ADA Environmental Solutions (ADES) is one of the few publicly traded companies that provide cost-effective technologies that reduce emissions and enable coal fired power plants to meet the new regulations. The business plan to monetize on their clean coal technology is compelling. In fact, they plan to grow pretax earnings from $2.5M in 2011 to a run rate of $50M/year by the end of 2012.
ADES is the market leader in mercury control technologies, providing a suite of solutions such as Activated Carbon Injection systems, Refined Coal, and Enhanced Coal (licensed to Arch Coal, (ACI) ). Based on our estimates, the share price can easily trade from the current share price of $20 to $50/share in 2012.
On December 16, 2011, the US Environmental Protection Agency (EPA) finalized sweeping regulations to reduce mercury and other toxic air pollutants from coal- and oil-fired power plants. These standards ended 20 years of industry uncertainty. The new requirements will reduce mercury and other toxic air pollutants that can damage children's developing nervous system, cause cancer and respiratory illnesses, and impact the fishing industry through water contamination.
When the Mercury and Air Toxics Standards, or MATS, is fully implemented, the EPA estimates it will save thousands of lives, prevent more than 100,000 heart and asthma attacks per year culminating to health care savings of $37 billion to $90 billion, and eliminate approximately 540,000 missed work or sick days, improving worker productivity.
Refined Coal - The Core Business
MATS mandates 1,400 coal and oil-fired power plants to reduce emissions of mercury and acid gases. Power plants are currently the dominant emitters of mercury (50%), acid gases (over 75%) and many toxic metals (20% to 60%) in the United States. The EPA estimates that this will create more than $9 billion per year market for emissions control. ADES recently placed in service 26 Refined Coal machines, using its proprietary CyClean and M45 technologies.
At the simplest level, a proprietary cocktail of chemicals is added onto sub-bituminous coal feedstock, preventing the mercury in the coal from becoming "volatized" as gas during combustion. This facilitates an easier and more cost-effective method of capturing pollutants. Post-combustion, the ash remains as macroscopic particles that can be captured using conventional technologies such as electrostatic precipitators, baghouses and particulate scrubbers.
ADES has guided a low-risk EBIT of up to $50 million from its Refined Coal activities by the end of 2012 for the next 10 years. This assumes that ADES is able to process approximately40 million tons of refined coal per annum. Consensus EBIT for 2011 and 2012 is approximately $2.5M and $21M; hence, it is trading 2012 P/EBIT = 10x. Should ADES execute on its 2012 plans to process 40 million tons of refined coal, the P/EBIT = 4x, making the current share price very attractive from a fundamental standpoint.
Clean coal and air pollution control firms such as Fuel Tech (FTEK) trade at 2012 P/EBIT = 12x. Should ADES execute on its operating plans, the target share price can trade up to $50/share, or 127% increase from current share price valuation. Even if ADES achieves a portion of its plan in 2012, we expect significant share price appreciation. The Refined Coal business segment is expected to generate the lion share of the operating profits in the near-term.
Currently, ADES has 2 CyClean or Refined Coal facilities operating for two years with Associated Electric Cooperative; hence, their technology is field tested and proven. Facilities in Thomas Hill and New Madrid are expected to generate about $20 million in revenue and $7 million in pretax earnings in 2012. Because the 26 Refined Coal facilities have been placed in service, utilities that choose to use ADES technology will benefit by receiving approximate $1/ton of the $6.33 per ton credit from US Internal Revenue Services for every ton of refined coal processed.
The tax benefit to the utilities last for 10 years and provides incentives to coal-fired power plants to adopt ADES' technology that reduces nitrous oxide and mercury by approximately 20% and 40% respectively. Utilities just have to say "yes" to ADES and they will be able to receive the IRS tax benefit with minimal costs and disruption to existing operations.
Figure 1: One of ADES's Refined Coal Facilities
Based on the monetization structure, ADES benefits by receiving upfront deposits of approximately $1/ton to $3/ton, which is accretive to cash (example: 6 million ton facility may generate about $9 million in upfront deposits). The upfront deposit is essentially prepaid rent for using ADES equipment. 40 million tons of coal processed, in aggregate, should generate up from approximately $50 million to $100 million (average estimate is around $70 million) in upfront cash deposits to ADES. In summary, with 26 new and 2 existing facilities online, expect ADES to generate greater than $70 million in upfront cash, $100 million in operating revenue until 2021, and $50 million in yearly EBIT until 2021.
Emission Control Business - Upside in Activated Carbon Systems
The Emission Control Business provides optionality upside to the stock. To date, ADES has sold Activated Carbon Injection or ACI equipment/systems to power plants producing more than 20 GW of electricity. Currently, ADES has installed or installing ACI systems on 55 boilers at coal-fired power plants. ADES has approximately 35% market share of the 159 boilers with mercury control mandates in place. With the new MATS regulations in place, we expect the many more boilers will turn to ACI systems to reduce mercury emissions.
Figure 2: Location of Plants using ADES ACI solutions
MATS is expected to create a $500 million market for ADES and other ACI system providers. Currently, ADES is in the procurement process with several utilities on ACI equipment. Powdered Activated Carbon is pneumatically injected from a storage silo into the flue gas stream of a coal-fired power plant or industrial boiler. Activated carbon is a form of carbon that has been processed to make it extremely porous and thus have a very large surface area available for absorption. The PAC absorbs the vaporized mercury from the flue gas and is then collected with the fly ash in the facility's particulate collection system. ACI systems can reduce mercury by more than 90%. Equipment costs approximately $600,000 to $1 million for average sized coal-fired plants.
Figure 3: Timeline of Opportunities for ACI Equipment in $Million
Low-Cost Option to Wet Scrubbers - Dry Sorbent Injection Equipment
Along with Activated Carbon Injected systems, ADES also provides Dry Sorbent Injection, or DSI systems, as a lower cost option to wet scrubbers, which can cost tens of millions of dollars. ADES DSI solutions address new environmental regulations to control acid gases such as HCL, SO3 and SO2. The EPA predicts that over 200 systems will be needed by 2015 and ADES provides the equipment at price of $2 million to $3 million for an average coal-fired plant
Longer-term, ADES is working with utility firms such as Southern Company (SO) to capture CO2 through lower cost materials and regenerable solid sorbents. Most competing technologies use liquid solvents such as ammonia, which have other environmental consequences. Currently, Arch Coal has a technology license with ADES. The intent is to enable Arch's Powder River Basin coal to burn with lower emissions of mercury and other metals. The royalty agreement allows ADES to receive up to $1/ton on enhanced coal sales. The initial market will be in states with mercury regulations already in place. The market is expected to develop by 2015. Other coal mining firms in the Powder River Basin include Peabody Energy (BTU) and Alpha Natural Resources (ANR).
The EPA has mandated stringent emission regulations that will create new opportunities for firms able to offer mercury and air toxin reduction solutions. ADES has proven solutions and an executable plan that benefits both shareholders of refined coal and coal-fired utility firms. Near-term catalysts for ADES include continuing updates on the qualification of the 26 refined coal facilities and new contracts for ACI/DSI equipment. Updates will provide more confidence to the investment community on project completion and will reduce risk at the project-level. Based on expected Refined Coal sales, the current valuation looks compelling at P/EBIT = 4x. ACI and DSI equipment sales are icing on the cake and are a call option on the stock. For the environmentally conscious or savvy investor, ADES is fundamentally compelling.
Disclosure: I am long ADES. Connective Capital is long ADES and we have no plans to trade this position within the next 72 hours.