There are only two pure geothermal plays listed on major exchanges: Polaris Infrastructure (OTCPK:RAMPF) and U.S. Geothermal Inc (NYSEMKT:HTM). In this article, I would like to do a quick review of the recent developments at these plays.
In 2015, Polaris was restructured from top to bottom. The company reduced its debt load, issued new shares and changed its management. Although the former shareholders were sent away empty-handed, Polaris got its second chance.
Currently, the company operates only one geothermal plant, located in northwest Nicaragua. The plant, called San Jacinto, generates around 430 thousand megawatt hours a year, which is equal to operating revenue of roughly $50 million. The company signed a power purchase agreement (PPA) with a large Nicaraguan power distributor, which expires in 2029.
San Jacinto is an established plant - it delivers steady revenue from year to year (plus 3.0% - 1.5% per year price escalator embedded). It means that, basically, the company should generate stable revenue until 2029 (when the PPA expires). On the other hand, Polaris could increase its production - San Jacinto turbines have a capacity of 72MW, of which only 78% is utilized. To do it, the company has to drill new production wells. Currently, there are eight production wells, drilled between 1994 and 2011. Each well has a capacity of 2-14 megawatt (around 56 megawatt in total).
In 3Q 2015, the company started its drilling program at the San Jacinto property. The program comprises drilling three production wells, of which one well had been successfully completed in December 2015 (it should start production in 2H 2016). The other two wells should start production (if they meet technical parameters) in late 2016 and early 2017.
In its last presentation, the company has delivered an interesting formula to calculate the financial input provided by production wells. Simply put, one megawatt of power is equal to $1 million in the annual EBITDA. One production well has the average capacity of 7MW (it is just an estimate - capacity may vary, depending on some geological conditions), so putting the first new production well in operation in 2H 2016 should increase the annual EBITDA from around $40 million to $47 million.
It looks like the company is confident that its drilling program is going to be a success. As a result, in 1Q 2016, it initiated its first dividend program, declaring that it would pay a quarterly dividend of $0.1 per share. It means Polaris is going to pay an annual dividend of $6.4 million - which is, more or less, the EBITDA generated by the average new well.
At this point, let me propose this somewhat funny estimate - each new production well added to San Jacinto should increase the quarterly dividend by $0.1 per share.
Summing up - in my opinion, Polaris, after experiencing a radical change, is now a decent energy play. It is delivering stable revenue, carries serviceable debt and has just started its first dividend program.
Relevant risk factors:
- The company operates only one power plant - any work stoppage, whatever the reason is, may have a negative impact on its financial results.
- Polaris is currently assessing a change in San Jacinto geothermal technology (into a binary one) - if the company decides to change it (and spend $25-30 million), it may temporarily halt paying dividends.
U.S. Geothermal Inc.
The company operates three geothermal plants, located in the United States. Additionally, US Geothermal has six geothermal projects under construction. Below, I am delivering a short review of these operations and projects.
Power plants in operation
The company runs the following power plants:
- San Emidio in Nevada - net capacity of 9 megawatts
- Raft River in Idaho - net capacity of 13 megawatts
- Neal Hot Springs in Oregon - net capacity of 22 megawatts.
Of these operations, San Emidio and Neal Hot Springs are the leading plants. Raft River is a laggard. The chart below shows the operating profits (losses) delivered by each plant in 1Q 2016:
Source: Simple Digressions
It should be noted that this situation (two plants outperforming and one being a laggard) has been typical for US Geothermal for many years. However, despite having a laggard, this mix of power plants delivers relatively stable, or, better said, slightly increasing, revenues and cash flows. In my opinion, it could be a desirable feature of any utility company, but there is one problem.
In the company's financial statements, all plants are presented under the consolidation method of accounting, where the so-called non-controlling interest plays a significant role. It means that only part of earnings or cash flows, delivered by power plants, is attributable to US Geothermal shareholders (in one of my articles on the company, I discussed this issue in detail, so refer to this article if interested). The chart below shows this situation, using free cash flow as an example:
Source: Simple Digressions
- Free cash flow is defined as cash flow from operations less cash flow from investing activities.
- Free cash flow attributable to US Geothermal is defined as free cash flow less distributions to minority interests.
Well, it looks like that situation is going to stay here. In December 2015, the company signed an agreement with Goldman Sachs to acquire the majority of its cash flow interest and ownership of the Raft River power plant. To remind my readers, Raft River (the lagging power plant) is a joint venture between the company and a Goldman Sachs subsidiary. It is quite a complicated joint venture - let me cite the company (1Q 2016 Report, page 21):
"The initial contracted terms stated that the Company would be allocated 70% of energy credit sales and 1% of the residual income/loss excluding energy credit sales. Under the terms of the amended agreement that became effective December 16, 2015, the Company will receive a 95% interest in Raft River's cash flows. Under the terms of both agreements, Goldman Sachs receives a greater proportion of the share of profit or losses for income tax purposes/benefits. This includes the allocation of profits and losses as well as production tax credits, which will be distributed 99% to Goldman Sachs and 1% to the Company during the first 10 years of production, which ends December 31, 2017."
Using reader-friendly wording:
- In exchange for financing, Goldman Sachs has the right to utilize 99% of the production tax credit, allocated to Raft River due to the fact that it is a renewable energy project.
- According to the December 2015 agreement, starting from the beginning of 2016, the company will be receiving 95% of Raft River's cash flow (it was only 70% previously).
Generally, it does not change much. Raft River is an unprofitable operation, and it generates no distributable cash flow. However, from now on, the company is more interested in increasing Raft River's capacity, because the entire cash flow generated by any Raft River upgrade will be attributable to US Geothermal (in 3Q 2016, the company plans to add 3 megawatts in additional capacity).
To summarize, three operating power plants are a source of stable income and cash flows. However, a big part of these earnings and cash flows is utilized by non-controlling interests - earnings and cash flows by Enbridge (it has a 40% stake in Neal Hot Springs) and tax credits by Goldman Sachs. In other words, there is little left for the company's shareholders.
Projects under construction
The table below presents the current portfolio of projects under construction:
Source: US Geothermal
As the table shows, three projects (Raft River, Neal Hot Springs and San Emidio) are extensions of current operations. These projects should be implemented till the end of 2017. As a result, the total capacity should increase by 16 megawatts (from today's 42 megawatts to 58 megawatts, an increase of 38%), of which 14.8 megawatts will be attributable to the company. I roughly estimate that 1 megawatt of additional capacity is equal to $0.4 million in annual EBITDA (in 2015, the company's EBITDA was $16.4 million and the total capacity was standing at 42 megawatts). It means the planned extension of operations should deliver around $6.0 million in additional EBITDA ($0.054 per share). In my opinion, this may be a turnaround story for the company. Increasing the EBITDA attributable to US Geothermal shareholders from today's $10 million to $16 million could transition US Geothermal into a dividend-paying company.
The other projects (WGP Geysers, El Ceibillo and Crescent Valley) are still in their early stages of construction. Each quarter, US Geothermal delivers some info on their development, but in my opinion, it is not crucial for the company (for example, no project has a power purchase agreement signed).
Below, I have plotted the chart showing current valuations of a few geothermal plays:
As the chart shows, Polaris is undervalued against its peers, while US Geothermal seems to be quite richly valued.
Ormat (NYSE:ORA) is a giant geothermal solutions provider. Apart from that, it runs a few geothermal power plants all over the world
Alterra Power Corp. (OTCPK:MGMXF) is a renewable energy producer operating four green power segments: geothermal, wind, solar and hydro.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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