Description

Crius Energy Trust (“Crius” or the “Company”) is a beaten down stock with significant upside potential and “multiple ways to win” – either though low-risk operational execution or strategic initiatives. Crius is currently trading at 4.3x F18 EV/EBITDA and generates a 19% free cash flow (“FCF”) yield with an under-leveraged balance sheet at 0.8x net debt/F18 EBITDA. Steady operational execution and the successful integration of the Company’s most recent acquisition should eliminate the current overhang and move the stock meaningfully higher in the coming 12 months. We value Crius at C$12.50/unit, representing 45% upside to the current price. If Crius was acquired by a strategic investor, we estimate the Company’s value at C$15/unit, implying 75% upside.

Background

Crius is a diversified electricity and natural gas retailer with 1.3 million customers across 19 U.S. states. The stock currently trades at 4.3x F18 EV/EBITDA, which equates to a 19% FCF yield. The Company has a strong balance sheet with only 0.8x net debt/F18 EBITDA and its current unit distribution yields 10%. Importantly, the 10% distribution yield reflects a conservative FCF payout ratio of ~65% based on F18 estimates.

In July 2017, Crius announced a transformative acquisition, acquiring U.S. Gas & Electric (“USGE”), another large diversified electricity and gas retailer. The USGE purchase price of ~$170 million was partially funded through the issuance of ~$85 million in public equity at C$9.80 per unit. Although Crius had been a public company since 2012, the stock’s limited liquidity and relative obscurity rendered the Company largely un-investable to all but the smallest Canadian investment funds. However, the USGE transaction increased Crius’ size and diversification – and the equity issuance improved liquidity. These factors led to a higher profile in the Canadian capital markets and a number of new investors becoming unitholders.

Q2 of 2017 was Crius’ first reported quarter following the USGE transaction announcement. Unfortunately, two non-core and relatively immaterial miscues by management shook investor confidence – leading to an immediate slide in the stock and several months of waning investor confidence. Q2 did not reveal any negative operational surprises; however, management increased the size of Crius’ legal reserve on a quarter-over-quarter basis from approximately $7 million (Q1) to $13 million (Q2). The increased legal reserve caused investors to question whether the Company had a handle on its legal risks. Management also reduced guidance on its nascent residential solar initiative. Importantly, residential solar is an immaterial component of the business, but it was a growth initiative that was promoted to investors earlier in the year – hence the disappointment with the announcement.

The hiccups from Q2 were compounded by a generally weak Q3, further straining investor confidence. However, the Company’s disappointing Q3 results had nothing to do with management execution or communication – but simply bad luck on account of bad weather. More specifically, summer weather in the U.S. states that Crius operates in was about 24% cooler on a year-over-year basis, which reduced electricity usage (for air conditioning) among Crius’ customer base in the quarter. In anticipation of the poor results, the stock sold off into the C$8.60 range in advance of the quarter, which is approximately where the unit price sits today.

Lost in the noise of the weather impact on Q3 results was a very positive update on the USGE acquisition. Crius’ management provided synergy estimates for the first time, which were very impressive – announcing an expectation of $12-$14 million in annual synergies, which is very significant in the context of consensus F18 EBITDA of $107 million.

Investment Rationale

Crius’ unit price is currently suffering from a lack of investor confidence related to two relatively insignificant miscues by management and bad (cooler) weather in Q3 of 2017. Obviously weather is a one-off factor and temperatures across the states that Crius operates in will revert to approximately long-term averages over time. Although management did not manage investor expectations on two non-core issues immediately following a major equity issuance, we believe execution on the core business and USGE synergies will rebuild investor confidence and drive a significant recovery in the stock during 2018.

A 4.3x F18 EV/EBITDA and 19% FCF yield valuation implies a risk of bankruptcy or a near-term cash flow cliff. Neither is remotely accurate. Crius’ balance sheet is strong and earnings are stable. In fact, consensus F18 EBITDA estimates should prove easy to beat. Prior to the abnormally mild weather experienced in Q3 of 2017, USGE and legacy Crius combined for ~$100 million in TTM EBITDA. The addition of $12-$14 million in synergies would take pro-forma EBITDA to $112-$114, which is comfortably ahead of F18 consensus that currently sits at $107 million.

The reality is, management’s credibility has taken a hit – so an important question to ask is whether the targeted synergies are achievable. We believe the resounding response to this question is “absolutely.” None of management’s expected synergies are premised on increased sales – but rather cost cuts that should be easy to achieve given the significant redundant SG&A and geographic overlap between Crius and USGE. More specifically, eight of the 11 states that USGE operates in overlap with Crius geographies and USGE’s pre-acquisition SG&A was $45mm per year – thereby leaving plenty of room to “cut the fat” on consolidation of back office and sales functions.

We value Crius at C$12.50, based on 6.0x F18 EBITDA and a 13% FCF yield. Crius’ closest public company peer, Just Energy Group (“Just Energy” or “JE”), currently trades at 6.3x F19 EBITDA (March Y/E). In our view, applying a lower valuation to Crius is highly conservative given Just Energy is more levered, at ~2.0x net debt/EBITDA, and lacks well-established sales channels. Conversely, Crius’ EBITDA growth is premised on the execution of low-risk cost-cutting, whereas Just Energy’s EBITDA growth is largely premised on the success of a new and unproven sales channel involving hundreds of retail kiosks in brick-and-mortar retail stores.

Given the above, we believe Crius is a low-risk execution story that will deliver an EBITDA “beat” in F18. In addition to upside to current Street estimates, there are a number of compelling reasons why Crius represents significant upside with only modest downside risk:

·         Distribution Yield: Crius currently yields 10% on a clean balance sheet and pro-forma payout ratio of ~65%. We expect yield-hungry investors to buy the stock at its current valuation and continue to chase Crius higher as the distribution is increased throughout 2018 and management’s credibility returns.

·         Acquisition Opportunities: With a strong balance sheet, Crius is in an excellent position to acquire smaller energy retailers in the U.S. As is the case with USGE, significant cost-cutting opportunities make these acquisitions highly accretive.

·         Take-Out Candidate: An acquisition of Crius by Just Energy would create significant value for unit/shareholders of both companies. Just Energy currently trades at 6.3x EBITDA and based on our analysis could acquire Crius for 7.0x EBITDA – yet the merger would be still be accretive for JE shareholders. Assuming a modest $50 million in cost-cutting between the two companies (representing only ~12% of combined SG&A), we estimate that Just Energy shareholders could still realize 25% accretion. In our view, the longer Crius’ valuation remains depressed, the more likely it is that a Just Energy / Crius merger will be consummated. At a 7.0x EBITDA take-out valuation, Crius would be worth C$15.00/unit.

Catalyst

We believe Crius is a low-risk execution story that will deliver an EBITDA “beat” in F18. The Company's unit price is currently suffering from a lack of investor confidence related to two relatively insignificant miscues by management and bad (cooler) weather in Q3 of 2017. Obviously weather is a one-off factor and temperatures across the states that Crius operates in will revert to approximately long-term averages over time. Although management did not manage investor expectations on two non-core issues immediately following a major equity issuance, we believe execution on the core business and USGE synergies will rebuild investor confidence and drive a significant recovery in the stock during 2018.