|Shares Out. (in M):||35||P/E||0||0|
|Market Cap (in $M):||330||P/FCF||0||0|
|Net Debt (in $M):||223||EBIT||0||0|
Buy PL equity. Based in Canada, PL is a private equity backed, growing renewable energy company that has experienced a challenging few months operationally which has led to its stock losing nearly half its value from the September highs. The stock now trades 16% below last year’s IPO price even as the business is much larger and more valuable today. The Company reports its Q4 and full-year results later this week where they will likely provide investors an update on their operational issues and as a result, there might be additional short-term downside in the stock if I’ve underestimated the materiality of their problems. The operational challenges, some self-inflicted and others outside their control, appear to be fixable and should not derail the longer-term growth trajectory of the business. With $5.0bn of contracted backlog (weighted average remaining life of 9+ years) with high quality customers and a favorable environment for additional high ROI growth initiatives, PL is poised to generate significant cash flow over the next decade.
With the stock currently trading at ~8.0x depressed FY19 EBITDA (and at a low-teens FCF yield), I believe the market is underpricing the Company’s prospects. Even if you assume a one turn contraction in the multiple to 7.0x, the stock could be worth ~$13.65/sh (+45%) by the end of next year based on my FY21 EBITDA estimate. Along the way, investors would also clip a healthy dividend yield, currently at 6.4%, which may grow as newer contracts in the backlog come online and start generating cash flow. Like it or not, this is a growth oriented company and with that comes execution risk (like the kind PL is experiencing right now) but also opportunity given the low transaction multiples (4.5 – 5.5x EBITDA) at which the Company can grow its backlog without equity dilution – any additional accretive acquisitions and/or expansion projects would provide upside optionality to the thesis.
In addition to growth execution risks, there’s no shortage of regulatory/policy risk with a name like this. Burning wood pellets for energy is super controversial and the massive subsidies allocated to it are even more so. To be honest, the ongoing debate between the climate/environmental experts relating to this topic is way beyond my brain capacity and so the best I can do is focus on the current policies in place and actively monitor any potential changes to them. While the policies are currently very favorable, you don’t need to be a rocket scientist to realize that any negative announcement from governments or customers that decreases the usage of wood pellets would be bad news for PL and its peers. What happens in 2027 with the U.K. subsidies expiring, and to a lesser extent with Brexit, is the major risk to the investment thesis. Given the recent news flow, I think the base case has to be that the subsidies will not be renewed and that U.K. wood pellet imports will decline significantly. This would then suggest that pellet pricing would also take a hit taking down the profitability for the entire industry as they deal with excess capacity. What’s not clear to me is how much of the U.K. volume will be replaced by the Asian countries such as Japan and South Korea, which are aggressively growing their imports of wood pellets from North America and elsewhere. I believe this risk of lower profitability post 2027 for the Company and industry is already baked into the valuation today.
Founded in 1989 as one of the first wood pellet producers, PL is now the third largest in the world after Enviva and Graanul. Industrial wood pellets are used as renewable fuel for electricity generation by utilities and large-scale power generators around the world to produce renewable and reliable baseload power. They can be used in converted coal power plants, newly constructed dedicated biomass facilities and are also co-fired in coal power plants. Industrial wood pellets are handled much like coal by power plants – they are milled into powder, mixed with air and blown into a boiler for combustion to heat water, which produces steam to turn a turbine and generate electricity. Industrial wood pellets are a low-cost and green substitute for coal. Many believe that life-cycle greenhouse gas emissions from the use of industrial wood pellets are lower than that of coal, with approximately 75% less ash content and approximately 80% less sulfur. PL operates nine production facilities with a combined run-rate production capacity of 2.2mm+ metric tons per annum (MPTA). The Company went public in February 2018 at $11.25/sh. Onex Corporation owns 31.6% of the Company.
With the exception of the Alabama facility just recently acquired, the Company’s facilities are strategically located in highly concentrated forest products regions of B.C. and Alberta, adjacent to Canadian National Railway rail lines and on back-haul trucking routes in key wood fibre regions, providing access to wood fibre supply and enabling efficient, cost-effective transportation of renewable biomass fuel. The Company’s plants process a variety of non-traditional forest product residuals (including bush grind, bark, and bio logs), in addition to traditional forest product residuals (including shavings, sawdust and chips). The majority of its wood fibre is sourced under long-term contracts with high quality forest products companies typically with exclusivity on residuals produced by their processing facilities near PL’s plants. The Company has secured wood fibre supply through 2021 for approximately 85% of its raw material needs. Industrial wood pellets produced in its facilities (or purchased from third parties during shortages) are transported to one of two port terminals in B.C. that export industrial wood pellets: its wholly-owned Westview Terminal at the Port of Prince Rupert in Northern B.C. or the Fibreco Terminal at the Port of Vancouver. Ownership of Westview creates a competitive advantage by reducing rail, port and ocean demurrage costs for industrial wood pellets produced in its facilities. In summary, the operations are nicely vertically-integrated – wood fibre is procured under long-term contracts, then shipped under long-term contracts with reputable shippers that match the life of the supply contracts with large utility customers. This vertical integration and the ability to process all types of residuals provide PL a significant competitive advantage over smaller operations.
Below is a map of the Company’s facility network: