Description

AMERESCO [AMRC]

Ameresco is the largest provider of energy efficiency upgrades in the United States and is quickly transforming into an owner of highly valuable renewable energy assets. Over the next three years, the company will more than double their recurring revenue via a backlog of green gas and solar projects. When added to the current portfolio, recurring EBITDA will approach $145mm and have a weighted contract life of 15 years. The lower margin efficiency business is currently masking this transformation and also adds confusing elements to the balance sheet and cashflow. These dynamics, plus the virus selloff and a seemingly uncertain regulatory environment have given investors the chance to own an incredibly high quality business before it shows up in the numbers. EBITDA dollars and margins should expand rapidly starting in 2020 as the pipeline is built out and multiple expansion should follow. The management team has a strong execution track record and owns over half the equity, creating excellent shareholder alignment. Corporate and government focus on clean and efficient energy will give the company a massive tailwind for years to come. Plus, the recent court ruling on the EPA's small refinery exemptions should remove a headwind for the stock and act as a short term catalyst for price appreciation. Using conservative assumptions, the share price should appreciate to $25 (+50% upside) over the next few years and has excellent downside protection given the current generation portfolio and recurring earnings streams. Growth beyond the current backlog, a recovery in credit prices and modest multiple expansion implies a stock price more than double today. trev62 did an excellent job writing up this idea seven months ago, but given the recent pullback and backlog growth, I thought it was worth it to add to the analysis.

Catalysts:

Despite the numerous positive developments announced in 2019, the stock stayed stubbornly close to $14 until the 10th District Court decision in December which effectively banned the EPA's use of small refinery exemptions (SRE's). Fears regarding the economics of Ameresco’s green gas plants have been a headwind for the stock, as renewable fuel credit prices declined as a result of the SRE's. However, this court case should act to balance the market and credit prices have already increased 65% YTD. See link from Bill's write-up on CLNE, which did a great job of explaining the dynamics of this case:

https://nfu.org/2020/01/27/tenth-circuit-court-strikes-down-epa-small-refinery-exemptions/

The EPA has said they will appeal the case, but there is a very low probability of the Supreme Court overturning the rulling given it was unanimous. This should alleviate any doubts on the +20% return profile for Ameresco’s green gas projects. The credits should return to previous levels ($2.00) in the long term as the EPA halts all SRE's and adopts their volume targets for 2020.

A medium term catalyst would be the sale of the company. The founder is getting older and will want to monetize his stake eventually like he did with his previous company Noresco. Earlier this year in fact it was rumored that Engie Energy was preparing a bid to buy the company. While I don't think a sale will happen in the short term I do think it is likely over the next few years.

https://seekingalpha.com/news/3544040-engie-eyes-deal-for-ameresco-reuters

Longer term catalysts include capital return to shareholders via dividend, increase in ESG investor awareness, carbon tax, spin-off of the generation business into a yield vehicle.

Business Units:

Energy savings (70% of revenue and 25% of EBITDA): 

AMRC is the largest energy efficiency ESPC contractor in the country. Efficiency involves everything “behind the meter” like onsite generation, micro-grid and storage solutions that help the customer save money on their utility bill. Energy savings contracts can be extremely compelling for the end client. They require zero upfront capital cost and AMRC will guarantee an annual energy savings rate and setup the third party financing. The customer then pays for the project with a portion of the savings from the upgrade while dramatically reducing their carbon footprint. Large government facilities such as military bases, universities and hospitals are prime candidates. For federal contracts, AMRC enters into an ESPC contract which involves selling their LT savings interest to a third party at a discount. These receivables have a wide range of purchasers from banks like BofA to niche lenders like Hannon & Armstrong (HASI). This liability (and corresponding asset) stays on the balance sheet until the project is complete at which point it’s treated as a sale. Importantly, this liability is not debt and goes away when the contract is complete. The cashflow statement is also distorted as the project expenditures are recorded in the operating cashflows, while cash advances for the projects are recorded in the financing cashflows. These dynamics make AMRC look over-levered and bleeding cash while in reality it’s highly profitable and conservatively financed. 

Current project backlog is $2.3B of which $1.1B is funded and generally carries a 7%-5% EBITDA margin. Ameresco typically converts 90% of project backlog into revenue in 12-36 months, providing visibility into 80% of their current year revenues. This also creates a high margin, long tail stream of O&M revenue that comes through at 50% EBITDA margins. The IEA estimates the energy efficiency market size at $11B per year which should grow 7% annually until 2023. AMRC should grow faster and more profitably than the market given the increasing demands for highly complex projects especially those involving distributed energy. Municipalities, hospitals, military bases and universities are all looking to upgrade old infrastructure with new, greener alternatives which provide grid independence and achievement of carbon goals.   

A good illustration of this move to complex projects is the recently completed ESPC project at the Paris Island Marine Corp Debot. Ameresco completed the +$90mm contract resulting in $6mm/year energy savings for the base while reducing energy consumption by 80%. AMRC installed 6.7 MW of solar, a new gas fueled CHP plant and a 4 MW battery with micro-grid to handle load balancing or shedding. Carbon footprint massively reduced while increasing resiliency via an “island mode” option where the base can cut itself off from the grid. Ameresco retains an O&M contract for the next 23 years.

Contracted Revenue from Generation Assets and O&M (19% of revenues but 68% of EBITDA). Ameresco currently operates 99 renewable energy plants which generate 260 MWe of power with a weighted average PPA life of 14 years. Ameresco generates renewable power from two sources: large scale C&I solar projects and renewable gas from Landfills (LFG) or waste water treatment plants (WWTP). The current fleet includes 23 LFG plants, 2 WWTP plants and 74 solar PV stations. Ameresco is one of the largest owners of renewable gas assets in the US which differentiates it from other renewable power producers. Unlike solar or wind, renewable gas derived from waste generates constant base load power for onsite use or sale back to the grid. Methane produced from landfills and treatment plants are some of the largest greenhouse gas (GHG) contributors, as such, most states have mandated the collecting and flaring of this gas. Instead of wasting this gas via flaring, Ameresco will build a power plant on the site, agree to a LT purchase agreement for the gas and a LT PPA to sell the power (see Ox Mountain example later). Ameresco is taking a known resource, which is already being collected for destruction and turning it into green energy.

This segment will more than double over the next three years from the current backlog of projects. Power generation will surpass 580 MWe and EBITDA will increase to $165mm. Importantly, this growth is only based on the current backlog which has almost doubled over the last twelve months. The backlog will take three years to buildout and cost around $680mm to construct. Project costs will be 80% financed on average and will generate a blended high-teens return on equity and 6x build multiple. The solar projects generally produce low teens yields while the green gas plants vary but average mid-twenties. Ameresco has given a framework for modeling long-term EBITDA/MWe for each vertical. Generally, the solar projects would contribute $0.2mm/MWe and the green gas around $0.7mm/MWe. These assumptions imply that current contracted EBITDA of $60mm will increase to $165mm in 2023 as the backlog of 67MWe of green gas and 254MWe of solar is built out and O&M EBITDA increases by 9% annually. The gas projects were based on an RFS credit price of around $1.50 (Also known as a D3 RIN). Much more to come on the RFS later, but the current D3 RIN is around $1.65. See chart below for EBITDA walk:

The economics for Ameresco’s new green gas plants called renewable natural gas (RNG) are highly sensitive to the prices of carbon credits generated by the Renewable Fuel Standard (RFS) and state programs like California’s LCFS. Instead of generating power, the gas is sold and fed into existing infrastructure. A detailed discussion of the outlook for the RIN credits is in the next section but prices have declined since 2018. This is not a huge cause for concern because (1) our assumptions for EBITDA $/MWe already incorporate artificially low RIN prices which should rebound from new EPA policies (2) the current portfolio does not depend on credits and the backlog of projects could be modified to produce onsite generation instead of upgrading the gas to pipeline quality needed for credit generation (3) Most of the RNG projects in backlog will be expansions of current LFG sites which dramatically reduces costs and risks (4) The majority of these projects will benefit from the California LCFS credit system.

The TAM is large for both RNG and solar. The solar opportunity is fairly well defined with the EIA estimating the market size for C&I solar at 1.75 GW and growing 8% annually. Green gas is a little less followed and for RNG/LFG there are a couple different ways to measure the opportunity. The EPA’s Landfill Methane Outreach Program (LMOP) has compiled a list of viable LFG projects. If we just use the landfills with over 5mm tons of waste in place, we get to a target market of 150 landfills across the US which could supply 500 MWe of electricity or 250 mmcf/d of RNG. Assuming current gas and credit prices that could equate to $250mm-$500mm of EBITDA. For WWTP’s the opportunity could also reach 400MWe from the roughly 15,000 plants that do not contain an RNG. Importantly, all of these are viable options for onsite power generation if the RNG market doesn’t pan out. Roughly a $1B EBITDA target market. The RNG coalition has much higher estimates, but I think this is a conservative way to measure the opportunity.

Again, I think project examples are the best illustration of the portfolio so I will detail a few below. 

I recently toured one of Ameresco’s largest LFG plants at the Ox Mountain landfill in Half Moon Bay. The plant generates close to 12MWe of power via 6 GE gas powered engines. The landfill will be in operation for the next twenty years and the plant will be operating at full capacity for 25 years afterward, then start a slow decline. The cities of Palo Alto and Alameda have signed 20 year PPA’s to purchase the power which helped the cities reach renewable energy goals. Prior to the plant opening, all the methane was being captured and destroyed.

Ameresco’s largest solar asset is a 18.6 MW facility located at the U.S. Army Garrison Fort Detrick Army installation in Frederick, Maryland.  It is comprised of nearly 60,000 solar panels installed across 67 acres and relies on a 25 year PPA with the base.

Other/Remaining Business (11% of Revenue and 7% of EBITDA)

This is a combination of enterprise energy management services, consulting services and the sale of solar PV energy products and systems referred to as integrated-PV.  The Applied Energy Group unit provides a wide range of energy efficiency and demand response related consulting services.  The integrated-PV unit design and engineer custom off-grid solar power solutions.  Both businesses have pretty solid backlogs with predictable revenue streams.

RNG Industry and Projects

Renewable natural gas (RNG) will play a large part of Ameresco’s future growth and represents a large portion of the projected EBITDA in their asset construction pipeline. RNG projects are very similar to the company’s legacy green gas generation projects at Landfills and WWTP’s. The only difference is that instead of using that gas to generate electricity onsite, Ameresco upgrades that gas to pipeline quality and injects it into the existing transmission lines. RNG is exchangeable with regular natural gas and can be sold to a multitude of different buyers. The vast majority of RNG is sold to the transportation sector, mainly distributors of natural gas fuel for truck fleets. The use of RNG as a transportation fuel is key to the economics of these projects as the associated carbon credits can drive project returns well north of 20%.

The carbon credits come from both the federal government via the EPA and state governments via their own renewable standards. In 2005, President Bush signed the Energy Policy Act which created the Renewable Fuel Standard. The standard enjoyed broad bi-partisan support as it promoted energy independence, supported the growing ethanol industry and spurred growth in renewable fuels. It set certain volume commitments for blending different renewable fuels into gasoline and a guideline for how those volumes should increase based on total greenhouse gas reductions. Obligated parties (refiners and distributors) must either blend their products or buy credits called renewable identification numbers (RIN’s) based on the prescribed volumes. After some clever lobbying by the RNG industry, which is mostly made up of landfill owners, nat gas utilities and dairy farmers, the EPA revised its pathways for biogas in 2014 and recognized RNG as a cellulosic biofuel that would qualify for D3 RIN’s. These D3 credits are in short supply and have historically traded at 3x the value of other RIN’s for ethanol or other biofuels. This is a function of their scarcity, but more importantly their potential to reduce greenhouse gas emissions by 70% or more vs. a conventional fuel like gasoline or diesel. Ethanol for example only has a 15% GHG reduction vs. conventional fuel.

Another source of credits are awarded by the states like California’s Low Carbon Fuel Standard (LCFS). This program was extended last year for another decade with the goal of reducing carbon intensity by 20% in the state by 2030. LCFS prices have firmed up since the extension and now trade for close to the price cap of $200/mmbtu vs. $120 at the beginning of 2018. Other states such as Oregon have similar programs and more are considering rolling them out.

Ameresco has recently completed some of the largest RNG facilities in the country. Examples include the Phoenix WWTP and the Woodland Meadows Landfill in Michigan. The current pipeline includes five RNG projects, two of which are in California and would be able to take advantage of both credit systems. To put it in perspective, a California plant would historically be able to sell the gas for a market price of $3/mcf, generate a D3 RIN worth $17/mcf and generate a LCFS credit worth $10/mcf. A combined value of $30/mcf of gas generally will provide mid-20% IRR’s on the equity contributed to the deal. This will usually involve a three year amortizing construction loan at 8%-10% interest rate, a long term PPA to sell the raw gas and a shorter term agreement to sell the credits. Ameresco is somewhat limited in their timeframe for hedging the credit prices because of limited participants and a potential change to the RFS in 2022 that I will discuss further. Ameresco is one of only a handful of firms with the expertise in permitting, engineering and construction to be able to execute these highly lucrative projects.

The RFS was established with annual renewable volume obligations (RVO’s) for each type of biofuel until 2022 when the volumes could be reset based on new data or fuel availability. Because of the GHG emission reductions of RNG (or other cellulosic biofuels) the EPA had their RVO increasing each year relative to ethanol. By 2022, the standard mandated that cellulosic biofuels make up the majority of the renewable volumes. This original framework and recent developments have created a number of uncertainties in the market: (1) The actual RVO is adjusted each year to reflect the estimated supply of RNG so the EPA has some ability to deflate demand. However, the EPA also issues CWC waivers at a set price of around $2.00 which acts as a floor for pricing during normal market conditions (2) The EPA can issue waivers to obligated parties called “small refinery exemptions” if the refinery can prove it would be unprofitably by complying with the standard. The EPA under Trump has been quick to issue these exemptions in the past year which has disrupted the supply/demand dynamics of the RIN market. However, the previously mentioned court case and new EPA volume requirement for the D3’s will buffer pricing. (3) After 2022 the EPA can reset the volumes with new long term targets (4) Technically the RFS could be negated by an act of congress, but will continue after 2022, just with potentially new volume rules. All of these issues have caused D3 RIN prices to fall from a high of $3.00 in middle 2017 to around $1.65 today.

Anything can happen in politics, but for a number of reasons, I believe the RFS system will continue without major structural changes. I formed this opinion after speaking with attorneys, lobbyists, researchers, trade groups and other public companies in the RNG space. The most important political attribute of the RFS is the appeal to both sides of the aisle. The main beneficiaries of the rule are corn farmers in Nebraska and Iowa who depend on ethanol sales which make up the vast majority of renewable fuel volumes. RNG is much smaller, but it’s main proponents are energy companies, farmers and landfill owners who generally lean independent or conservative. Democrats obviously like the GHG reduction efforts of the rule and would likely favor RNG over other fuels if they got the chance to remake the standard. Both sides want to see the general framework of the RFS to continue, so a complete revamp is highly unlikely.

The EPA came out with their final 2020 RVO late last year which required a 40% increase in cellulosic biofuel which corresponds with the D3 RIN. Importantly, this was the only category to receive an increase in volume requirements, highlighting the growth potential even under a Republican led EPA. Both the final RVO in November and recent court case will support RIN prices, which I expect to gravitate to $2.00 in the long term. The RFS is a win for both sides and almost all signs point to a long existence.

RNG creates D3 RIN’s by being utilized in the transportation industry. RIN’s are only created once the supplier proves their RNG has been delivered via a qualified pathway. In that sense, the expansion of RNG is directly tied to natural gas usage as an alternative to gasoline/diesel. A combination of cheap natural gas prices and corporate sustainability goals have fostered large growth in natural gas fueled vehicles. In addition, utilities have shown an increased appetite for providing green gas to environmentally conscious customers. A couple of recent data points highlights a strong backdrop for continued RNG demand:

1. SoCalGas announces plan to replace 20% of traditional natural gas with RNG by 2030. https://sempra.mediaroom.com/index.php?s=19080&item=137611

2. UPS has recently signed the largest ever RNG supply agreement. They will purchase 170M gallons of RNG over the next 7 years. UPS will use renewable fuels for 40% of their ground fleet fuel purchases by 2025. https://pressroom.ups.com/pressroom/ContentDetailsViewer.page?ConceptType=PressReleases&id=1558453536437-113

3. Smaller retail energy firms are also getting in the mix. Genie Energy subsidiary has a plan for a green gas offering. https://www.prnewswire.com/news-releases/mirabito-natural-gas-launches-mirabitoclean-a-carbon-offset-program-for-natural-gas-customers-300865370.html

Electric vehicles might pose a long-term risk to the RNG industry, but for now, RNG beats out electric trucks on almost every metric. Most importantly, on a full lifecycle measurement called a “well-to-wheel” methodology, RNG provides twice the GHG reduction benefits vs. electricity. Natural gas powered vehicles also perform better on long-haul trips and are easier to maintain without the need to replace expensive batteries. 

The future of RNG seems clear in the long-term, but given the number of regulatory risks, I think it is important to provide a possible hedge against a deteriorating renewable credit environment. Probably the best way to hedge these dynamics is to short CLNE if it goes back to $3. They are one of the largest distributors of natural gas fuel for trucking fleets and have committed to 100% RNG in their stations by 2025. They currently distribute more than half the national supply of RNG and generate around 40% of all the credits in California. Around 60% of their EBITDA is generated from the combination of D3 RIN’s and LCFS credits. If credit prices deteriorate in the long term their business will be severely impaired. Full disclosure, we are long CLNE and think it is also a great way to play RNG. However, if you are worried about the viability of the RFS and the LCFS, this is a great hedge.

Valuation

As the backlog of renewable generation assets is built out over the next 30 months, contribution to total EBITDA will more than double. The company will resemble a high growth, renewable energy IPP vs. a low margin engineering company. As such, these price targets are formed from a SOTP’s methodology using pro-forma 2023 EBITDA contributions from both businesses.

Base Case: $25 Price Target in 2022. Total return of 54% and 15% annualized. Assumes recurring EBITDA from generation assets and O&M contracts reaches a $165mm run-rate by the end of 2022 and is valued at 11x. The current project backlog of $2.3B is deployed over the next three years, resulting in an average EBITDA contribution of $40mm. A 25% increase from where it is today, assuming the 5% EBITDA margin stays constant. This contribution is valued at 6x, resulting in a combined price target of $25. Combined total company EBITDA will surpass $205mm and the company will generate $1.45 of earnings. These assumptions seem conservative for three reasons: (1) Pro-forma EBITDA only assumes conversion of current backlog, no incremental growth. (2) RNG project EBITDA is modeled on $1.50 RIN prices, which have reached $3.00 in the past (3) This price target incorporates ZERO multiple expansion and implies 10x EBITDA and 17x earnings, which are roughly the same forward multiples as today. This is also where the stock traded on the buyout news before the recent market decline.

High Case: $40 Price Target in 2022. Total return of 150% and 35% annualized. Assumes recurring EBITDA expands by an additional $20mm and Project EBITDA by $10mm from my base case. If RIN prices return to 2017 levels or backlog continues to grow, this case is easily attainable. Value the recurring EBITDA at 13x, which is closer to a high quality renewable IPP, and project EBITDA at 7x, which is still a discount to clean tech engineering firms. Combined total company EBITDA of $225mm and EPS of $2.00 a share would imply modest multiple expansion to 12x and 21x respectively. As Ameresco gets more credit for its growth profile, it should trade more in line with high quality renewable energy and consulting firms which both trade close to 15x EBITDA, implying a share price well north of $50 and substantial incremental upside.

Low Case: $12 Price Target. Downside of 26% from current levels. Assumes recurring EBITDA only expands to $125mm and Project EBITDA stays flat at $30mm. This seems highly unlikely given current backlog levels, but could happen if execution issues arise or RIN prices decline from current levels. There is a strong margin of safety at $12/share due to the current stream of recurring EBITDA which stands at close to $60mm and has a +14 year remaining PPA life with virtually no carbon credit risk. Large buyers have emerged for green gas projects including oil majors BP and Total. Liquidating the asset portfolio for 9x EBITDA ($9/share) and the project business for 5x ($3/share) seems very conservative and values the backlog at zero.

Additional assumptions include: (1) Earnings are a close approximation for owner’s FCF (2) All earnings are reinvested to cover the equity component of the backlog buildout, therefore no need for corporate debt issuance, only non-recourse construction financing of approximately $530mm. A detailed model is available upon request.

Recent Results

Fairly conservative in their guidance. They have beaten annual earnings and EBITDA estimates for the last 5 years in a row and the shift to recurring revenue streams is making the business more predictable. Historically they have guided conservatively and continually increased annual guidance as the year goes on. Barring any project delays, I think there is a good chance for EBITDA upside in 2020.

Risks

Competition from larger firms like Johnson Controls and Honeywell. 

Voting stock and control from CEO/Chairman who has been selling stock recently. I hate to see this as much as anyone, but I think he will ultimately sell the company and monetize his stake.

Should be recession resilient because of the zero upfront capital cost and real energy savings. Credit might dry up for these type of deals, but there should be plenty of demand.

Renewable energy credits are obviously a risk here. Shorting CLNE seems like the best cure.

Confusing financials: Perceived lack of cashflow and high liabilities in government deals.

Rising energy prices? No actually tethered to lower NG prices and more infrastructure buildout.

Project delays from the virus fallout? Maybe, but if the cure is a big infrastructure bill then their backlog would explode to the upside.

Disclosures:

We are long AMRC.

Catalyst

(1) Recent court case ruling and 2020 RVO. This should balance the D3 RIN market in the medium/long term and alleviate the doubts around the economics of AMRC's green gas projects.
(2) Build out of record backlog of renewable energy assets.
(3) Longer term catalysts include a sale of company, capital return to shareholders via dividend, increase in ESG investor awareness, carbon tax, spin-off of the generation business into a yield vehicle.