Ormat Technologies (NYSE:ORA) is a pure play, vertically integrated company that builds, operates, and owns geothermal and recovered energy power plants. Ormat sells electricity from its owned geothermal plants according to long-term purchase agreements with other electric utility companies. Ormat also designs, manufactures and assembles power plant components in-house.
Ormat's IPO was completed in 2004, and in recent years Ormat has grown its earnings steadily, which the market has noticed. Since 2009, the year after ORA's last post-IPO share offering, the market price has been generally correlated to earnings. A thesis for a long position therefore requires a conviction that per-share earnings should continue to grow. This article will examine ORA's past performance and future prospects.
Ormat has two main business segments: Electricity, and Product. The Electricity segment consists of building, owning, and operating geothermal power plants around the world, selling the generated electricity. As of the end of 2015, Ormat owned 697MW of generation capacity worldwide. Ormat's owned geothermal plants are distributed as follows:
ND, SD, MN, MT, CO
The Product segment is the design, manufacture, sale, and maintenance of geothermal and recovery energy generation equipment. As of the end of 2015, Ormat has installed over 2000MW of generation capacity worldwide.
In the 2015 10-K, Ormat expressed interest in venturing into Energy storage, providing power to Commercial & Industrial clients, and large solar photovoltaic generation plants outside of the United States, such as in Latin America and East Africa. These prospects will not be discussed in this article as Ormat did not report any significant projects, revenue, or earnings figures.
Intrinsic Competitive Advantages (Extracted from 2015 10-K)
Vertically integrated business with an experienced management team. Ormat explores and drill wells using in-house resources, Ormat designs and manufactures all the major components of their generation plants. Ormat does not need to significantly rely on outside resources or other businesses for its operations, so Ormat is fully accountable for all delivery of services they promise. Ormat has been in operation for over 50 years.
Internally developed patent portfolio & patent pipeline. Ormat has 72 patents in force in the US, with 30 patents pending. Ormat's 2015 10-K did not provide any insight about which, how many, or in what way these patents are significant to maintaining their competitive edge. A conservative attitude would entirely discount the commercial value of this patent portfolio, and only note that Ormat independently generates and possesses unique & defensible intellectual property. A full list of Ormat's patents can be found here.
Pricing advantages & friendly legislation. National and subnational jurisdictions around the world have renewable energy portfolio goals, and provide financial incentives to companies to build renewables. Geothermal energy is one of the cheapest sources of energy on a levelized cost of energy basis, since it has no fuel expenses. Ormat also claims that their geothermal plants generate energy at a competitive price. Again, a conservative attitude would drive us to only concede that their business is profitable given the current tax benefit and subsidy structures. Ormat's 2015 10-K did not comment on their hypothetical profitability in an environment totally lacking governmental incentives. Legislation in specific jurisdictions will be discussed in the next section.
Power generation assets & contracts. Ormat sells power from its owned geothermal facilities according to 15-year power purchasing agreements. Geothermal power is considered "baseload" power, since the earth supplies uninterrupted heat. Baseload power is also easier to integrate into the grid, provides grid inertia (dampens voltage/frequency changes), and does not require voltage regulation. This means that Ormat's revenues are stable in the long run, and do not incur service costs that other intermittent sources (solar, wind, etc.) require. For more details, refer to Lazard's Levelized Cost Of Energy (LCOE) Analysis Version 9.0 here.
Lazard's findings state that without subsidies, Geothermal LCOE is $82-$117 per MWh, which compares favorably with Nuclear ($97-$136), unfavorably with Gas Combined Cycle ($52-$78), and unfavorably to Wind ($32-$77). However, the gas combined cycle has fuel price sensitivity; natural gas prices are currently about half of the historical average. Wind power is intermittent, and more difficult to integrate into power grids.
"Ability to finance our activities from internally generated cash flow." This claim is an assertion about Ormat's profitability and ability to grow organically. This will be elaborated more in the Financial Statements Analysis section.
Legislative & Governmental Advantages (Extracted from 2015 10-K)
The jurisdictions where Ormat has the bulk of its electricity generation business have legislation that strongly encourages renewable energy development, including geothermal energy. For the sake of brevity, only those countries where Ormat has significant operations will be discussed here. Further details can be found in the 10-K filings.
Within the U.S.
U.S. federal legislation - Recovery Act (ARRA) grants, under Section 1603. 30% of eligible costs for projects with construction starting before Dec. 31, 2016. This grant tapers down to 10% beginning in 2024.
California's Renewable Portfolio Standards (RPS) was established in 2002, requiring utilities to provide 33% of power using renewable sources. Governor Jerry Brown extended these goals to 40% by 2024, 45% by 2027, and 50% by 2030. Additionally, California has a well-known climate change law which stipulates that greenhouse gas emissions are to be cut to 1990 levels by 2020.
Nevada's RPS is similar to that of California, but less ambitious: at least 25% of power to be generated by renewables by 2020. Under Assembly Bill 239, geothermal projects are also eligible to apply for property tax abatements for 20 years, and local sales and use tax abatements for 3 years.
Hawaii established an RPS goal in 2001. The interim requirements are 15% renewables by 2015 end, 30% by 2020 end, 40% by 2030 end, 70% by 2040, and 100% by 2045. Hawaii's power supply is already heavy in renewables - by 2014 the Hawaiian Electric Company had reached 21.3%, excluding energy efficiency and solar water heating.
Outside of the U.S.
Turkey - Since 2004, Ormat has built 17 geothermal plants, with a collective capacity of 300MW. Ormat currently has 5 plants currently under construction in Turkey. Turkey has the richest known geothermal generation potential in Europe, and the Turkish National Renewable Energy Action Plan has set a goal of 61GW renewable generation by 2023, with geothermal contributing 1.5GW. Turkey also provides feed-in-tariffs at $105/MWh for geothermal sources, for 10 years from the date of commissioning.
Guatemala - Ormat operates 43MW of generation capacity in Guatemala. Guatemala's 2013-2027 Energy Policy targets an 80% renewable energy mix, with 1000MW of geothermal capacity. Guatemala also provides incentives for renewable power generation with import tax exemptions for select equipment.
Kenya - Ormat operates its Olkaria III geothermal complex, generating 139MW of geothermal power. Kenya has vast geothermal potential, and the government has set a target to develop 5000MW of geothermal power by 2030. Kenya provides feed-in tariffs of $88USD/MWh for geothermal installations with 35-70MW of capacity. Kenya also allows an enhanced 150% investment deduction on taxes, as well as 10 years of tax loss deductions.
Financial Statement Analysis
Unless otherwise stated, all income statement and cash flow items were taken from the 2015, 2012, 2009, and 2006 10-K filings, and all balance sheet items were taken from the 2015, 2013, 2011, 2009, 2007, and 2005 10-K filings.
Figure A shows Electricity and Product segment revenues, as well as overall EBITDA and calculated Owner Earnings. EBITDA and Owner Earnings were calculated as follows:
EBITDA = Reported Net Income + Net Interest Expense + Depreciation & Amortization + Tax Expense
Owner Earnings = Reported Net Income + Depreciation & Amortization + Maintenance Capex
Maintenance Capex was estimated for years prior to 2014 by using the reported estimates for 2016, 2015, 2014, from the 2015, 2014, and 2013 10-K reports, and scaling in proportion to previous year revenues.
Calculated EBITDA and Owner Earnings are better metrics of financial performance. This graph shows the predictability of Ormat's revenue, EBITDA, and owner earnings growth.
In 2011, Ormat took a ~$200 million impairment charge to write off a geothermal plant that showed poor performance. The graph shows calculated EBITDA and owner earnings both with and without the impairment charge. Without the impairment charge, calculated EBITDA and owner earnings show that the underlying business were sound, and growing.
Figure B shows the EBITDA margin and Owner Earnings margin, as a percentage of overall revenue.
Without the impairment charge, EBITDA margins were around 40%. Owner Earnings margins were generally 20% - 30%, with the exception of 2011.
Figure C shows the historical sources of financing (bars), as compared with calculated EBITDA, Estimated growth capex, and Net Interest Expense. Estimated growth capex was calculated as the total capex minus estimated maintenance capex.
ORA depended heavily on financing by share issuance during 2004-2008. After that though, ORA only relied on long term debt, and began to receive grants under the Recovery Act, Section 1603. ORA has elected to receive the cash grant, worth approximately 30% of eligible costs of a geothermal facility.
2015 was a turning point for ORA, the first year of growth that was funded almost entirely by owner earnings. However, given the revenue growth trend, it looks unlikely that ORA can sustain its current 6% revenue growth rate only using its owner earnings.
Since 2011, Ormat's EBITDA to Interest expense ratio decreased, as a result of growing EBITDA
Figure D shows the evolution of the composition of ORA's balance sheet, from 2004 to 2015. Balance sheet items were extracted from the financial statements from the 2015, 2013, 2011, 2009, 2007, and 2005 10-K filings.
The majority of assets are production facilities and construction in progress, typical of a utility company. Construction in process has fallen as a fraction of long-term assets during recent years. This indicates that ORA's pace of growth has moderated.
The changing composition of ORA's long-term debt is worth noting. In 2010 and 2011, full recourse debt was around 60% of the total long term debt, while by 2015 that fraction had fallen to ~30%. The simplest interpretation is that ORA's creditworthiness has slightly improved since 2009.
A cursory glance at the Q1 2016 quarterly report shows that the average interest rate on the long-term debt is around 6.5%.
Figure E below displays the minimum debt repayments, as of Dec. 31, 2015.
Year Ending on December 31
There is an upcoming maturity wall in 2017 with payments totaling $313 million. This is unlikely to be an issue, since total current assets as of Dec. 31, 2015 and March 31, 2016 were $375 and $380 million, respectively. It seems unlikely that Ormat would repay all 100% of the debt with cash, given the low interest rate environment in the U.S., and the abundance of investment opportunities.
ORA currently pays a ~1% token dividend yield. We should not want ORA to return capital through dividends given that ORA has so many opportunities for growth both in the US and internationally.
From 2004 to 2015, owner earnings grew from $43.5 million to $202.5 million, which is equivalent to a 15% CAGR. Given the signs from the balance sheet and from the linear shape of the revenue and owner earning lines from Figure A in the Financial Statement Analysis section, revenue and earnings growth is no longer as "explosive" as they were immediately after IPO. To provide a more conservative estimate of where the share price may be in the near future, an earnings growth rate of 7% was assumed.
The graph suggests that 9x earnings multiple would be the most appropriate here. Therefore, a 5-year price target would be around $55 to $60 per share.
Disclaimer: I wrote this article purely for research purposes. Price targets are informed estimates, and are inherently imprecise forecasts.
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.