Last fortnight, I asked Supporters to suggest ASX stocks they would like me to write about. (If you haven’t already done so, feel free to make a suggestion here.) Interestingly, there was quite a bit of interest in companies that appeal to investors who want exposure to environmental trends such as water purification and renewable energy. So today, I’ll take a quick look three ASX companies that get paid to improve improve environmental outcomes for society.
Mercury NZ (ASX: MCY)
Mercury NZ is a renewable energy generator in New Zealand, which provides power using wind, geothermal and hydro generation assets. In recent years, the company has seen steadily reducing profits, due to a combination of faults with one geothermal power station, and reducing rains causing its hydro power generation to reduce. Despite this, it has increased its dividend and currently yields about 2.9%.
It is possible for an asset rich company like Mercury to pay out more than its profits in dividends, because many of its expenses, such as depreciation, are non-cash expenses. For example, the company says it made free cash flow of over $282 million in FY 2021, much higher than its statutory net profit of $141 million.
To my mind, Mercury is a mature renewable energy business that could be a good investment for ESG investors who want to invest in a cleaner environment, but without too much risk. While the business itself is unimpressive, the fact that its coming off two very difficult years (with low rainfall) means that one could reasonably hope that things might get better purely based on the weather. Of course, with Climate Change it’s possible that the lower water levels for Lake Taupō may become more permanent.
In August 2021, Mercury “acquired Tilt Renewables Limited’s five operating wind farms in Aotearoa, as well as their future development options to add to our own pipeline of future wind development sites” in New Zealand. This should allow the to find modest growth over the coming years, in a jurisdiction that is far less hostile to renewable energy than Australia.
According to S&P data, the analyst consensus is for Mercury to grow earnings from around 11 NZ cents per share in 2021, to 19 cents per share in 2024. I have my doubts about whether that will happen, but I do at least think Mercury will be paying dividends to shareholders for many years to come. And if the analysts are right, those dividends should be increasing. In the long term, I’d expect slow and steady Mercury to outperform the promotional and hyped up Calix with ease.
Calix Limited (ASX:CXL)
Calix is a company that earns most of its revenue in water management. The vast majority of that revenue comes from IER Water, a recently acquired US business. Calix’s water business seems to principally sell ACTI-Mag, advertised as “one of the safest, most cost-effective and earth-friendly ways to manage hydrogen sulphide, odour, pH and alkalinity, BOD/COD, phosphate and fats/oils/greases (FOGs) in wastewater.”
However, as you can see in the image below, Calix also receives a lot of government incentives, as well as project income from its carbon sequestration project called LEILAC.
Now in order to understand the business better, it probably makes sense to seperate out the ‘real’ business that solves real problems today. For example, Calix’s Aqua-Cal product helped detoxify water at a shrimp farm, leading to healthier shrimp.
It’s not really possible to figure out how profitable this business is, standalone, but we can see that it generates a little under $20 million revenue. Now, for this kind of industrial business, net profit margins of 20% would be phenomenally good. So we can probably safely say that this business couldn’t make more than about $4 million per year in profit, even if it was standalone.
In reality, this business is probably not that profitable. The IER water business that contributes most of the revenue cost Calix less than $10 million to buy, and at the time (in 2019) was slated to add just $1.1 million in EBITDA, not profit. So even though the revenues have improved since then (after dropping from $13.4 million in 2019 to just $9.6 million in FY 2020), you’d be hard pressed to argue the water business could make $4 million in actual real profit any time soon.
Nonetheless, to illustrate how absurd the valuation of Calix is, let’s pretend this business is going to make $4 million per year, and that that will grow, so that it deserves a ludicrous 50x multiple on $4 million, which equates to a valuation of $200 million.
The rest of the Calix business consists of speculative businesses in biotech, advanced manufacturing and carbon capture and storage. The basis for these new business lines is supposedly Calix’s advanced kiln technology. Even assuming the kiln technology has real value, the actual businesses it is investing in do not make revenue from customers. Rather, most of their income is grant revenue from governments that want to push this kind of innovation.
For example, the company has had a lot of luck receiving government money for its carbon capture and storage technology. Of course, in reality CCS has been a complete money sink, but is kept alive by polluting industries and governments who want to pretend that their polluting activities can one day continue in a green way.
Of course, the idea of pumping CO2 into oil wells to sequester it is completely absurd. There is no standardised way of measuring whether the CO2 will actually stay sequestered, and in any event, we already know we can sequester carbon with trees and algae at much lower cost.
Nonetheless, “The Group achieved a significant milestone in its path to commercialise the technology within this segment with a Memorandum of Understanding (“MOU”) executed with ADBRI in Australia, and a second with Tarmac in the UK for the development of lime projects using the LEILAC technology. In June, the Group was part of a consortium that was successful in securing $39m in government funding for the Heavy Industry / Low Emissions Co-Operative Research Centre (“HILT-CRC”) with partners such as ADBRI, Alcoa, Boral, Fortescue and South32.”
That might sound exciting, but the fine print of the annual report gives us a hint to where I think this LEILAC project is going longer term. To quote the report, “The Group recorded a non-cash impairment loss of $3,675,831 relating to the LEILAC project (2020: $3,581,539).”
After much hype and excitement, Calix has a market capitalisation of about $850 million. After valuing the water business at very very generous $200 million (and I do not think it is worth that much) that leaves about $650 million for the unproven speculative businesses with no customer revenue. Clearly, this is well in the league of “speculative meme stock” rather than “value investment.”
First of all, Carbon Capture and Storage, or CCS, (in gas form, underground) has historically found more success as a method for extracting money for greenwashing, than for actually reducing carbon dioxide in the atmosphere. Arguably, it is far much faster for a cement manufacturer to simply plant trees to offset emissions, and use as much renewable energy as possible. In fact, it makes zero sense to try to sequester carbon dioxide that is difficult to avoid (like Calix proposes for cement companies), when we have so much easy-to-avoid carbon pollution coming from petrol vehicles and coal power plants.
For many years, critics have argued that CCS “The technology still faces many barriers, would only start to deliver too late, would have to be deployed on a massive scale at a scarcely credible rate and has a history of over-promising and under-delivering.”
What does make sense is for polluters and their bought-off politicians to keep the dream of carbon sequestration alive, as a tool in the argument to avoid having to actually reduce, re-use and pay a price on carbon. If they can say they are working on a solution, but the technology isn’t ready yet, then they can avoid paying for the damage they are causing now. We know this works, because polluting industries have been using the method for more than a decade.
Indeed, back in 2009 then Prime Minister Kevin Rudd announced the “Global Carbon Capture and Storage Institute”. At the time nature.com reported:
“Australia — the world’s leading exporter of coal, and also a big user of the fossil fuel — will support the GCCSI with up to AU$100m (£48m) per year. The public-private partnership has so far been pledged support from around twenty governments, including the United States and China, and over forty industrial companies.”
But nothing has been achieved in terms of actually helping the environment, in the many years since. In fact, Australia’s only CCS project has been a complete failure. To quote RenewEconomy:
“The operator of Australia’s only commercial-scale carbon capture and storage project has conceded the project has failed to meet its targets, and is now seeking a deal with Western Australian regulators on how to make up for millions of tonnes of carbon dioxide it failed to store.”
To my mind, Calix will end up using a hyped share price and speculative story about sequestering carbon to raise money from both well-meaning ESG investors and capital raising flippers alike. It is important that investors understand that the share price is following a narrative. From a value investor perspective, the stock is probably worth closer to $0.50 than the current share price of $5.30.
Calix will likely attract well-meaning investors who care about the environment but do not understand that CCS is more a public relations solution for polluters, than an actual solution to carbon pollution. If the myriad of CCS projects before them are any guide, Calix will succeed in securing a social license to operate for some large emitters, but it won’t succeed in making profits for shareholders, or sequestering a meaningful amount of carbon dioxide.
In reality, there is no satisfactory legal framework for the pipe dream of gaseous sequestration of carbon (there may one day be a case for mineral sequestration; but that is a long way from commercialisation too).
In existing Australian legislation such as the Barrow Island Act, “liability generally passes from the operator to the government once operations cease,” according to Hodgkinson and Garner in Global Climate Change: Australian Law and Policy (2008) (p185). Clearly, then, Calix is proposing replacing one system of negative externalities (carbon pollution) with another (carbon sequestration), at great expense to the taxpayer.
I realise I may upset a few readers saying this. Sorry. But the truth is that I have seen some very deluded projections about Calix, and CCS in general, over the years and while I have no view what the share price will do, I believe its current market valuation is ridiculously optimistic.
Traders could well make money off Calix shares, if they sell to a ‘greater fool’ less capable of valuing a business, or self consciously buying “the story”. But I fear true believers in the Calix story (their catchphrase being “Mars is for quitters”) will be sorely disappointed in the long term.
From the current share price of $5.30, I think that some good hearted ethical investors may learn a harsh lesson. Of course, I cannot predict how long the hype will last, or how much higher it may drive the share price. But I hope I have at least demonstrated that the current valuation can only be justified with some very optimistic assumptions about the future.
Calix had about $15 million in cash at the end of FY 2021, and burnt through about $15 million in that year, so I assume it will need to raise more capital within a year.
Caveat Emptor.
MPower (ASX:MPR)
Mpower is certainly a high risk turnaround story. Like Calix, the company financials resemble a dumpster fire, but it will have a demonstrably good impact on the world if it succeeds. And unlike Calix, its $14 million market cap reflects its high risk nature, and lack of profitability. Mpower is priced with a much lower chance of success than Calix, but its strategy is based on proven technology and proven (revenue generating) expertise.
Mpower’s current business is to build solar farms as a contractor. As you can see from the profit and loss statement below, this is a terrible business. Out of revenue of $11 million, it made a measly $2.8 million, a pathetic gross margin of just 25%. Of course, this isn’t enough to cover their corporate costs, so the company loses money every year, and at the end of 2021, had just $3.5 million in cash and $5 million of debt.
Now, in the worst case scenario, Mpower can never make a profit building solar farms. Certainly, at current levels of scale it cannot. However, it is trying to build own and operate solar farms, not just build them. This should allow the company to improve its business model in three ways.
First of all, by instigating its own projects, it will look to increase the scale of the business, which may make its engineering, procurement, and construction activities profitable. Second, by owning the solar arrays, Mpower thinks it can earn returns on capital in the vicinity of 8% to 10%. Third, Mpower earns most of its revenue in constructing new arrays, but it also earns (higher gross margin) revenue from maintenance. If it can build its maintenance portfolio, it will improve its economics.
MPower’s first two projects, Narromine and Mangalore, will cost about $19 million to develop, and remain unfunded for now. The Narromine project already has connection and planning approval. The company has said that instead of singing a power purchase agreement (usually used to ensure revenues and access debt) it will simply export energy at the spot price. This will allow the company to take advantage of price spikes in the future, by installing battery back up. Furthermore, the average price achieved should be higher than with a PPA, since a company would only sign a PPA if it can get a better price than on the open market.
Importantly, Mpower has a track record building these smaller solar farms, so unlike Calix, it isn’t attempting to build novel systems with government support. Rather, it’s aiming to build commercial systems that should be profitable in their own right (though this will depend on electricity prices).
Of course, none of this can happen without the company raising capital, finding funding partners or (more likely) both.
The CEO recently said “now that there is greater clarity and visibility on the first projects… we are well positioned to progress various funding options with potential funding partners and we look forward to sharing that with you at the right time..”
At the moment, the share price is languishing because the company hasn’t proven that it can even get started with its plan to build, own and operate its first smaller scale solar farm. To wit, the company raised $5 million at a share price of 8.5 cents per share in February 2021, but its share price is currently sitting at just 6.5 cents per share.
Now, it’s perfectly possible that Mpower could go bankrupt. However, if it finds a funding partner and if it actually starts building solar farms and (as unlikely as it seems) becomes profitable, then it’s hard to believe that the company will continue to languish at its market capitalisation of $14.2 million.
If Mpower can profitably, repeatably roll-out a series of 5MW solar plants, then it will be likely to gain a lot more popularity on the share market. You see, these smaller plants have a much easier time connecting to the grid because the connect to the distribution network rather than the transmission network. At the moment, this is a regulatory sweet spot, so the business plan seems feasible, but it is far from guaranteed. And with half of politics ideologically opposed to solar, I wouldn’t put it past the government to change the rules, making solar development even harder.
If Mpower can gain financing, and succeed operationally, then it still faces the risk that power prices may fall, ruining its profitability. Of course, if you think that wholesale electricity prices might rise, then Mpower would be more attractive (assuming it builds the solar arrays successfully).
At the moment, Mpower is a near bankrupt business with zero ability to make a profit and a long history of punishing retail investors who backed the current management. On the upside, it is priced accordingly, and the CEO’s family owns over 30% of the business, so I’m sure they would love to see success.
If Mpower captures the imagination of the same crowd buying Calix at $5, then it could multi-bag from here (though that would be equally ridiculous). If Mpower achieves satisfactory financing of its first solar projects, then it might be in a position to capture some of that investor interest in the short term. The main reason for buying Mpower in the short term would be that if it can attract the valuation insensitive ESG investors buying Calix shares, then it could arguably re-rate by 50% or (a lot) more in the near term.
Secondly, if Mpower actually delivers on its plan, then it could eventually more than justify its current market capitalisation. If revenue doubled from here, then the company’s EPC business would approach breakeven, and if it can end up owning equity in a range of solar plants, then it could end up with some decent recurring revenue streams that are quite profitable (since Mpower would also be earning a decent margin on maintenance activities).
Indeed, their maintenance business looks after 100s of power systems, and might actually be profitable on a standalone basis.
Mpower has about $14 million in market capitalisation and $7 million in franking credits. If we adjust for cash, debt and franking credits, then the implied enterprise value at current prices is probably around $10 million. While it will take some good execution, it’s possible that the business could in time be worth considerably more than this, so at least there is significant “upside potential” to the current share price.
With 3.4 cents per share in franking credits, and a share price of 6.5 cents per share, I’d say that the downside here is limited. Three directors have purchased shares on market at around current prices. The company will need to raise more capital, so I’m sure they will continue to advertise the story to investors. Given some downside protection, high insider ownership, and recent director buying, I think the risk versus reward on Mpower looks good, even though it is obviously extremely high risk.
I have to say I am somewhat tempted to take a very small shareholding in this company, so that I can sell the shares if they become more hyped up. The attraction to me is partly financial (since I think the risk versus reward stacks up) but also partly because I would love to see Mpower succeed in building, owning and operating solar farms.
That would certainly reduce carbon pollution in the near term; so despite the company’s precarious situation, I am absolutely rooting for it to succeed. The CEO says that “with as little as 2-3 projects we can have positive EBITDA,” so the company will remain in a horrid financial situation for a couple of years at least. However, by the time it reliably makes a positive operating profit (if it does), I suspect the share price will be higher. Arguably, a sensible investor would (at least) wait for the company to start operating its first solar plant before investing.
The CEO has said it is looking to have project funding locked in by the end of the 2021 calendar year. To fail that milestone would be a significant red flag.
Please remember that these are personal reflections about a stock by author. I do not own shares in any of these companies and these thoughts are incomplete. This article must not form the basis of an investment decision. It is an investment diary valuable only for the cognitive process it demonstrates. We do not provide financial advice, and any commentary is general in nature. Please read our disclaimer.