being forced to cut the dividend . . . which they ended up doing anyway a few months later. Given the further deterioration in operating results, the next capital raise is likely to be more onerous.
 We note “relatively” benign. The company still did not account for capital expenditures in their Adjusted FFO metric.
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