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Advanced Emissions Solutions: A 9% Yield, Capital Gains Upside, And Some Risk

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About: Advanced Emissions Solutions, Inc. (ADES)
by: Wealth Insights
Wealth Insights
Dividend growth investing, long-term horizon, dividend investing, portfolio strategy
Summary

Advanced Emissions Solutions, Inc. offers investors an eye-popping dividend that is yielding more than 9%. Despite its outsized yield, it's currently covered by the company's financials.

The business is projecting a surge in cash flow from its coal business through the end of next year. After that however, the risk will be cranked higher.

A risky micro-cap stock, a low valuation offers significant upside over the next 18-24 months if catalysts come to bear fruit.

Advanced Emissions Solutions, Inc. (ADES) is a relatively small company that happens to pay a big time dividend. In a low interest environment, the company's current 9% yield can be a bit eye-popping. Oftentimes, large yields can come with a lot of risk, and the company's business model is set in the coal industry - a sector that is steadily shrinking in the name of climate change concerns. The company is projecting a large influx of cash flow through 2021. This is not factored into a valuation that is already at bottom floor levels. The stock can be volatile and carries execution risk, but significant upside is there if catalysts are realized.

Advanced Emissions Solutions (or ADES for short) is a company that sells products and services used to control pollutants and toxins in the emissions of its customers. The company's customers primarily operate in applications including coal-fired power generation, municipal water, and industrial applications. The company's offerings help these businesses meet emissions and safety requirements by reducing pollutants at various areas of operation.

source: Advanced Emissions Solutions, Inc.

Dividend Analysis

When we examine the company's dividend, there are a number of things we look at. We quantify the dividend's yield, its growth trajectory, and the financials behind it. We also look at the company's business model moving forward to determine what macro-economic forces could impact the business, and the severity.

The yield on the dividend that ADES pays out is what really catches the eyes of dividend investors. The company's annual total payout of $1.00 per share yields 9.08% on the current share price.

source: YCharts

The dividend yield is enormous, and dwarfs the yield offered by more conservative income instruments such as 10 year US treasuries (offering just 1.86%). It's actually pretty remarkable because ADES just has to hold steady on its stock price and continue paying the dividend, and investors are pretty much bagging historical market returns every year (about 10%).

The dividend itself however, really hasn't been around long. It was initiated by the company in 2017, and its annual payout of $1.00 hasn't changed.

This would make the dividend's growth rate 0%, but with such a high starting yield it really shouldn't bother most investors. With such a high yield, most interested investors will be in it for the established dividend anyway.

Cash flow streams have been a bit volatile over time, but the dividend appears to be on pretty stable footing at the moment. The total dividend outlay of approximately $18.67 million is just over half of both cash flows, and earnings.

source: YCharts

The dividend will be well funded for the next couple of years as well. With the upcoming expiration of tax incentives for investments into reducing emissions of coal fired power plants at the end of 2021, the company is slated to benefit from a surge in cash flows. These are projected to total between $150 - $175 million by the end of next year.

source: Advanced Emissions Solutions, Inc.

The cash flows received already over the past year or so have enabled the company to pay down debt related to its acquisition of ADA Carbon Solutions (the deal cost $75 million), as well as buy back a significant portion of its outstanding shares.

source: YCharts

The surplus of cash flow will enable the company to pay down the remaining long-term debt on its balance sheet ($26 million), buy back more shares, and continue paying its dividend. The real questions will come after 2021, as coal is an aging and increasingly obsolete means of power generation.

Business Trajectory & Associated Risks

With sustained low natural gas prices and the continual cost improvements of renewable sources, the increasing scrutiny of coal's large carbon footprint is resulting in its steady demise. Coal production peaked long ago and as plants continue to be taken out of service, production is dropping between 4%-6% per year.

source: EIA

ADES will need to transition its business assets to new industries in order to thrive over the long term. The company's acquisition of ADA Carbon Solutions is supposed to play a large role in that. The Carbon Solutions assets strengthened the company's operations and share of the activated carbon/mercury removal markets. But it also gave the company exposure to water purification for municipal water, and industrials - which use similar technologies.

source: Advanced Emissions Solutions, Inc.

This graphic is essentially management's roadmap to future revenues. Water infrastructure in the United States is currently holding a "D" grade by the American Society of Civil Engineers, so the demand should be there for these technologies. It will ultimately fall on management to execute the long-term transition of this company from its refined coal focus, to a more diverse future. As cash flows from coal begin to dwindle after 2021, things could get volatile in a hurry if management fails to execute.

Valuation

This volatility was on display when the company last reported its earnings in November. The company had a bad miss on analyst estimates, and the stock got pummeled. It has yet to fully make a recovery from that.

source: YCharts

The stock's current price of just under $11 per share is towards the bottom of its 52 week range ($9-$15). With analyst projections for the full year of $2.35 EPS, the stock currently trades at an earnings multiple of just 4.65X. This is a 31% discount to the stock's 10 year median P/E ratio.

source: Guru Focus

What's more, is that estimates for the 2021 fiscal year are much higher at more than $4 per share because of the influx of cash flows from refined coal. Already trading at a minimal earnings multiple, there is significant upside that isn't currently priced into the stock. If the stock holds a rough P/E of 5X, the resulting $20 share price against 2021 earnings alone offers approximate total returns of 100% (capital gains + 9% yield).

Wrapping Up

The upside in ADES hinges on some very specific catalysts. Failure to realize those would be catastrophic on the outcome of any potential investment. However the high yielding dividend is solid for now, and the company's upcoming surge from its coal business provides large potential gains due to a suppressed valuation.

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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.

Additional disclosure: This is a micro-cap stock, and a company that is very dependent on specific factors. This makes ADES a speculative investment. Proceed with caution.