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December 30, 2015

Lightbridge Flirts with Areva

by Debra Fiakas CFA

Last week nuclear fuel developer Lightbridge Corporation (LTBR:  Nasdaq) announced an agreement with nuclear power plant builder Areva (AREVA:  Paris; ARVCF:  OTC/QB) to form a joint venture.  The present pact is a precursor to a formal joint venture agreement that would team up the two companies  -  one very large multinational nuclear power house and one still quite small fuel developer  -  in joint development of Lightbridge’s metallic nuclear fuel technology.

Lightbridge has developed and patented a novel design that replaces conventional tubes filled with ceramic uranium pellets now used by pressurized water reactors.  Lightbridge’s fuel rods are also produced differently.  A co-extrusion technology is used to shape a single piece of solid fuel rod from a metallic matrix composed of a uranium and zirconium alloy.

The Lightbridge fuel rod affords a number of advantages.  Most important for nuclear power plant operators is the potential for a 10% to 17% increase in power generating capacity from existing reactors.  For new reactors the “power uprate” as Lightbridge calls it, could be as high as 30%.  The Lightbridge all-metal fuel rods could also extend the operating cycle length from 18 months to 24 months.  These benefits mean a dramatic change for the better in the economics of nuclear power plants, making both existing and new plants more attractive alternatives to fossil fuel plants that spew out offending carbon pollution.

Some reactor system adjustments would be required to use Lightbridge’s all-metal fuel rods.  That means the company needs to work closely with nuclear plant designers and fuel suppliers to fully commercialize the Lightbridge fuel rod design.  Ultimately it will be the nuclear fuel suppliers that will be Lightbridge’s customers.  In a post on September 11, 2015, discussing the U.S. Clean Power Plan and nuclear power, we noted that Westinghouse or Areva could be two of Lightbridge’s most likely commercial partners.

True enough the agreement that was just announced is not much more than a firm handshake on a plan to meet again.  However, it is not likely that Areva would even bother with Lightbridge if they had no interest in Lightbridge’s novel nuclear fuel rod design.  In my view, with this announcement Lightbridge has become an even more interesting play in nuclear power through the possible endorsement by Areva.

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

December 29, 2015

The Great Algae Flour Fight: Solazyme Wins Again

Jim Lane

After the bizarre attempted heist detailed in The Great Algae Robbery, Roquette tries the US courts but comes up short, in its quest to get a hold of Solazyme’s (SZYM) algae tech.

On a slow news day just before Christmas, those of us on the industrial biotechnology beat have no need to stop by the firehouse to ask if there is a breaking story to report, because we always have the lively docket of Judge Sue Robinson, Federal District Judge for the District of Delaware.

This Christmas she did not fail us, for in our Christmas news stocking is a judgment for Solazyme and against Roquette, confirming an earlier arbitration award we covered last February in The Great Algae Robbery, here.

Fans of lively intellectual property disputes will long remember another case in the Robinson files — the dispute between Gevo (GEVO) and Butamax over isobutanol IP which we compared to the saga of the Montagues and the Capulets as detailed in Romeo and Juliet.

The ruling

First, the news. Just before Christmas, Robinson ruled that “the court confirms the Award. More specifically, the court grants Solazyme’s motion for an order to confirm the Award and denies Roquette’s motion for an order to vacate the Award, as well as Roquette’s motions for summary judgment as to its declaratory judgment actions. Judgment shall be entered accordingly.”

The background

For those who have not yet read The Great Algae Robbery, the case revolved around the use of Solazyme’s intellectual property to create high lipid algal flour and an algal protein with attractive nutritional characteristics.

As we noted then:

“Think about the world “diabesity” crisis, an ominous combination of diabetes and obesity that is threatening to cause ballooning medical bills and shortened average life spans. The culprit? An excessive intake of carbohydrates, mostly, especially in the developing world. And especially from carbohydrate-rich bread and carb-loaded flour. And while there were many good healthy food choices available, not many of them tasted so good.

How do you get a good flavor, but with healthy fats (instead of transfats, for instance) and other nutritional benefits? That was the challenge. The company that could come up with a healthy and palatable flour — many saw a route to riches.”

Herein lay the promise of the Solazyme technology, which was contributed to a joint venture with Roquette Freres, called Solazyme Roquette Nutritionals. When the JV dissolved in 2013, arbitration was invoked to determine who owned what of the intellectual property.

In early 2015, arbitrators ruled comprehensively in favor of Solazyme, including ownership of “[a]ll Roquette patent applications filed on or after November 3, 2010 relating to microalgal foods, microalgal food ingredients, and microalgal nutritionals, as well as all methods relating to making and using the same, including but not limited to those” patents listed by the Panel. This, after the arbitrators determined tat Roquette had been secretly filing duplicate patent apps on the (then) SNR intellectual property, only filing for them as Roquette and omitting Solazyme’s ownership interest.

At which point, Roquette headed for Federal District court to overturn the arbitration ruling. Not an easy undertaking, as under the Federal Arbitration Act, a court’s role Under the Act, Judge Robinson noted that “a court’s function in reviewing a commercial arbitration award is “narrow in the extreme” and is “extremely deferential.”

I’m Not Dead Yet

For comic value and the sheer inventiveness of the Roquette legal team’s arguments, we have to look beyond the medieval traditions of Romeo and Juliet and the Montagues and the Capulets that we saw in the Gevo-Butamax dispute.

Instead, we might look to Monty Python and the Holy Grail, where the Black Knight just can’t quite give up the fight against King Arthur even after all four of his limbs have been hacked off, shouting “Running away eh? You yellow bastard, Come back here and take what’s coming to you. I’ll bite your legs off!”

One of the Roquette team’s premises for overturning the arbitration ruling was so novel that Judge Robinson noted that there was “There is no case law directly on point.”

The theory? Roquette challenges the Award as being so broad as to “curtail Roquette’s ability to compete in the manufacture or sale” of all microalgal food products, in effect granting Solazyme monopoly power in the microalgal food market and violating the public policy against monopolization.”

Solazyme, not surprisingly objected on the grounds that there is “no authority which stands for the proposition that a commercial arbitration award may be vacated on public policy grounds.” Solazyme goes on to point out that the “breadth of the relief awarded by the Panel is due to Roquette’s own failure to comply with the discovery ordered by the Panel; i.e., “[b]because Roquette refused to provide any discovery, the Panel was left with no way to delineate between the patent applications to which Solazyme was entitled (because they represented improvements to the intellectual property Solazyme contributed to SRN) and any patent applications that Roquette was entitled to retain.”

Monopoly vs patent

The idea that a limited-time monopoly on intellectual property — known as a patent — is forbidden under US law on public policy grounds that they create illegal monopolies is indeed a novel one.

The framers of the Constitution may have thought that they dealt with this issue in Article I, Section 8, where they protected exclusive rights for inventions: “The Congress shall have Power To…promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries….”

Monopolies, by definition, are markets controlled by a single actor — or, a group of shareholders acting as one. In this particular case, nothing prevents a patent-holder such as Solazyme from licensing its whole algal flour to 10,000 companies and creating a vibrant market for algal flour that has nothing to do with a monopoly. Zillions of technologies are widely licensed within highly competitive markets without destroying them.

We might add that the original agreement for Solazyme Roquette Nutritionals provided for the possibility that the company’s intellectual property could be licensed to third parties (should the SNR board, Roquette and Solazyme approve of it). Even 10,000 of them. It’s right here in Article 11.

Judge Robinson dispatched the whole idea into the dustbin of legal theory, thus:

“It is not surprising that Roquette’s public policy argument has either not been presented or has not prevailed in the context at bar, when commercial arbitration awards are reviewed with great deference and patents constitute exceptions to the general rule against monopolies. The court declines to create case law out of whole cloth under the circumstances at bar.”

In short, the novelty in this case is going to be firmly fixed around the know-how of making high lipid algal flour and algal protein.

Algility — the most innovative ingredient of the year.

You can buy it today. Algility that is, a Roquette product based on the SNR patents which have been awarded to Solazyme in arbitration and now confirmed in US District Court.

Transformative for diets and the corporate fortunes of their makers — it is not hard to guess why the Food Ingredients “Europe Excellence Awards” for 2013 gave the nod to Algility as “the most innovative ingredient” of the year. And no surprise that Roquette values the patents and Solazyme wants them back. The products are very cool. Here’s a quick look.



Hello, Court of Appeals

With that kind of product appeal, we’ll be mighty surprised to read of anything less than a Roquette filing in the United States Court of Appeals for the Third Circuit to overturn the district court ruling. The Black Knight never gave up in Monty Python and the Holy Grail, and it looks like we’ll see a similar story arc with Roquette.

Roquette’s chances of success? We’ll offer them one thin line of gruel. In her ruling, Judge Robinson writes on page 13:

The court concludes that the Panel did not exceed its authority in reviewing the MTA in connection with its task of determining whether improvements were made to Solazyme’s intellectual property, pursuant to § 21.1 ( c)(i) of the JVOA, as the MTA shed light on that issue.

But then she writes on page 15:

Although the court has concluded that the Panel exceeded its authority by substantively reviewing the MTA and finding a breach thereof, it is not clear whether the Panel exacerbated that conduct by using the breach as a basis for the broad relief granted to Solazyme, and/or whether the relief itself is so broad as to be outside the scope contemplated by the JVOA.

Did the Panel exceed its authority or not? We’re left to wonder.

On the other hand, it probably doesn’t matter. Judge Robinson conclusively ruled that, even if it had exceeded its authority, the arbitration panel did not “base the Award (to any determined extent) on the breach of the MTA.”

So, some inconsistency in the working of the ruling may not spell much relief for Roquette. But we’ll look forward to their appeal with the excitement usually reserved for the arrival of a new landmark Hollywood comedy.

The good news: powerful battles speak to powerful value

We are encouraged — as we were with the Gevo-Butamax case — in only one respect. The tussle of the parents over the custody of their offspring can be taken as a general indication of how powerful the technology will prove to be.

You see, no one argues over ownership of valueless inventions. Losers are consigned to the Land of Misfit Toys along with the train with square wheels, polka-dotted elephants, and Charlie-in-the-Box.

In this case, we have had some two years of expensive squabbling in the courts and arbitration halls over this one. The one parent shouts for “joint custody”. The other parent is shouting that the kid predates the marriage. It’s material that usually features a combination of Jenners and Kardashians and is related in the pages of The National Enquirer.

But instead of the Kardashians, we have Solazyme, Roquette, and a Memorandum Opinion of the US District Court. So, the discussion may be a tad more technical, and the kid in question may be a single-celled wonder organism instead of a batch of celebrity children.

What will happen to the flour?

So far, the arbitration panel and the US District Court could have not been more emphatic that what is being marketed as Roquette’s algility whole algal flour and algae protein is based entirely on Solazyme’s intellectual property. Whether Roquette will ultimately license the IP from Solazyme, or some other commercial arrangements will appear — that’s remains unclear.

But we’ll not forget for some time the theory that you can’t grant an inventor the right to his or her patent on the grounds that it would lead to a breach on public policy regarding monopolization. As innovative as Solazyme’s technology in the area is, or might become — nothing will challenge that laugher for sheer inventiveness for a long, long time to come.

Jim Lane is editor and publisher  of Biofuels Digest where this article was originally published. Biofuels Digest is the most widely read  Biofuels daily read by 14,000+ organizations. Subscribe here.

December 28, 2015

Lights of Energy Focus

by Debra Fiakas CFA

It is the season of lights.  Lights for Hanukkah.  Lights for Christmas.  Energy Focus (EFOI:  Nasdaq) has been having a season of lights all year.  The company reported $62.3 million in total sales of its LED lighting products in the most recently reported twelve months.  Customers included large business and industry, property owners and the military.  The oil and gas industry is an important market vertical.

Energy Focus really shines for the U.S. Navy with its explosion proof LED globes in all the colors the Navy needs to provide military personnel safety warnings.  The Navy also buys special LED lights for the berths on its ships.

The company has been in the lighting business for over thirty years.  Energy Focus has successfully made the transition to new more environmentally friendly technologies such as LED by investing consistently in research and development.  Research and development expenses represent about 5% of total sales.

Sales provided $6.2 million in net income or $0.66 in earnings per share in the last reported twelve months.  The stock is currently trading at about 14 times trailing earnings.  Although small, Energy Focus has cultivated a following of analysts who have published relatively bullish views on the stock.  The consensus estimate for 2016 is $1.02 in earnings per share on $87.9 million in total sales.  That represents about 12% growth in earnings, suggesting the stock is trading at a bit of premium to growth projected for the next year.  That might still be a bargain given the long-term opportunities in LED lighting, especially for a company with standout products and strong customer relationships.

Energy Focus is well capitalized, with very little debt. Consistent generation of operating cash flow has helped build cash on the balance sheet to nearly $35.0 million.  Fast growing market opportunity, strong and loyal customers, profits, cash flow, low-leverage balance sheet.  EFOI is truly a bright and shiny light!

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

December 21, 2015

Interest Rate Increase? FuhGettaBoutIt!

by Debra Fiakas CFA

There has been considerable fuss in recent weeks about the Federal Open Market Committee decision to raise its benchmark interest rate.  The one-quarter point increase has finally been announced and investors now are watching with bated breath to see how the increased cost of funds at the Fed ‘window’ will impact borrowing costs for companies large and small.  In our Beach Boys Index of alternative energy producers, we found a number of companies that rely on debt as a capital source. 

However, not all energy producers have debt.  So when Janet Yellen made her historic announcement, raising the benchmark interest rate for the first time in over nine years, they just said ‘fuhgettaboutit.’ 

Operating Cash Flow
Cash Flow-to-Sales Ratio
Cash Balance
Debt-to-Equity Ratio
Trailing twelve months ending September 2015; balances on September 30, 2015

Energy sector investors might be surprised to see Liquidity Services, Inc. (LQDT:  Nasdaq) in our index.  The company facilitates the recycling of used assets, scrap metal and salvage through its auction marketplace.  Recycling is a critical element in energy efficiency.  The founders might not have anticipated the duel meaning in the name, yet the company has become very liquid through its track record of turning as much as 11% of its sales into operating cash flow.  The success has made it possible to keep a debt-free balance sheet.

Astec Industries, Inc. (ASTE:  Nasdaq) is also a net generator of cash through sales of its industrial equipment and components.  Astec has been pivotal in helping build geothermal power plants and wood processing plants, both of which are important participants in renewable energy production.  Its sales-to-cash conversion rate is a modest 2.8%, but that is enough to maintain a low-debt balance sheet.  Astec also has sufficient cash to pay off its long-term debt if their creditors call with a rate increase.

Seed producer Ceres, Inc. (CERE:  Nasdaq) has applied it biotechnology to the both food and energy crops.  The company is still a net cash user as it struggles to win customers and ramp revenue, relying on the sale of common stock to make ends meet.

Codexis, Inc. (CDXS:  Nasdaq) is swimming against and even stronger current.  The company has refocused its biocatalysts away from the ethanol and biofuel sectors to pharmaceutical, flavors, fragrances, food and feed applications.  The decision appears to have been astute as the company reported a net profit in the quarter ending September 2015.  Operating cash flow in the quarter was also positive.  With that accomplishment, Codexis management can thumb the corporate nose at interest rate increases as its current cash kitty appears adequate to see the company through to more prosperous times.    

Over the last few weeks management teams in every U.S. company have likely put a pen to paper to figure out what an increase in interest rates might mean for their future.  However, for these four companies the rate increase poses no immediate problem for them.

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

December 18, 2015

Bearing The Interest Burden

by Debra Fiakas CFA

Smaller companies frequently avoid debt as a capital source, relying instead mostly on equity.  After all common stock  holders are often content to wait for years for a dividend as the small, young company secures its market position and builds profits.  Pesky creditors are always knocking on the door for interest payments and principal return.

Yet, a number of smaller companies included in our Beach Boys Index of alternative fuel producers have chosen to use debt. We reviewed a group of them to determine the impact of increase in interest rates that could result from an upward revision of the Federal Reserve’s benchmark interest rate. 

Waste-to-energy producer Covanta Holding Corp. (CVA:  NYSE) wins top prize as the most levered company in the group with Darling Ingredients (DAR:  NYSE), a food by-products recycler and renewable diesel producer, follows up as a distant second.

Operating Cash Flow
Cash Flow-to-Sales Ratio
Cash Balance
Debt-to-Equity Ratio
Trailing twelve months ending September 2015; balances on September 30, 2015

First we looked at the total debt and calculated the after-tax impact in earnings per share of a quarter point increase in interest rates.  We then took our analysis to the next level by measuring the impact on the stock price that might result from the reduction in earnings.  For this analysis we used the company’s forward earnings multiple, if available, and otherwise the trailing earnings multiple.  Not surprising the two companies for which we estimated the greatest price reduction are the two most-leveraged operations based on debt-to-equity.

Current Price
Change in EPS
Valuation Impact / Share
Percent of Price

For some of the companies in the group this initial uptick in the bench market interest rate may be a ‘non-event.’  For example, the stock price of Covanta may ultimately show the least impact of higher interest rates.  Covanta’s production of electricity from low- or no-cost waste materials affords a highly efficient business model with strong profits and cash flows.  Covanta converts nearly 14% of its sales dollars to operating cash flow, making it one of the strongest cash generators in the group.

In contrast to Covanta, Amyris, Inc. (AMRS:  Nasdaq), Pacific Ethanol, Inc. (PEIX:  Nasdaq), Green Plains, Inc. (GPRE:  Nasdaq), and Ameresco, Inc. (AMRC:  Nasdaq) have all struggled to maintain positive operating cash flows.  Each of these companies is a reported net user of cash in the most recently reported twelve months.  The strain on cash balances could trigger greater concern on the part of traders and shareholders.

Perhaps a greater concern for these smaller companies than the impact of greater interest burden on earnings per share, is the risk that increases in interest rates might make it more difficult to remain in compliance with debt covenants.  Nearly all companies with debt have agreed with creditors to maintain minimum financial performance such as minimum coverage of interest obligations by operating earnings or maximum debt-to-equity ratio.  Darling Ingredients is the second most levered company in this group and has had difficulties in maintaining covenant compliance in the past.

It will take some time to determine how the increased Federal Funds rate will impact lending patterns.  In the meantime, it appears these renewable energy producers have the mean to bear up under their interest burden

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

December 17, 2015

Can Broad Shoulders Shake Off The Rate Hike?

by Debra Fiakas CFA

Some investors may be surprised by the repercussions of an increase in the Federal Reserve’s benchmark interest rate.  The Federal Open Market Committee is expected to take action next week for the first time in nine years to increase the rate from near zero.  Odds makers have pegged the magnitude of the rate increase by a quarter percentage point.

We decided to take a look at some of the companies in Crystal Equity Research’s Beach Boys Index composed of biofuel, ethanol, renewable diesel and other alternative fuel producers.  We looked to see which ones might be vulnerable to an interest rate increase by virtue of having large amounts of debt.

Top of the list is agriculture giant Archer Daniels Midland (ADM:  NYSE), which appears on our Beach Boys Index by virtue of its biodiesel and ethanol interests.  Of the five companies in this group, ADM uses the lowest leverage.  Eastman Chemical (EMN:  NYSE) is a specialty chemicals company that is attempting to transform its old-line petrochemical-based products with renewable materials.  Eastman is the most levered in the group.  Ethanol producer, The Andersons (ANDE:  Nasdaq) is the smallest of the group in terms of sales and assets and has the second lowest debt-to-equity ratio in the group.  Air Products and Chemicals (APD:  NYSE) is the most successful in the group at converting sales to operating cash flow.  Yet even with all that cash flowing in, debt is still an important element in the company’s capital structure.  The Praxair Group (PX:  NYSE), the second specialty gas producer in the group, has the higher debt-to-equity ratio in the group. 
For each of these companies, we estimated the incremental interest burden that might ensue with an quarter point interest rate increase.  Our calculation assumes all of the debt was either subject to variable rate interest rates or would need to be refinanced within the year.

Operating Cash Flow
Cash Flow-to-Sales Ratio
Cash Balance
Debt-to-Equity Ratio
Trailing twelve months ending September 2015; balances on September 30, 2015

Next the impact on earnings per share was calculated.  Then we used each company’s forward earnings multiple to determine the potential impact on price.  As ominous as an interest rate increase sounds, from a valuation standpoint, these large companies might not experience any significant price adjustment. 

Current Price
Change in EPS
Valuation Impact / Share
Percent of Price

It is also possible that the impact of rising interest burden has already been incorporated in stock valuations.  This particular decision by the Federal Reserve has been discussed for months.  It seems logical that equity investors have already taken increasing interest rates into consideration in completing forward projections and determining target prices.  For this group of five large companies, all of which have ample analyst coverage, the FOMC meeting and Janet Yellen’s announcement next week might be anti-climactic.  These ‘broad shouldered’ companies have appear ready to shake off an interest rate hike whenever it comes along. 

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

December 16, 2015

Comparative Valuation of 15 Yieldcos

Tom Konrad CFA

Compared to the peak of the Yieldco bubble in May, many Yieldcos have dropped by more than half, and most by more than a third.

Some of this decline is because rapid dividend growth depends on an endless supply of cheap investor capital-- which is another way of saying that we can have rapid dividend growth or high dividend yields, but not both.  Part of the decline was due to the realization that many Yeildcos (most notably Terraform Power (TERP), Terraform Global (GLBL), and Abengoa Yield (ABY)) were not immune to the financial problems at their sponsors, and so they were far more risky than many investors previously thought.

These problems affect different Yieldcos differently.   NextEra Partners (NEP) has a strong sponsor, others (Brookfield Renewable Energy Partners (BEP) and Hannon Armstrong Sustainable Infrastructure (HASI)) develop projects internally, while Pattern Energy Group (PEGI) has a private sponsor, with very strong investor protections in place to protect investors from conflicts of interest.  While these Yieldcos have fallen as investors began to demand higher current yield instead of only the promise of rapid future yield growth, they are much less vulnerable financial difficulties at their sponsors.

These effects can be seen in the following chart, which shows that Yieldcos with high expected growth, and/or public sponsors have fallen the farthest since the peak of the Yieldco bubble in May.

how they have fallen

With Yieldcos having declined so much, there is likely opportunity, but is it in the giant declines of the riskiest Yieldcos, or the smaller declines of the safer ones? 

Valuation With The Dividend Discount Model

The answer lies in valuation.  For income stocks like Yieldcos, the dividend discount model (DDM) is by far the best valuation method.  DDM valuation requires us to estimate future dividends, and also choose a required rate of return (discount rate) which should be higher for riskier Yieldcos.  If we choose our discount rate to accurately reflect the likely risks, we can use DDM to compare valuations of Yieldcos with entirely different risk profiles.

Below are my estimates of Yieldcos' dividend growth rates going forward:

yieldco growth rates
When these are combined with the current dividend, we get estimated dividends for future years:
5 yr dividend
Given future dividends, the dividend discount model gives us stock valuations for any required rate of return.  I show these below (as a fraction of the closing market price on December 11th) for ranges of discount rates that reflect my estimation of the relative riskiness of each Yieldco. 
DDM valuations
You can click on any of these charts to see a larger version.

Evaluation of Results

For investors who accept my dividend and discount rate estimates, it's clear that almost all Yieldcos are currently trading below their inherent worth.  The only exceptions are NextEra Energy Partners (NEP), and Capstone Infrastructure Corp (TSX:CSE or MCQPF.) 

NEP seems to be trading at a relative premium because it is widely seen to have the strongest sponsor, NextEra (NEE) with the largest list of right of first offer ("ROFO") projects that can be dropped down to its Yieldco, and minimal risk of financial instability at the sponsor.  I personally feel that ROFOs are greatly overvalued in the current climate.  Few Yieldcos have any cash to invest in new projects, and those that do can easily buy project from any number of developers. 

Capstone Infrastructure is the only other fairly valued Yieldco in my list.  It is one of the few Yieldcos I owned before the recent decline, and the only one showing a gain since May.  This gain is in part due to the recent announcement that Capstone has retained investment banks to help it "review and consider various alternatives."  This is investment banker speak for the company being available for sale if a sufficiently attractive offer should emerge.

Terraform Power (TERP) is also trading near fair value, at least at the high discount rates that reflect the financial strains at its sponsor, SunEdison (SUNE), and SunEdison's recent moves in taking control of the boards at Terraform Power and its sister Yieldco, Terraform Global (GLBL).  TERP recently advanced when it received news that SUNE had revised the terms of its much-criticized deal with Vivint (VSLR), and the Yieldco emerged as the biggest beneficiary of the new deal, likely because of the attentions of activist investor David Tepper. 

While Terraform Global's share price also benefited from the news, it did not appreciate nearly as much, because Tepper has not disclosed any position in GLBL and it was not a direct beneficiary of the revised Vivint deal.  Terraform Global remains one of the best-valued Yieldcos, even at discount rates that reflect the very real risks of owning this company.

By far, the best valued Yieldco is Pattern Energy Group (PEGI).  Pattern combines a high (8%) current yield with continued prospects for modest yield growth and strong protections for investors.  By my estimate, PEGI is trading at a 50% discount to its true value even at a 9% required rate of return.

The next best values are still very attractive and trade around 60% of fair value.  They are NRG Yield (NYLD and NYLD/A), Hannon Armstrong Sustainable Infrastructure (HASI), Terraform Global (GLBL), 8point3 Energy Partners (CAFD), Brookfield Renewable Energy Partners (BEP), Innergex Renewable Energy (TSX:INE or INGXF), TransAlta Renewables (TSX:RNW or TRSWF), Enviva Partners, LP (EVA), and Green Plains Partners (GPP).

One quick note of caution on wood pellet and ethanol producers Enviva and Green Plains is that these two are Master Limited Partnerships, and are generally not appropriate to own inside a retirement account such as an IRA.  In addition, my research into the newly listed Green Plains has so far been cursory, so I do not have a lot of confidence in the numbers used to produce my estimate of its fair value.

required ROR
Another way to look at these estimates is to calculate the required rate of return needed to justify the current price from expected cash flows.  I calculated the internal rates of return in the above chart under the assumption that the shares would be held until 2037, at which point they would be sold at the current market price.


While nearly all Yieldcos are excellent values and good additions to any value or income-oriented portfolio, some are far better than others.  Investors looking to add just a few Yieldcos to their portfolios should focus on Pattern Energy Group (especially for risk-averse investors), Enviva (in taxable accounts), and Terraform Global (for investors willing to accept a high degree of risk in return for extremely high (25%) expected annual returns.) 

The Green Global Income Portfolio, which I manage, owns all of these except NEP (because of valuation) and GPP (pending further research.)  It has recently been increasing its stakes in the ones with the best valuations by this analysis.


DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

December 13, 2015

What Yieldco Managers Are Saying About The Market Meltdown

by Tom Konrad Ph.D., CFA

Note: This article was first published on GreenTechMedia on Noveber 27th.

In the last six months, YieldCos have fallen from stock market darlings to pariahs. 

YieldCos are companies that buy clean energy projects such as solar and wind farms, and use the majority of free cash flow from these projects to pay dividends to investors. Many are listed subsidiaries or carve-outs of large developers of clean energy projects.

Last year, investors repeatedly punished leading solar developers and manufacturer First Solar and SunPower for their reluctance to launch YieldCos. When they finally relented and formed a joint YieldCo (later called 8point3 Energy Partners), both were instantly rewarded. Their stock prices each rose 20 percent over the course of two weeks.

Now, the situation is reversed, with many YieldCos trading at half their peak prices. The Global X YieldCo ETF (YLCO) is trading around $10, down one-third from its $15 launch near the peak of the YieldCo mania in May.

Is the YieldCo model broken?

Many market observers are questioning if the YieldCo model is broken.

The YieldCo model has no official definition, but its detractors typically point to the rapid dividend growth targeted by many of the ones based in the United States when making their point. This dividend growth was achieved (as I explained at the time) by public offerings of stock at successively higher prices, which produced more capital per share to invest. More capital per share allowed dividend growth and higher share prices.

Each link in this virtuous cycle depended crucially on the last, and when share prices broke down, the ability to raise cheap capital did too. 

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What managers are saying

If the YieldCo model is broken, it is only this aspect of the model that's a problem. How YieldCo managers are confronting the new environment depends on how much they intended to rely on stock market capital before the crisis.

Below is what a selection of YieldCo managers said in their recent third-quarter conference calls. How bullish they are depended directly on how much they were relying on stock market capital for their growth plans, but all emphasized how they remain sustainable businesses even without growth.

Independent YieldCos, which often have other ways to access capital and less pressure to buy projects from their sponsors, were also generally more sanguine about the market turmoil.

Subsidiaries of clean energy developers

NextEra Energy Partners: “The YieldCo model can work and work well”

NextEra Energy (NEE) is widely seen to be the strongest of YieldCo sponsors, and many investors appreciate this strength. Although NextEra Energy Partners (NEP) shares have fallen significantly, Jim Robo, chairman and CEO of NEP, said, “The YieldCo model can work and work well for our partnership like NEP that has the right structure and the support of a world-class sponsor.” 

He thinks “the capital markets' re-evaluation of the YieldCo space can play to our competitive advantage.”

But even NEP is cautious about raising new capital in the current market conditions. “We continue to evaluate the optimal capital structure for NEP. As it has some additional debt capacity that can help finance future transactions.” The YieldCo “plan[s] to issue a modest amount of NEP public equity” in 2016, but will both buy and sell NEP units based on market conditions.

Abengoa Yield: Working to “become a completely independent company”

Abengoa SA (ABGB) is in significant financial difficulty, so its YieldCo [ABY] is taking steps to protect itself from any possible fallout. CEO Javier Garoz spoke about Abengoa Yield's plans in a conference call in early November.

“ABY has all necessary [elements] in place to achieve the run rate in 2016; concentrating on the execution and delivery of the expected cash flows…must be our top priority.” He continued,  “We want to reinforce our autonomy from Abengoa to become a completely independent company. We will incorporate the necessary resources at the corporate and staff functions to avoid the current dependency.”

In addition to building its own management team, ABY is actively searching “for another sponsor, in addition to Abengoa.” Garoz reaffirmed 2016 dividend guidance of $2.10-$2.15 per share, emphasizing that it does not “depend on any additional acquisition.”

Like many other YieldCo managers, Garoz thinks his company's assets are undervalued by the market. “[E]ven considering an hypothetical worst case scenario, where ABY have no access to growth for some time, our current portfolio of assets have a very significant value not recognized by the market at this point.”

TransAlta Corporation will continue to pursue drop-downs to YieldCo

Unlike most YieldCos listed on U.S. exchanges, TransAlta Renewables (Toronto:RNW) never promised double-digit dividend growth rates. Because of this, its share price has suffered much less than those of its U.S.-listed rivals. 

In a conference call on October 30, TransAlta Corporation (TAC) CEO Dawn Farrell emphasized that little had changed for the YieldCo. She stated that TAC will continue to “pursue asset drop-downs to TransAlta Renewables.”

She also felt it important to emphasize the YieldCo's value proposition, stating that management believes “TransAlta Renewables is a solid investment for shareholders who want stable and secure dividends with moderate growth.”

NRG Yeild: "Investment porposition is unchanged."

NRG Yield (NYLD and NYLD/A) will continue to target 15% anual dividend pre share growth, and will be able to do so for at least two years without access to the equity markets by increasing its payout ratio.

8point3 Energy Partners: Sponsors committed to drop-downs

In a call on October 29, First Solar (FSLR) CEO James Alton Hughes said that plans for 8point3 Energy Partners were on track. “Both sponsors at this point in time are committed to the drop-downs that we would envision in the first half of 2016. We've also indicated that we do not have a need to raise capital at this point in time. We've left enough capacity in 8point3 to manage those anticipated drop-downs.”

SunPower's CEO Tom Werner agreed, saying, “We think 8point3 can successfully buy projects without issuing equity for a period of time.”

The TerraForms: TERP and GLBL “maintaining liquidity” and “sufficient capital”

SunEdison's (SUNE) twin YieldCos have been suffering more than any of the others, because investors had previously looked at the YieldCos as the cure for SunEdison's over-leveraged balance sheet. With TERP's and GLBL's stocks in the tank, it looks less likely that the TerraForm twins will be able to access the market in order to buy more solar farms from SunEdison in exchange for much-needed cash.

Both YieldCos have been trying to soothe investors' worries with comforting talk about sufficient resources to fund existing commitments. 

Recently replaced CEO Carlos Domenech stated that TERP has $1.5 billion in cash and an undrawn credit facility. The CFO, Alex Hernandez, pointed to a recent U.K. project financing which he said "demonstrates the company’s access to financing markets at an attractive cost of capital and ability to continue funding the growth of our business.”

He said TERP “remain[s] focused on further strengthening the company’s liquidity position and maintaining the quality of our balance sheet.”

Regarding TerraForm Global, Domenech said the company has sufficient capital to fund pending transactions, bringing the portfolio to 1.3 gigawatts. At the time, it had $1.1 billion in unrestricted cash and a $500 million credit facility.

On Monday, Domenech was replaced as CEO of both TerraForm YieldCos by SunEdison CFO Brian Wuebbels. And on Tuesday, SunEdison reversed its prior stance of not selling additional assets to the TerraForms, selling 425 megawatts of Indian solar to GLBL for $231 million. In order to buy these projects, the YieldCo canceled plans to buy other projects from third parties.

Was the deal forced, or were the Indian solar farms simply too good a deal to pass up? The timing, right after the replacement of Domenech, looks suspicious. At $0.51 per watt, the $231 million purchase price of the Indian farms seems very low, but without knowing how much debt was involved in the transaction and a number of other details, it's impossible to know how good a deal this was for Terraform Global.

In a transaction agreed on in June, NRG Yield bought 137.5 megawatts of the Desert Sunlight Solar Farm from GE Energy Financial Services for cash and the assumption of debt amounting to $4.16 per watt.

Independent YieldCos

Pattern Energy: Volatility in YieldCo sector “very healthy”

In a conference call on November 5, Pattern (PEGI) CEO Michael Garland said, “We believe [the recent volatility] is very healthy for Pattern and the sector, as it allows us to highlight the strength of our corporate strategy, the robustness of our cash flows and soundness of our growth strategy.”

He went on to discuss Pattern's ability to manage without returning to the capital markets. He stated, “[C]ash available for distributions is stable and sustainable...over the next 25 years. These assets don't require any additional equity capital.”

Pattern increased its dividend for the third quarter, but declined to give a dividend growth target for 2016, stating that growth would depend on market conditions. Garland emphasized the advantage of Pattern's private development arm, Pattern Development, which is not subject to stock market whims. If Pattern's stock price does not recover, Pattern Development will hold operational assets longer, rather than dropping them down to a YieldCo, which cannot finance them at attractive rates.

Hannon Armstrong Sustainable Infrastructure: YieldCo pullback is an opportunity

Hannon Armstrong (HASI) does not have a development arm, but its expertise in energy efficiency finance gives it access to high-quality energy-efficiency projects beyond the scope of other YieldCos. It also invests in many of the same projects as other YieldCos, but generally as a more senior creditor.

In a conference call on November 4, CEO Jeffrey Eckel stated that there has been a “pullback of buyers of projects from the YieldCo issues. … [T]he required rate of return for investors in the equity has gone up. … [T]hat gives a little air cover for the senior slices of capital to go up as well.”

Hannon Armstrong reaffirmed its 14 percent to 16 percent annual per-share earnings growth target for 2015 and 2016.

Brookfield Renewable Energy Partners: “We're very different”

In a call on November 3, Brookfield (BEP) CEO Sachin Shah emphasized that Brookfield does not have most of the characteristics that are leading investors to question the YieldCo model.

“We're very different. We have internal operating capabilities. We have our own development. We don't rely on a drop-down from parent. We fund our growth largely through our own existing cash flow," said Shah.

He added, “I think the opportunity set will actually get better if we see a weaker capital market, and we're one of the few organizations that is really well positioned to benefit from that. We saw YieldCos drive the cost of assets to levels that were really difficult for us to compete with, and this was largely off the back of them trading at a very, very low cost of capital and, really, the market believing that their growth into perpetuity could sustain itself."

Looking ahead

While most YieldCos are responding to low stock market prices by shelving plans for new share issuance and new acquisitions, the model of connecting low-cost stock market capital with capital-intensive clean energy projects is far from dead.

Even the growth of YieldCo dividends is not dead. Many YieldCos have considerable cash on hand, borrowing capacity, or (a few) retained cash flows. These companies are likely to take advantage of the new environment to scoop up a few choice assets on the cheap.

Investors would likely do well to do likewise and scoop up YieldCo shares on the cheap.

Tom Konrad is a portfolio manager and freelance writer with a focus on clean energy income investments. He manages the Green Global Equity Income Portfolio and is editor of AltEnergyStocks.com.  

DISCLOSURE: Tom Konrad, his clients, and the Green Global Equity Income Portfolio own shares of NEP, ABY, TSX:RNW, CAFD, TERP, GLBL, PEGI, HASI, and BEP.

December 09, 2015

AeroVironment Hits Pay Dirt

by Debra Fiakas CFA

After the market close Tuesday, AeroVironment, Inc. (AVAV:  Nasdaq) is scheduled to report financial results for the quarter ending October 2015.  Management is holding conference call with investors and analysts directly following the announcement.  It is going to be an interesting call.

AeroVironment has some crowing to do.  Hyundai recently tapped the company to provide electric vehicle charging stations at its dealerships for the 2016 Sonata plug-in hybrid model.  Sonata drivers will also have the option to buy the company’s TurboCard charging system or the wall-mounted EVSE-RS charging station.  Hyundai is the seventh car manufacturer to choose AeroVironment’s charging solutions.

AeroVironment has forged a new automotive relationship, but that might not mean a big jump in sales.  Demand for electric cars has declined along with gas prices.  Tesla is the only electric car that has not experienced a decline in unit sales.

Hyundai has not been intimidated and is expanding its electrification line-up.  The plug-in variant of the Sonata hybrid is the most recent addition.  The 2016 Sonata has an internal combustion engine augmented by an electric motor that feeds power to the front wheels.  Pure electric power gets the Sonata off to a good start and then transitions to the internal combustion engine.  The car has a larger lithium-polymer battery pack than most of the hybrids that makes it possible to reach 60 miles per hour in eight seconds.

Image result for aerovironment uav imageAeroVironment is not entirely dependent upon Hyundai or any of the other car manufacturers.  If questions about electric car demand get too uncomfortable, management can change the subject and talk about the company’s recent new order to one of its unmanned aircraft systems.   The U.S. Marine Corps is paying $13.0 million for one of the company’s Puma AE aircraft, which can be used for a remote scouting system.

The company’s mix of products and services may seem a bit eclectic, but generates solid results.  In the most recently reported twelve months the company recorded $254.6 million in total sales, of which $12.4 million was converted to operating cash flow.  The company has managed to build up cash to $217.5 million.  Cash flows are so strong management apparently sees no need for leverage.  There is no debt on the balance sheet.

The clutch of analysts who have published estimates for AeroVironment seem to think there is growth in the company’s future, but not the sort of growth the company experienced even just a year ago.  The estimates for the quarter ending October 2015 reflect a net loss of $0.09 per share on $57.7 million in total sales.  The loss situation is apparently perceived as a temporary situation, with profitability restored as early as the January 2016 quarter.  The current fiscal year ending April 2016 is shaping up as a transition year, but fiscal year 2017 is clearly expected to be a year of growth and profits.

Confidence in the future has apparently caught up with traders in AVAV.  The stock registered a particularly bullish formation in a point and figure chart a week ago called a ‘triple top breakout’ in a point and figure chart. The same chart suggests the stock has developed sufficient momentum to reach the $34.00 price level.  

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

December 08, 2015

The Status of The Yieldco

by Tom Konrad, Ph.D., CFA

Last week I delivered the keynote at Yieldcon USA, a conference put on by Solar Plaza entirely focused on Yieldcos. (Yieldcos are companies that own clean energy assets such as solar and wind farms and use the cash flows to pay a high rate of current income to investors.)

Given all that's gone on in the space in the last few weeks, the conference could not have been more timely.

You can find the presentation here and embedded below:

December 04, 2015

Investing For The Anthropocene

by Garvin Jabusch

Jack Bogle is flat wrong. I mean, within his worldview and that of Modern Portfolio Theory, he’s right, but in the Anthropocene, he’s wrong. Bogle, founder and retired CEO of the Vanguard Group, is known for championing the superiority of low-fee index funds. His firm’s largest product, the $155 billion Vanguard 500 Index Fund is the perfect poster child for his philosophy. It closely tracks the S&P 500 Index of America’s largest companies, and it has a fee of only 0.06% inclusive. The S&P 500 has performed better than most actively managed portfolios over time, so Bogle’s thesis of “don't look for the needle in the haystack. Just buy the haystack!”, and buy it as cheaply as you can, is brilliant in its simplicity. Elegant, even.

Here’s where it fails: investing in a broad index, Bogle’s or anyone else’s, means owning every sector and company in that index. Every sector and stock. Including oil. Including tar sands. Including coal. Including myriad other causes of major yet avoidable risks around water, agriculture, transportation and many other sectors. All the traditional equity market indexes were built by, of, and for the old business-as-usual economy. Index rules of economic sector allocation demand ownership of all areas of the economy that were important when these indexes were devised in the middle part of the last century, before anyone had heard of climate change, could imagine resource scarcity on a global scale, or could fathom 7.3 billion people and a mass extinction event likely to rival the largest in prehistory. There are massive economic risks now that simply did not exist when our stock market indexes and the body of theory that supports them, Modern Portfolio Theory, were devised.

Modern Portfolio Theory has another big limitation: It requires measuring risk by analysis of past performance. It asks, of any stock portfolio, "what would the return for that have been over the last 10 or 20 years, and at what level of risk?" Here again, this seems eminently reasonable, but it has the negative result of making the economic causes of our most threatening risks appear to be wise investments. Today, though, our primary risks are so obvious, and human innovation is advancing solutions so rapidly, that there’s no economic outcome 10 or 20 years hence that looks anything like the last 10 or 20 years. Where legacy economy stocks have traded historically is irrelevant now. Causes of economic and environmental risks, like fossil fuels, are not the safe source of risk-adjusted returns that they used to be. The world has changed, and following Bogle’s advice to invest in an S&P 500 Index fund doesn’t give you much access to this new world of profitable innovation and investing opportunity, but it does keep you invested in the causes of our problems.

Like it or not, we’ve ushered in a new era. It’s the Anthropocene now, yet we’re still largely investing with old Holocene methods.

It’s time for a new investing philosophy, one that reflects what we have learned at last about how to sustainably inhabit the Earth. So, what updates could portfolio construction theory employ? If we believe we can arrive at an indefinitely sustainable and even thriving economy, here are some ideas:

  1. No more blind use of traditional sector allocations. Even some green, SRI, and ESG funds use the old allocations schemes, and then try to screen out some of the objectionable companies. This won’t work. Instead, we must allocate portfolio investments by evaluating forward-looking risk. It’s time we created portfolios from the bottom up, intentionally, by selecting the economic areas to invest in via risk-factor allocation, rather than traditional sector allocation methods. That is, we must stop investing in causes of systemic risks, wherever they may exist, and start investing in the most economically exciting, innovative solutions to those risks, economy-wide. Continuing to invest in all sectors of the economy regardless of the risks that a given sector has to our future viability has no place in today’s investing world.
  2. Stop evaluating risk using backward-looking models. In order to create portfolios that accurately factor in today’s and tomorrow’s risk continuums, investors need to change their paradigm and begin using forward-looking economic modeling. Innovation is far more rapid now than at any time in all human history, and we can finally now bring to investing a vision of where the economy is going, and where it should go, in both economic and sustainability terms. Modern Portfolio Theory’s rearview mirror approach to risk evaluation can actually be said to violate the causality principle in physics, in that it expects past outcomes to emerge from present events. They won’t.
  3. We must each be aware that the rules, habits, and institutions of the past do not have to bind the future, and indeed they must not. We must be aware of as much as we can, studying science and basic principles, and working hard to suggest new, better ways forward.

We can’t acquiesce into accepting that the framing of investing for the future can be achieved within the terms of Modern Portfolio Theory, which was developed in the 1950s with no knowledge of the world of 2015. We can’t work on evolving our economy from within the terms of that frame. To the extent that we could, it would be far too slow. As Jacob Goldstein, host of NPR’s Planet Money, said of Paul Volcker’s comments to him regarding fighting another systemic risk, the runaway inflation in the 1970s, “Volcker told us that in the '70s the Fed had tried doing things gently, and it didn't work because it didn't convince people. You know, he said gently wasn't enough to change what was in people's heads to make them really believe” (Episode 664: The Great Inflation).

Our ability to do all this will depend on the rigor of our economic models in factoring realistic risks related to climate change, resource scarcity, and population growth, paired with innovation and solutions. A holistic model of what it will take to fit human civilization less awkwardly and less destructively into the rest of biodiversity and, beyond that, into the fundamental conditions and physical limitations of Earth, won’t arrive any time soon. The problems and systems involved are too complex.

Nevertheless, we have to take strides toward understanding our place in, and effect on, the world represented by that model. Because in full light of what we now know in 2015, the consequences of continuing to accept investing advice rooted in the outdated dynamics of the legacy economy, even from a mind as brilliant as Jack Bogle’s, will cause our environmental and economic situations to rapidly become unimaginably worse.

Garvin Jabusch is cofounder and chief investment officer of Green Alpha® Advisors, LLC. He is co-manager of the Shelton Green Alpha Fund (NEXTX), of the Green Alpha Next Economy Index, the Green Alpha Growth & Income Portfolio, and of the Sierra Club Green Alpha Portfolio. He also authors the Sierra Club's green economics blog, "Green Alpha's Next Economy."

December 03, 2015

FuelTech: Pushing on a String of New Orders

by Debra Fiakas CFA

Earlier this month Fuel Tech, Inc. (FTEK:  Nasdaq) announced the receipt of order for air pollution control systems totaling $2.0 million.  The customers are strung out across the U.S., Europe and China, but they all have dirty combustion systems and need to reduce toxic nitrogen oxide (NOx) and carbon dioxide (CO2) emissions or risk running afoul of government clean air standards. 

These shipments are just the most recent in a string of orders Fuel Tech has won in recent months.  In late August 2015, the company received similar air pollution contracts from customers in South America, China and the U.S. totaling $7.7 million.  Then in October the company received another three orders from customers in the U.S. and China valued at $11.0 million.

Push all these orders together and investors get a much more interesting picture of order flow at Fuel Tech.  New orders totaling $20.7 million over a period of three months might mean a turn-around for Fuel Tech’s future.  The company reported $74.2 million in total sales over the twelve months ending September 2015, well below the $108.3 million in total sales the company reported in 2013.  The stepped-up pace of new orders suggests Fuel Tech is clawing its way back in a market that has been trouble by growth concerns and financing obstacles for the industrial and energy companies that need pollution control systems.

New business is not the only problem before Fuel Tech.  The company has had trouble maintaining profits as sales have slipped.  In the most recently reported twelve months the company reported a new loss of $20.4 million or $0.89 per share.  Nonetheless, the company was able to generate $3.0 million in operating cash flow.
It appears the company needs a run rate near $100 million in total sales to make a profit.  Management has tried to reduce operating costs, including force reductions and other budget cuts.  In the first nine months of 2015, the company reported saving $2.1 million or 8% of spending last year.

Emissions control for combustion systems is vital and there appears to be a large, unmet market.  When the economics finally drive customers to make the investment, Fuel Tech is likely to get orders.  Unfortunately, economics of late have not been in Fuel Tech’s favor. That has left the company’s stock priced at a bargain 0.70 times revenue. 

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

December 02, 2015

EPA increases US Renewable Fuel Standard Volumes, But Only Slightly

Jim Lane

EPA-RFS-120115-cover-smIn Washington, the U.S. Environmental Protection Agency announced final volume requirements under the Renewable Fuel Standard program today for the years 2014, 2015 and 2016, and final volume requirements for biomass-based diesel for 2014 to 2017. This rule finalizes higher volumes of renewable fuel than the levels EPA proposed in June, boosting renewable production and providing support for robust, achievable growth of the biofuels industry.


“The biofuel industry is an incredible American success story, and the RFS program has been an important driver of that success—cutting carbon pollution, reducing our dependence on foreign oil, and sparking rural economic development,” said Janet McCabe, the acting assistant administrator for EPA’s Office of Air and Radiation. “With today’s final rule, and as Congress intended, EPA is establishing volumes that go beyond historic levels and grow the amount of biofuel in the market over time. Our standards provide for ambitious, achievable growth.”

The final 2016 standard for cellulosic biofuel — the fuel with the lowest carbon emissions — is nearly 200 million gallons, or 7 times more, than the market produced in 2014. The final 2016 standard for advanced biofuel is nearly 1 billion gallons, or 35 percent, higher than the actual 2014 volumes; the total renewable standard requires growth from 2014 to 2016 of more than 1.8 billion gallons of biofuel, which is 11 percent higher than 2014 actual volumes. Biodiesel standards grow steadily over the next several years, increasing every year to reach 2 billion gallons by 2017.

The RFS, established by Congress, requires EPA to set annual volume requirements for four categories of biofuels. The final rule considered more than 670,000 public comments, and relied on the latest, most accurate data available. EPA finalized 2014 and 2015 standards at levels that reflect the actual amount of domestic biofuel used in those years, and standards for 2016 (and 2017 for biodiesel) that represent significant growth over historical levels.

EPA-120115-3 EPA-120115-2 EPA-120115-1


Well, you might think to yourself, why is the EPA finalizing a mandate for 2014 and 2015 n November 2015. Well, they were two years late on the 2014 mandate and a year late for 2015. But they are on time for 2016. Let’s celebrate.

What’s next?

Likely, someone is going to sue the EPA. Possibly a coalition of biofuels trade groups, who will focus on getting court rulling that the EPA does not have the authority to create a distribution waiver by redefining a waiver authority basded on shortfalls in the “supply of renewable fuels” to mean “supply of renewable fuels OR gas pumps to deliver fuels to consumers.”

What the numbers mean

First of all, the EPA increased the volumes from the spring 2015 proposal, after receivging 670,000 comments. However, much of that stems from correcting an accounting error in the original proposal, and because rising gasoline consumptino increases the available pool for E10 ethanol blends.

Bottom line, the EPA has embraced an implied “distribiution waiver”, something that was proposed in the House version of the original EISA Act, not included by the Senate, and eliminated in the final bill. Congress feared at the time that the oil & gas industry would use its effective monopoly of infrastructure to strangle growth of biofuels past an E10 saturation point, which essentially happened. Critics say the EPA and Obama Administration have caved in to Big Oil on this one.

Reaction from Stakeholders

Chip Bowling, president, National Corn Growers Association

“America’s corn farmers are proud to grow a cleaner burning, renewable fuel source for America and the world. In July, we asked the Environmental Protection Agency to restore the 2014-16 corn ethanol renewable volume obligation to comply with the Renewable Fuel Standard as passed by Congress and signed into law.

“While we are pleased to see the EPA take a step forward and revise its original proposal, the fact remains that any reduction in the statutory amount will have a negative impact on our economy, our energy security, and the environment. It is unfortunate that Big Oil’s campaign of misinformation continues to carry weight in the court of public opinion, and in this decision. The Renewable Fuel Standard has been one of America’s most successful energy policies ever. Because of it, our economy is stronger, we are more energy independent, and our air is cleaner. We should be strengthening our commitment to renewable fuels, not backing down.

“In light of the EPA’s decision, we are evaluating our options. We will fight to protect the rights of farmers and consumers and hold the EPA accountable.”

Joe Jobe, CEO, National Biodiesel Board

“This decision means we will displace billions of gallons of petroleum diesel in the coming years with clean-burning biodiesel. That means less pollution, more American jobs, and more competition that is sorely lacking in the fuels market,” said NBB CEO Joe Jobe. “It is a good rule. It may not be all we had hoped for but it will go a long way toward getting the U.S. biodiesel industry growing again and reducing our dangerous dependence on fossil fuels.”

“I want to thank President Obama, Administrator McCarthy and Secretary Vilsack for supporting growth in the program and for their commitment to biodiesel,” Jobe added. “We have seen three years of damaging delays, but the Administration took a strong step forward today that should put biodiesel and the RFS on a more stable course in the years to come.”

“We will continue working with the Administration toward stronger standards moving forward that drive innovation and productivity. We certainly think the biodiesel and overall Advanced Biofuel standards could and should have been higher. The production capacity is there, and we have surplus fats and oils that can be put to good use.”

Brent Erickson, Executive Vice President of BIO’s Industrial & Environmental Section

“Today’s rule is a severe blow to American consumers and the biofuels industry. To date, BIO member companies have invested billions of dollars to develop first-of-a-kind advanced and cellulosic biofuel production facilities. EPA’s two-year delay in finalizing the rule created untenable uncertainty and shook investor confidence in the RFS program. BIO estimates that investment in the advanced biofuel sector has experienced a $13.7 billion shortfall due to EPA’s delays and proposed changes. Unfortunately, this final rule exacerbates the problem.

“As EPA has acknowledged, its delay allowed obligated parties to act as though the law did not exist. The delay increased U.S. carbon emissions by millions of tons over the past two years, compared to what could have been achieved with required use of biofuels. As the United States enters negotiations with the rest of the world to limit greenhouse gas emissions, EPA is putting in place an RFS rule that will sacrifice achievable reductions of emissions in the transportation sector.

“Moreover, EPA has violated the law. As BIO explained in its formal comments on the proposed rule, EPA has misconstrued Congressional intent, and its attempt to change the plain meaning of the RFS law regarding waivers is a needless and impermissible departure from EPA’s successful implementation of the RFS program through 2013. EPA’s action will undoubtedly trigger Court challenges that prolong and aggravate uncertainty about this program. BIO, its members and allied groups are now considering their available legal options to remedy EPA’s violation of the Clean Air Act.

“EPA’s decision increases carbon emissions from the transportation sector above achievable levels. This backsliding on transportation emissions – which account for 30 percent of all U.S. carbon emissions – unnecessarily and regrettably undermines America’s credibility at the Paris Climate Change Conference, which starts next week.”

Tom Buis, chairman, Growth Energy

“Growth Energy and its members are pleased to see that the President and the Environmental Protection Agency have recognized the need to move the renewable fuel industry past the so-called blend wall for the sake of America’s climate, energy security and rural economy. While this rule still relies on a flawed methodology that sets renewable fuel volumes below the statutory levels enacted by Congress, it is an important improvement from the proposed rule, and moves us closer to getting America’s most effective climate policy back on track and providing certainty for biofuels in the marketplace.

“Specifically, we are pleased that the RVOs have been finalized after such a long delay and that the levels have increased from the original proposal. This final rule makes it possible to drive the growth of higher ethanol blends through the so-called blend wall, giving consumers choices at the pump, such as low-cost E15. Additionally, the numbers for 2016 represent a final rule closer to the statutory levels established by Congress, avoid the “reset” and indicate a more certain future for renewable fuels.

“However, we remain concerned that the final rule continues to rely on the “distribution waiver” that redefines supply as demand and was rejected by Congress when the RFS was enacted into law. Of particular concern is that by using such a waiver, the oil industry is being rewarded for its unwillingness to follow the law and invest in infrastructure to move toward cleaner, renewable fuel, which sets a dangerous precedent for the future of the program. The uncertainty this waiver will create risks sending investment in the next generation of renewable fuel overseas just as this new, homegrown industry is taking off.

“We appreciate Administrator McCarthy’s stated commitment to return to statutory levels, and our industry is committed to working with her to ensure the final rule announced today is the first step toward fulfilling that commitment.”

RFA President and CEO Bob Dinneen

“EPA’s decision today turns our nation’s most successful energy policy on its head. When EPA released its proposed RFS rule in May, the agency claimed it was attempting to get the program back on track. Today’s decision, however, fails to do that. It will deepen uncertainty in the marketplace and thus chill investment in second-generation biofuels. Unlike Big Oil, the ethanol industry does not receive billions in tax subsidies and the RFS is our only means of accessing a marketplace that is overwhelmingly and unfairly dominated by the petroleum industry. Today’s decision will severely cripple the program’s ability to incentivize infrastructure investments that are crucial to break through the so-called blend wall and create a larger market for all biofuels.

“There is simply no reason for EPA to adopt API’s blend wall narrative. Data shows that EPA, in its initial RFS proposal, understated the likely market for E85 and non-ethanol conventional biofuels in 2016 by at least 440 million gallons. The data suggests there will be at least 14.7 billion gallons of undifferentiated renewable fuel blended next year. With approximately 2 billion surplus RIN credits already available for refiners to use for compliance in 2016, and with another 900 million RINs potentially becoming available from 2015 over-compliance, the EPA’s decision to lower the 2016 RVO below the statutorily imposed level of 15 billion gallons is simply unnecessary.

“What makes today’s decision even more perplexing is that it continues to reflect the administration’s conflicting views regarding ethanol. The Department of Agriculture continues to fight for ethanol, working hard to secure necessary infrastructure, promoting exports, correcting food versus fuel myths, investing in new technologies and new feedstocks and advocating for ethanol’s positive climate change benefits. The Department of Energy, too, works hard to complete biofuel research on higher ethanol blends and infrastructure that is moving this industry forward. Why is EPA so out of step?

“Today’s decision by EPA furthers that conflict and, sadly, significantly undercuts President Obama’s credibility as he prepares to take the world stage to address climate change at the COP21 talks in Paris. RFA recently commissioned a study which concluded that biofuels consumed under the RFS have reduced U.S. greenhouse gas (GHG) emissions by 354 million metric tons of carbon dioxide-equivalent since 2008. For context, that is the equivalent of avoiding carbon dioxide emissions from 74 million passenger cars. How can the president speak credibly about the need to address climate change on a global stage when his EPA is failing to fully implement the most potent and proven weapon to combat climate change in his own backyard?”

“This final rule directly contravenes the statute and places the potential growth for biofuels like ethanol in the hands of the oil companies. It will have the unfortunate consequence of increasing Big Oil’s ability to thwart consumer choice at the pump without even a scintilla of fear that EPA will enforce the statute. With no consequences for Big Oil’s bad behavior, consumers will be denied greater access to the lowest cost liquid transportation fuel and number one source of octane on the planet.”

POET CEO Jeff Broin

“The EPA volumes announced today are a move in the right direction, and they correctly call the oil industry’s bluff about our ability to surpass 10 percent ethanol use in the U.S.

“However, these numbers fall well short of our capability to provide clean, domestic ethanol to America’s drivers. Additionally, the EPA’s method for arriving at these numbers is contrary to the intent of the Renewable Fuel Standard.

“I look forward to breaking the so-called ‘blend wall’ next year and proving this country’s ability to replace more imported oil with biofuels produced within our borders. In the future, we need to see a stronger and more consistent commitment to renewable fuel from Washington if we are ever going to realize the true potential of renewable fuels, including the development of cellulosic ethanol.”

Brooke Coleman, Executive Director, Advanced Biofuels Business Council

“What we’re seeing in the RFS final rule, volumetrically at least, is continued growth in renewable fuel blending. That counts for something, predominantly in markets already inclined to offer consumers more renewable fuels. But it is frustrating that the Administration missed this opportunity to fix two waiver issues that are undercutting U.S. investment in low carbon, advanced biofuels. Waivers are absolutely critical to U.S. investment, because they define for investors when the field of play can be altered. It is confounding that the Obama Administration would side with the oil industry against Democratic members of Congress and the advanced biofuels industry in reinterpreting its waiver authority to allow for “distribution waivers,” which would permit EPA to waive the RFS if the oil industry refuses to make arrangements to distribute renewable fuel and comply with the law.

“The entire purpose of the RFS is to prohibit oil companies from using their market power to block the distribution of renewable fuels. We do not expect this reinterpretation to stand up in court; but regardless, it is the exact type of policy bait and switch that chills investor confidence in the United States. And while initial discussions with EPA have been productive, we must also move quickly to address waiver issues in the cellulosic pool, which currently allow the oil industry to buy year-end waivers to avoid buying cellulosic gallons. The Obama Administration has supported advanced biofuel development, and certainly the programs administered by the U.S. Department of Agriculture are an important part of that picture, but letting the oil industry off the hook with industry-friendly waivers is not consistent with the Administration’s position on innovation, clean energy development and climate change – especially against the backdrop of the President’s message in Paris. What’s at stake when it comes to the RFS is not whether the advanced and cellulosic biofuels industry will succeed commercially; but rather, whether it happens here in the United States. The Council will continue to work with the Administration and stakeholders to get the RFS back on track. We are not there yet with this rule, but we are confident that we can continue to improve the program in 2016.”

Mike McAdams, President, Advanced Biofuels Associstion

“The Advanced Biofuels Association applauds EPA’s support of next-generation biofuels. Today’s final rule is a step in the right direction that recognizes the importance of growing supplies of advanced and cellulosic biofuels to help provide more sustainable fuels for our future to combat climate issues. Only advanced biofuels reduce greenhouse gas emissions by more than 50% compared to today’s gasolines and diesels.

While we appreciate EPA’s efforts, we continue to believe that legislative reform is required to address ongoing hurdles facing next-generation biofuels. Congress needs to strengthen the RFS to help focus and expedite the production of advanced biofuels. Outdated definitions, cellulosic waivers, as well as overall program uncertainty have created significant barriers to entry for the advanced and cellulosic industry. That’s why ABFA will continue to work with Congress and the Administration to reform and strengthen the RFS so it can deliver on the promise of next-generation renewable fuels.”

Brian Jennings, Executive Vice President of the American Coalition for Ethanol

“When Congress enacted the Renewable Fuel Standard it voted to side with those of us who said ‘yes we can’ reduce greenhouse gas emissions from motor fuel, ‘yes we can’ allow consumer access to E15 and flex fuels, and ‘yes we can’ spark innovative ways to produce cleaner fuels,” said Jennings. “While we appreciate that the Administration made incremental improvements compared to the proposed RFS rule, unfortunately, today they are choosing to side with those who say ‘no, we can’t’. Regrettably, EPA’s final RFS rule protects the old way of doing business by obstructing consumer access to cleaner fuels, stifling competition in the marketplace, and undermining innovation. Given all the President hopes to accomplish at the international climate talks which begin in Paris today, it is inconsistent for the Administration to unravel the most effective policy at their disposal to support low carbon fuels.”

Despite the fact that the Clean Air Act calls for ethanol use to exceed ten percent of gasoline consumption, EPA’s final rule sets blending targets for 2015 and 2016 which fall short of statutory requirements and instead draw on the legally questionable E10 “blend wall” methodology put forward by oil companies who don’t want ethanol to comprise more than ten percent of fuel use in the U.S. Congress did not authorize EPA to adjust volumes based on the E10 blend wall.

“Thanks to the RFS, ACE members have made significant biofuel production advancements and we know that further innovation is just around the corner. ACE is strongly committed to ensuring consumers have access to higher blends of ethanol and we will explore all options at our disposal to achieve that goal with this Administration and the next.”

American Energy Alliance President Thomas Pyle

“EPA bureaucrats continue to prove they are incapable of managing the RFS. The agency consistently misses deadlines and sets unrealistic levels for cellulosic ethanol, which is expensive and not commercially viable. This gross mismanagement is just one more reason to scrap the entire mandate, and why anything short of full repeal would just make the RFS worse.

“The RFS was ill-conceived from the get-go. The mandate distorts markets, raises gasoline prices, and benefits a limited few at the expense of all Americans. Partial repeal would only make the mandate worse by moving it closer to a California-style Low Carbon Fuel Standard, causing Americans to pay more at the pump. Full repeal is the only option for those concerned about the interests of all Americans, and not just the self-interests of the biofuel industry and its lobbyists.”

The Urban Air Initiative President Dave VanderGriend

“EPA has made it clear it has no intention of opening the market for ethanol and other biofuels. We have been challenging EPA for years to take actions that would protect public health, lessen our dependence on petroleum, and reduce CO2 and other harmful emissions. The EPA has rejected us at every turn.”

“This is simply one program. We can move well beyond that and we will not let EPA and its faulty, inaccurate models define our value and limit our growth. EPAs action should be a message to the ethanol industry that it needs to secure its own future and recognize that ethanol’s highest value is as a clean fuel that can provide high octane to reduce the toxic compounds in gasoline while reducing a range of harmful emissions.

UAI has identified a number of steps to provide access to the market, all of which will improve fuel quality and protect public health. Specifically, UAI has called for EPA to:

  • Lift the Vapor Pressure Restriction on Higher Blends since RVP actually goes down as ethanol volumes go up above E10;
  • Enforce Section 202 (l) of the Clean Air Act to limit aromatics and open the market for ethanol as a source of clean octane;
  • Reinstate fuel economy credits (CAFE) and prorate them for mid-level blends;
  • Make 87 AKI gasoline the minimum octane for all states;
  • Revise modeling for both the life cycle analysis of biofuels and the emissions profile, notably the MOVES Model.

“The RFS has done its job up to this point in building a bridge but from here on we need to seize our future and look forward, not backward.”

Brazilian Sugarcane Growers Association

“UNICA is heartened by EPA’s recognition the RFS requirements for advanced biofuel can and should increase. Today’s decision appears to leave the door open for continued American access to sugarcane ethanol from Brazil, one of the cleanest and most commercially ready advanced biofuels available today.”

“EPA has taken another step toward a cleaner, healthier environment, and Brazilian sugarcane producers stand ready to make even higher volumes of advanced biofuel available to America. According to the latest estimates, Brazil is on track to produce nearly six percent more sugarcane ethanol this year compared to 2014 – an additional 450,000 gallons. Under the right market conditions, Brazil has the capacity to produce up to two billion additional gallons of this advanced biofuel for export according to installed capacity figures.”

“America and Brazil have built a thriving global biofuels market, creating economic growth and environmental benefits, through good policy implementation. UNICA applauds today’s decision by EPA to maintain that growth by encouraging production of clean, low-carbon fuels.”

Jim Lane is editor and publisher  of Biofuels Digest where this article was originally published. Biofuels Digest is the most widely read  Biofuels daily read by 14,000+ organizations. Subscribe here.

December 01, 2015

Looking for Cash in Old Refrigerators

by Debra Fiakas CFA

Appliance Recycling Centers of America (ARCI:  NYSE) is a typical small company, toiling away in seeming obscurity and struggling to get proper valuation of their success.  There is little glamour in old refrigerators and washing machines, but ARCA has figured out how to wring cash from recycling our household appliances.  In the last three fiscal years the company converted 1.6% of sales to operating cash flow.

Unfortunately, things have turned a bit sour in the world of old Frigidaires and tired Maytags.  Last week ARCA reported financial results for the quarter ending September 2015.  The company suffered an operating loss in the quarter.  Sales totaled $28.1 million, resulting in an operating loss of $1.1 million and a net loss of $773,000 or $0.13 per share.  Sales were lower year-over-year due to slower activity in municipal and utility energy efficiency programs.  Weakened pricing of scrap steel and iron have resulted in lower selling prices for metal by-products from the company’s recycling plants.

It is does not appear to be a temporary weakness.  Revenue in the first nine months of 2015 totaled $85.8 million compared to $99.2 million in the same period in the previous year.  This represents a 13.5% decline in sales value, but the operating profits collapsed into a loss of $2.5 million in 2015 from a $3.2 million profit in the previous year.

Of course reported results according to GAAP rules are often deceptive.  Operating cash flows can provide a clear picture on the health of a smaller company.  For ARCA the picture has turned a bit bleak.  After years of being a cash generator, the company has to use $2.1 million in cash to support operations in the first nine months of 2015.  A line of credit was drawn down by $3.2 million to help pay the bills.

The line of credit has come in handy for ARCA over the past few months, but it is also a bit of problem for the company.  The loss in for the year-to-date has put the company crosswise with the credit facility covenants.  Management has pledged to arrange a replacement facility sometime in the next year.

Raising capital through equity is probably not an alternative.  The stock is currently trading well below a dollar a share, representing multiple of sales of 3/100s.  It would be a costly effort to boost cash resources with a sale of common stock.

Although the debt-to-equity ratio is 141.90, net long-term debt is $2.6 million and suggests ARCA’s balance sheet can support more debt.  That pesky line of credit is a problem here as well.  At the end of the most recently reported quarter the outstanding balance was $12.4 million, casting quite long shadow across ARCA’s capital structure.  

It might be better for ARCA to simply tighten its belt by reducing costs.   Economic conditions will eventually cycle around to support higher selling prices and deeper demand.  

Debra Fiakas is the Managing Director of
Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. 

« November 2015 | Main | January 2016 »

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