U S GEOTHERMAL INC HTM
May 07, 2017 - 4:52pm EST by
mm202
2017 2018
Price: 4.20 EPS 0 0
Shares Out. (in M): 19 P/E 0 0
Market Cap (in $M): 80 P/FCF 0 0
Net Debt (in $M): 5 EBIT 10 0
TEV ($): 85 TEV/EBIT 8.5 0

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Description

Thesis:  US Geothermal offers low downside supported by assets and over 25 years of predictable cash flows at 15% FCF yield with lots of optionality on announcements of signing of PPAs to move the stock up 100% to 200%. The recent “removal” of a promotional CEO by the board shows they are getting discipline and in my opinion increases a likelihood of a sale to a strategic or private equity buyer.

What is HTM right now?

Market cap: $80mm at $4.20 stock price.

Debt (tricky) … depends on how you look at it and I don’t want to make it overly complicated but I guess I'll have to

It’s a collection of 3 geothermal plants in Idaho, Nevada and Oregon each with 20-25 year contracts.

1.    Neal Hot Springs, Oregon: 22 MW/25 year contract, 60% owned by HTM/40% owned by Enbridge, provides $8mm in cash flow to parent growing 1-2% a year.  Neal has $60mm in debt, $15-16mm in restricted cash (for DOE) to offset debt.  So net is approximately $45mm and HTM portion is $27mm. Its up to you as an investor to decided whether this debt should be added to enterprise value or not. For me, its non recourse project debt (2.5%) and the equity holders do not bear responsibility for default.

Raft River, Idaho: 10MW/25 year contract, 95% owned by HTM/5% owned by Goldman (99% of tax credits to GS). Provides approximately $2.0mm in cash flow to HTM growing 1-2% a year. It has no debt and about $6mm in restricted cash.

3.       Sam Emidio, Nevada: 10MW/25 year contract, 100% owned by HTM. It provides approximately $2.5mm in forward cash flow to HTM parent, growing 10% year+ because of heavier debt load/interest expense which gets paid down regularly (Interest expense $2mm). Prudential Debt is $29mm at 6.75% and has about $4mm in restricted cash.  The equity holders do not bear responsibility for default.

4.       The parent has a 5.8%, $20mm corporate group loan with prudential backed by Neal and Raft river. Parent has option to issue another $50mm in next two years. The parent also has $15.3mm in unrestricted and restricted cash. Net debt of $5mm. The equity holders have recourse to this debt.

So to recap before we get into other projects/parent costs:

The parent receives approximately $12-$12.5mm in cash flow growing 3-5% a year before corporate costs from the 3 plants it owns. The plants either have $46mm in net debt and another $5mm in net debt of parent debt for a total of $50mm or HTM stock holders bear responsibility for about $5mm in net debt.  Since project debt is non recourse, for purposes of this analysis I am choosing to look at it from perspective of $5mm of net debt or enterprise value of $85mm. THIS IS VERY DIFFERENT FROM WHAT IS REPORTED on databases etc, because of consolidation accounting etc.

Before we get to what happens with the $12-$12.5mm the company which owns a net of 40MW of geothermal producing power is engaged in 2 small but very high ROIC projects in Neal and Raft river to add 3MW and 3MW of capacity by end of 2017 and should increase cash flow to parent on a 2018 run rate by $2.0 to $2.5mm. I am fairly confident in the completion of these low capital cost projects. While I am not by any means an engineer adding a cooling pool to Neal and expanding hole capacity/flow through at Raft Rifer are not high risk of incompletion projects.

So now as we look forward to 2018 cash flow the company should start to receive regularly $14mm to $15mm cash flow from its 3 projects and should bear a $1mm in interest expense from the Prudential loan. What does it spend it on:

In 2016 the company incurred:

- $1.3mm in admin costs of which $.15 was for storage of 35 MW of plant equipment acquired (great deal to be discussed later). This will no occur in 2017/2018. So $1.2mm is a good run rate estimate here.

- $1.6mm in professional fees. This was very annoying as in 2016 the company blew $600k on a non-sense “strategic review” that resulted in nothing really. The run of $1mm is a good estimate here.

- $0.3mm in “promotion costs/travel/conference” … too much but whatever.

Total: $2.5mm

- “Compensation” – 2016 was $3mm. Of this $1mm was non cash compensation. Denis Giles the CEO received $800,000 last 2 years of which $500,000 - $550,000 was cash for him.  He came highly recommended and to be fair he righted the ship to get the company to the point where it is producing solid recurring cash flow and lots of potential projects (to be discussed below). However, he seemed like an empire builder and wanted to get this company from 40MW to 200MW in next 4-5 years without having delivered A LOT (he has delivered though, so lets not mistake that). He was just too promotional for my taste. $800k for an $80mm firm was entirely too much. In April 2017 the board has decided not to renew his contract because he was asking too much. I think Doug Glaspey will take over (total comp $330,000) and I think Doug is a capable guy. Or they will find someone else. But either way the company wont be spending $800k a year on a new CEO.

So a good run rate going forward I believe is $2.5mm and cash expense of $2mm.

- Taxes: The company has $102mm in Net Operating Loss Carryforwards. The company does not pay taxes. At a 35% corp tax rate the $35mm in undiscounted value of NOLs with 20.8mm of shares of stock outstanding (19mm + 1.8mm in options + .4mm in warrants) I think assigning a $1.00 per share in NOL value is a good estimate.

So final recap of CURRENT cash flows and capital structure:

- 19mm shares at $4.20 = Market Cap $80mm

- Parent level debt: = $5mm

Enterprise Value $85mm

- Cash flows from assets (2017/2018 run rate): $14-$15mm

- Parent level cash expenses: $4mm to $5mm

Free Cash Flow: $10mm a year, growing 3-5%. On a fully diluted basis this is about $0.45 to $0.50 per share.  Keep in mind this is a low maintenance capex biz and most of its expensed at plant level.

In addition you get: $1.00+ in NOLs (though maybe double counting if not using taxes to calculate FCF) and 35 MW of brand new capital equipment (3 plants company bought in 11/2015 at 95% discount).  Based on company’s capital cost estimates the cost to build new MW plants is about $5-$6mm and right now you get net 40MW of relatively new and $35mm of brand new equipment for about $1.2mm/MW replacement cost.

Bottom line: I think at a current valuation of 12-15% highly predictable, though low growing, FCF yield, and .2x replacement value plus $102mm in NOLs, the current price provides a significant margin of safety.  In general, I think the company should be trading 15-20% higher just for being too cheap but that’s an opinion based on owning this for a few years. Not a fact. The real appreciation will be from projects discussed below.

PS: A PE/strategic can easily take out $2mm-$2.5mm in prof costs (Exec salaries, professional services, etc) in addition to refinancing corp debt at lower rates or even levering for the cash flow. AES/Ormat/Enbridge come to mind.

So whats the real value here or what will make HTM appreciate in price?

HTM has about 115MW in capital projects on the drawing board. Before I get into individual project names (and I don’t want to get into a big geothermal discussion here, I think its up to the investor do make their own industry conclusions) but realistically the industry risk profile is pretty stratified. On the one hand you have pretty risky “E&P/wildcatting” type of risk.  You are drilling holes in potential areas (sometimes even using oil rigs) looking for the best heat and permeability holes. Lots of hits and misses which ends up being a risky proposition.  On the other hand, once a site is identified and the proper permits are in place, the financing is not hard to line up (DOE provides a lot), there are 30% tax credits that you get back relatively quick, construction is not complicated though takes 12-18 months and usually signed to 25-30 year periods with utilities. Unlike other alternatives (solar and wind) geothermal is considered the most reliable source (in wake of droughts in the West, even more reliable than hydro) and is bought as baseload by utilities for pretty high price (HTM’s contracts are $66 to $102/MWhr for 25-30 years growing at 1-2% year escalators).  One of the reason HTM is attractive for me is because most of the REALISITC projects it has on the drawing board are closer to the latter phase of development vs the risky exploratory stage.

For me HTM has 2 very realistic projects on the drawing board which are waiting to have PPAs signed (also why Denis Giles have underdelivered).

- Geysers, CA – 30MW, expected capital cost $150mm, 30% tax credit qualified. This was a nice buy by Denis Giles a few years ago who use to be the geothermal chief of Calpers which owns 800MW of capacity in that area. This project is essentially developed, all permits received and is in the process of bidding on many RFPs in California to get a PPA.  Could potentially come online in early 2019.  My estimates based on MW price of $60 to $100 the FCF to parent could be $4mm to $12mm a year and at a 12.5% discount rate can add anywhere from $1.00 to $$3.00 in value to the equity price.  Interesting dynamic is that this is not necessarily a utility based purchase but potential a community or a commercial purchase from someone like a Monterey Bay Community Power or Google/Facebook. I assign a low risk to this project not happening because at worst, if the company is unable to get a PPA they can sell steam which would be a lower capital cost project and a more immediate cash flow impact however, unlikely as lucrative.  I am not familiar with these types of deals so I wont comment on value added but I think adding $1mm to $3mm to parent cash flows is likely.

Sam Emidio II, Nevada – 35MW this was a great development. The binary 35MW of plants purchased in 2015 should be very useful here. Basically HTM had the option to add 10-12MW to the existing plant and has spent a few years looking at hot holes.  As a shareholder it was a little bit annoying to see how long this took but all the sudden a few months ago the company announced that instead of the 10-12MW this site was actually 35MW to 43MW or proven power. This should bring $6mm to $12mm to the parent and add $2.00 to $4.00 per share in DCF value.  While the company has an agreement to add this to existing PPA with Nevada Energy since it’s a much bigger project, its likely to go back to the drawing board with PPAs which could be sold to CA as well. With Vegas casinos willing to leave the grid and purchase power in the open market (https://www.bloomberg.com/news/articles/2016-05-20/vegas-casinos-plan-to-leave-warren-buffett-s-nevada-utility) I also believe this project has a good chance of succeeding.

Other: I would recommend browsing 10-k/presentations for other projects including one in Guatemalla and other Nevada/Oregon/Idaho ones however they are so far off and in my mind have a low probability of happening during my investment holding period I am not assigning any value to them.

So from my perspective for 4.20 you are buying a 15% FCF yielding company with upside for another 100-200% if the company announces its PPAs in the next 12 to 24 months.  

Risks/Dislike

- CEO transition is never easy but I view this as a positive. I think Doug Glaspey would be good. A sale would be better.

- The company is incredibly insecure about its stock price. It talks about it non stop. I have discouraged it from talking about it/publishing valuation metrics. I think they will lower this discussion going forward.

- Operational risk always happen. A blown pump here, a downtime there but for most part this is covered by insurance and is par for course.

- High capital intensive projects. Needs govt policy (who knows with new DOE head Rick Perry) to keep ITC credit, liquid markets etc. Company’s $50mm credit line with Prudential and $15mm cash on hand plus incoming cash flow should allow it to complete/finance at least one of the two projects without having to find a partner.

- The management team is getting better. They are learning now that this is a real company. Last year they had the strategic review which they announced a stock buyback. A few months later they had to go to their equity line partner to issue $200k more shares because they couldn’t forecast cash flow correctly (since then the credit line and cash on hand have taken financing/dilution risks off the table). It was embarrassing. Kerry Hawkley, CFO is a smart guy just this was not the best move. I would say their inexperience as a real public company is a dislike.

- I’m watching battery storage development. We’re still a far way from making solar and wind as reliable and competitive to be base load with same economics as HTM but it could be a game changer which would make future projects less lucrative.

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

- Completion of Neal and Raft river low risk projects

- Announcement of PPAs for Geysers and Sam Emidio

- Sale of Company

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