Description

Pioneer Power Solutions (Nasdaq: PPSI)

Shares of Fort Lee, NJ based Pioneer Power Solutions have 45-90% upside over the next 12-18 months as the Company executes on a robust backlog of business and overcomes many of the headwinds that plagued the business during 2015.  Investors coming in at today’s prices have the benefit of a recent capital raise, firming orders, and a motivated CEO (19% shareholder) that has made the appropriate cost reductions in response to softness in certain of the Company’s market segments.  Despite growing sales 50%+ over the last three years, PPSI shares trade at nearly 60% of their January 2014 peak, and, ignoring the recent move since March 18th on inconsequential volume, have languished between $3.00 and $4.00 ever since the Company’s equity offering in September, 2015.  Applying the midpoint of FY16 guidance to the current share price, PPSI is trading at roughly .30x FY16 revs, 4.5x FY16 EBITDA, and 7.25x earnings.  The shares are attractively priced and very likely to rerate as Management executes. 

Brief Background

Pioneer Power is a diversified electrical equipment manufacturer, sales and service organization with a strong brand name and reputation in the industry.  The Company focuses on niche applications and service within large, growing market segments for power equipment, serving customers such as utilities, industrial and commercial businesses.  Product lines include a wide range of liquid-filled and dry-type power, distribution and specialty electrical transformers, which are magnetic products used in the control and conditioning of electrical current for critical processes. Pioneer designs and manufacturers standard products that are sold through distributors and also works on bespoke, project based custom engineered equipment.  A portion of their revenue is recurring, in the form of annual service contracts.

The Company was founded in 1994 when CEO Nathan Mazurek acquired the original transformer business from Schneider Electric S.A.  Over the course of the next 20 years, Mazurek would go on to acquire 7 specialty electrical transmission and distribution equipment businesses, the largest of which were Jefferson Electric (2010, $19m revenue) and Titan Energy (2014, $18m revenue).  The Company was taken public in September of 2013 at $7.00 per share, raising a mere $8m with a subsequent capital raise of $5M in September of 2015.

Pioneer is organized into two divisions:

1. T&D (Transmission & Distribution) Solutions (80% of revenue)

T&D sells electrical transformers (substation, power dry, utility) and switchgear.  Two thirds of the business consists of custom engineered products with the balance sold by catalog.  Brand names include Pioneer Transformers Ltd., Jefferson Electric, Inc. and Pioneer CEP.

Customers include utilities such as Georgia Power, Hydro Quebec, Enmax, Austin Energy, NextEra Energy and Toronto Hydro Corp.

2. Critical Power Solutions (CPS) (20% of revenue)

CPS sells onsite power generation systems, control equipment and services that ensure uninterrupted power to operations in times of emergency and in primary power applications.   The business consists of two main product lines (65% of revenue) and one service business (35% of revenue).

Products Business:
-    engine-generator sets
-    switchgear and controls

Service business:
-    preventative maintenance and monitoring services

Pioneer’s brand names in CPS are Pioneer Critical Power Inc. and Titan Energy Systems Inc.

Customers include datacenters, hospitals and retailers.

IPO - Present

Pioneer raised $8M in September 2013 via an IPO that led to the shares trading publicly on the NASDAQ for the first time. Investors supported the stock initially with shares moving from its IPO price at $7 to highs above $10 in the months that followed. The investor thesis and rationale for uplist at that time was simple. PPSI was a very profitable growing business, fueled by strong industry tailwinds, with an extremely low float that wanted to increase their public profile and trading liquidity from the OTC market. Trends of note supporting their business include an aging power grid, growth in applications across critical power and the data center markets, increasing adoption of renewable power sources, and simply, increasing power consumption.

During 2014, Pioneer's shares were fairly stable between $8 and $10 as investors digested consistent profitability, albeit below the single public analyst estimates at the time. However, in 4Q14 the business disappointed significantly which began a 9 month trend of declining price per share that culminated in a near term bottom near $3. The broad weakness during that period was twofold and driven primarily by company exposure to Canada. First, currency exposure hurt them materially as the Canadian dollar fell from parity in 2013 to a recent low of $0.70 in 2016, a decline of 30%. Secondly, Oil & Gas companies in Canada have driven the country as a whole into a recession as commodity prices have experienced severe declines. The result of this dynamic has put pressure on Capex across several industries including Oil & Gas, but also the Mining sector.  That macroeconomic impact flowed through to PPSI shares which fell over 50% during 2015. The declines, however, were not solely attributed to macro factors as the company also raised $5M in the Fall of 2015, a subject discussed in more detail later. 

To provide more context on Canada and its impact, management recently stated on a conference call that Canadian weakness explained an almost $5M drop in EBITDA from December of 2013 through June of last year. While neither headwind has reversed course today, PPSI does not have the exposure it once had to both and thus, has much easier comps going into next year.  As stated on the most recent earnings call, Pioneer has taken steps to deemphasize parts of its Canadian distribution business, a portion of Titan equipment business and some of the lower margins switch gear businesses. During the fourth quarter, Pioneer completed the transfer of certain manufacturing operations of the Canadian business unit to its existing facility in Reynosa, Mexico and outsourced certain other products to Asia.

Pioneer reported $106M in revenue during 2015, up 15% YoY from $92M in 2014. Adjusted EBITDA in 2015 was $3.8M, exceeding their guidance, but below the $5M reported in 2014. Most notably the company doubled its EBITDA recently from 3Q15 to 4Q15 which reflects changes made to streamline their operations, reduce expenses, and improve margins. Even further, the full impact of their cost reduction initiatives won’t be felt until the company reports their first quarter results in May.

During its recent conference call, management noted that annualized fixed costs would be reduced by at least $2.5M, an initiative that was completed during 4Q15 and 1Q16. On the same call, management also updated its FY16 earnings guidance increasing the low end of its EBITDA range to $8-$9.5M on revenue of $117-$127M and EPS of $0.55-$0.66. Their most recent 4Q EBITDA run rate puts them approximately at the low end of their expected range, implying a low hurdle for over-achievement over the next 12 months as the company continues to grow. Their recent performance and change in sentiment ahead of earnings has turned the tide for investors with shares finally moving higher and the persistent selling seemingly subsiding for the first time in months.

Private Equity firms have consolidated smaller companies in this industry in the past. Should 2016 guidance be achieved, the Company’s valuation is simply too compelling for larger players to ignore. Second, it is important to note, the U.S. business as a whole remains sound and has not been subject to the weakness felt in Canada. In fact, Pioneer recently announced a major supply award for energy efficient transformers in the U.S. This award is from a preexisting “major” customer and could quite possibly be Siemens, their second largest customer overall and their largest in the US with 10% of revenue in 2014. The new transformer will likely carry a higher price point and should have a positive impact on margins.  Management announced this along with other awards recently worth $30M, but even more significant, an incremental $20M of business in 2016. The awards should give investors even greater confidence, above and beyond the cost cutting initiatives driving profitability, in the Company's ability to hit and potentially exceed the current $8M-$9.5M EBITDA guidance.

Other Considerations to Drive Shares Higher

-    The company has a fantastic customer list: Hydro Quebec, Suncor, Rio Tinto, Valero, Siemens, Target, Schindler, NextEra Energy, etc.  Strong customer lists in micro caps lead to acquisition. Without substantial customers, bigger companies don't want to buy.

-    Management owns 60%+ of outstanding shares. Alignment of interest is not a question here.  There is a solid institutional investor base in place (Heartland, Perritt, First Wilshire) as evidenced by the last capital raise.  The large insider ownership means that it will not take a lot of volume to move the stock higher.

-    The CEO has a successful track record of building and selling companies.  His last two entities were sold and he is likely in a position to sell Pioneer in the next 12-18 months.  This is an industry that has been consolidated by PE firms in the past – names like Kohlberg (buyer of Siemens’ Power Transmission businesses in 2002) and Blackstone (PQ Energy partnership) come to mind.  There would be at least $2m in synergies to a buyer plus at least $750k in public company cost savings.  A strategic could pay 8-10x EBITDA.  A list of industry comps justify this multiple:

2016e EV/EBITDA multiples (note: not all are pure-play direct comps)

ABB Ltd. (SWX: ABBN) 9.8x
Eaton (NYSE: ETN) 10.9x
Emerson Electric (NYSE: EMR) 10.3x
Powell Industries (Nasdaq: POWL) 10.6x

Average: 10.4x

Macro Forces are Moving in the Right Direction

Pioneer is on the right side of several important macroeconomic trends that should increase demand for its products and services:

-    An aging and overburdened North American power grid whose backbone was designed in the 1950s.  According to some studies, 70 percent of transmission lines and transformers are now at least 25 years old, and 60 percent of circuit breakers date back over 30 years.

-    The increased use of on-site distributed generation and renewables.

-    The rapid expansion in critical power needs (hospitals, airports, defense).

-    Growing investment in data centers.  According to NRDC, "In 2013, U.S. data centers consumed an estimated 91 billion kilowatt-hours of electricity, equivalent to the annual output of 34 large (500-megawatt) coal-fired power plants. Data center electricity consumption is projected to increase to roughly 140 billion kilowatt-hours annually by 2020, the equivalent annual output of 50 power plants, costing American businesses $13 billion annually in electricity bills."

2016 Guidance - Classic Microcap Equity Offering in Sept 2015
 
PPSI recently updated its 2016 guidance when it reported preliminary numbers on March 14th and reiterated these figured when it reported 4Q15 this week. The company expects revenue of $117-$127M, EPS of $0.55-$0.66, and EBITDA of $8-$9.5M.

If Mr. Market were taking this guidance seriously, the stock would not have sat in the $4 range following the preliminary results.  We think that the market is employing a “show me” attitude coupled with a case of a bad hangover following last year’s (Sept 2015) capital raise ($4/share for total proceeds of $4.5M).  The raise was a classic micro cap case of announcing the deal before it was closed.  Shares fell 6.5% from $6.40 to $5.98 when the offering was announced on 9/21/15, and then proceeded to fall to $5 before the deal was closed. The raise was ultimately priced at $4 on 9/25/15, a healthy 20% discount, but by that time the damage was done and shares closed at $3.80. They have since stagnated around $4 for the past 6 months as the stage is set for accelerated growth and profitability in 2016.

Valuation and Target Price

We suspect that given the missteps in 2015, Management has reset expectations and set up its 2016 guidance to be conservative. Revenues are trending higher with cost cutting initiatives taking hold.   4Q EBITDA was $1.9M, which annualized puts the company near the low end of its guidance range. This is without any further revenue gains or cost cuts/synergies that may be realized during the year. 

There are some other drivers as well:

-    Guidance numbers also not reflect any new orders that could result from new DOE transformer specs.  The Department of Energy (DOE) has regulated the energy efficiency level of low-voltage dry-type distribution transformers since 2007. Beginning in 2016, the DOE laid out newly amended, federally mandated, energy efficiency standards for distribution transformers and increased the spec dramatically for dry-type distribution.  PPSI’s sales that feature new specs should carry much higher margins than old spec models as the industry will see a lag effect before any commoditization in pricing. Management expects this to be a catalyst throughout 2016 as they work through old inventory and begin selling the more favorable product during 2Q/3Q.
 
-    Cost cuts include both the closing down of a Canadian manufacturing facility and a reduction in total headcount.  As stated earlier, contracting that was formerly being done in Canada is now being handled out of an Indian facility.

-    Siemens:  Management has discussed a new contract with Siemens that will expands PPSI’s EBITDA opportunity with that customer.

-    Facility consolidation:  PPSI has guided to a $1m cost savings opportunity via the consolidation of three facilities.

-    Verizon and Target:  PPSI has spoken about a couple of projects they are pursuing with VZ and Target involving back up power generation which haven’t fully kicked in yet. Additional opportunities for expansion from original contracts that would provide incremental upside with management noting on the last CC that Verizon is already expanding further in the Midwest. They expect positive results from Target but will not know for another month or so.
 
Illustrative Target Value:

2016e EBITDA: 9m (note that guidance is $8m - $9.5m)
Multiple: 8-10x
Value: $72m-$90m
Net Debt: $17m
Equity Value: $55m-$73m
Shares out: 8.7m
Value per share $6.32 - $8.40
Current: $4.39
Upside: 45% - 90%

Summary

Pioneer’s underlying businesses may be lumpy at times, similar to the setbacks we observed in 2015.  However, the Company is a proven mid-to-upper single digit growth company in an industry that has suffered from decades of vast underinvestment on one side, and rapid technological change and need on the other.  PPSI shares trade like an old washed out industrial widget maker with a declining market and an irrelevant product set. This is hardly the case. After last year’s depressed order book, top line is set to enjoy grow greater than 25% in 2016, a very nice rebound. From a trading perspective, the several large blocks that were leaning on the stock seem to have disappeared. Shares may appreciate more than 50% in 2016 if the company simply meets their guidance, a current run rate that exists today. However, given the conservative expectations, further upside scenarios exist if the company can outperform and deliver on several projects in the pipeline that have been validated in recent months.

Catalyst

-the stock is too cheap on $0.55-$0.65c of 2016e eps

- increased visibility of growing backlog & earnings followed by execution

- once stock stabilizes to its fair value, Management may look to sell the Company to a strategic acquirer