AMRC - Ameresco: A Debt-Accumulation Machine And Concerns Around Its Business Model

2023-09-08 09:24:06 ET

Summary

• Ameresco, Inc. consistently fails to generate positive free cash flow, leading to debt accumulation and increased risk.
• The company's business model relies heavily on selling environmental credits to boost net income, raising concerns about profitability.
• Insider selling and lack of disclosure on environmental credits add to concerns about governance and the company's financial health.
• We think the stock is overvalued by around 40% after a comparables valuation analysis.

We believe that Ameresco, Inc. (AMRC) is consistently failing to reach a positive free cash flow ("FCF") run rate, despite years spent building their brand and backlog. The company burns a high amount of Capex compared to its portfolio size, and its cash generation has never been positive over the years. This led, of course, to consistent debt accumulation, which is now piling up on the balance sheet thus increasing the risk profile of Ameresco's equity. We start our Ameresco, Inc. rating with a sell recommendation and a target price below $24.

The business model and past results

Ameresco is a renewable energy asset developer, owner, and operator. This means that the company is engaged in the management of energy assets from its planning to its operation management (and thus its maintenance). This business model has many implications, with the main ones being that they keep the assets on their balance sheet and need to spend yearly Capex to maintain the facilities operational.

As we can see Ameresco is operating 423 MWe of renewable energy capacity, which translates into $1.4 billion of PP&E. The bulk of organic growth for the company's revenues comes from energy efficiency projects that aim to improve the renewable energy mix in many buildings/facilities. This is also the main reason why AMRC has so much revenue coming from the U.S. government and other public entities, including the U.S. Army Corps of Engineers, the Naval Facilities Engineering Command ((NAVFAC)) Mid-Atlantic, and the U.S. General Services Administration. And the other very important fact to mention is concentration risk. Indeed,

Approximately 46.0% of our revenues were derived from federal, state, provincial, or local government entities

Let's now turn to their financial results and position. We believe that a single picture will be self-explanatory on our concerns over the past results:

There appears to be a significant discrepancy in net income - and stated profitability margins - and cash generation. This is mostly due to high Capex requirements which consistently eat away more than every cent generated by the business. As one can imagine, this creates liquidity issues, which have been managed by issuing additional debt.

While some of this debt is structured as non-recourse as it's attached to some Variable Interest Entities (VIEs) that are bankruptcy-remote to Ameresco, the leverage ratio is still very high. With only $50 million of cash, $1 billion of debt net of VIEs liabilities, and $130 million of estimated EBITDA for FY23, the leverage is above 7x times. Well above conservative levels.

Fortunately for Ameresco, they have some decent visibility on revenues and profits. The company has a disclosed backlog of orders in the size of $2.4 billion, 36% of which is expected to be recognized in the next 12 months. This reduces uncertainty around debt sustainability but does not lower our concerns for the long term. In fact, the current backlog represents only 1.5 years of operations at the 2022 revenue run rate, which is not enough to call it a "parachute."

The concerns: short report raised valid questions in 2022

We have been looking to Ameresco for quite some time now. We first analyzed the company in the early days of 2022, when it was trading at levels at least 30-40% above the current price. Shortly thereafter, a short report by Jehoshaphat Research was published on Ameresco, arguing that investors may not receive the complete picture from the financials and that its shares were way overvalued.

After carefully analyzing the report, we believe there are agreeable points in Jehoshaphat's thesis. The first and boldest claim is that:

Our calculations find that approximately 80-90% of AMRC's net income comes directly from the sales of "environmental attributes," also known colloquially as renewable energy "credits."

This means that, like Tesla (TSLA) during the past years, Ameresco has relied on selling credits to turn its net income positive and give the appearance of strong profitability and margins. This would actually explain well the great disconnect between net income and FCF, as shown in the chart before. We tend to believe the short report in this instance as Ameresco's business model does not appear profitable at all on a cash basis, but it is surprising that the company has managed to show positive net income given the circumstances. The "credits argument" would explain this gap.

It is also noted by the short report that disclosure has been greatly reduced around the discussion of these environmental credits. And by looking at the latest 10-K and 10-Qs , we find indeed no tangible disclosure on the numbers and volume of such credits.

Last but not least, we also focus on insider selling. The report mentioned some directors aggressively selling down their position in Ameresco's shares, and we noticed this pattern continued in 2023 after the report. We quote:

AMRC's Lead Director, the former CEO of Enron International, sold ~75% of his AMRC stock holdings in the past 18 months, after many years of patiently holding and accumulating.

Along with him, Director Anderson, and Director Wisneski sold substantial amounts of their holdings. It is very recent news that the latter sold another $100k worth of Ameresco's shares right away after executing his options, bringing down his personal holdings to just 11,000 shares.

We find all this very concerning, which adds to our already discussed concerns on cash, debt, and profitability. If we add insider selling and the environmental credit issues on top of those, we have a good case for why not to buy Ameresco. But let's now look at the valuation.

How we may be wrong

First of all, the market is hardly wrong. It is clear that the market has a very different view on Ameresco and even the reaction to the 2022's short report was mild. The concerns around its business model and its debt accumulation appear to be no secrets, and there is enough liquidity for the market to recognize them. Yet, AMRC's valuation is still at record highs.

We may not understand the (highly complex) business well enough to be able to see the "light at the end of the tunnel" in terms of cash generation. The company is spending massive Capex that may come back years from now in the form of high and consistently positive cash flows.

Also, the massive spending wave around renewables, especially solar and wind power, definitely acts as a powerful tailwind for Ameresco. We may see this trend not only continuing but also accelerating as strong fiscal spending supports it. And it may well translate into higher revenues and FCF for the company.

Last but not least, Ameresco is not alone in this valuation "frenzy". Sunrun ( RUN ) is another company that appears very inclined to accumulate debt to finance its massive Capex needs. It even generates deeply negative EBITDA. Yet the market evaluates this company - which has a business model quite similar to AMRC - at very generous levels. Thus, again, the market may be seeing some hidden value that we and the short sellers that published the report are not able to spot.

However, that said, if we look at the hard numbers and signs we can see that things are not going well so far. And instead of improving the economics of Ameresco worsened over the years. This confirms our thesis rather than the markets.

Valuation: The fair value mystery

Trying to find a fair value for Ameresco through a DCF model or other net income or FCF-based measures is not feasible. Thus, we will use a set of comparable companies that will set the benchmark for some of the multiples we are going to compute and compare for Ameresco. Even comps are actually hard to find, but we want to present three candidates: Montauk Renewables (MNTK), and Archaea Energy - which was acquired by BP in December 2022.

We want to emphasize that Archaea Energy's multiple is the one we will put more weight on, as it is representative of a real all-cash transaction. This means that it is a fair and sound representation of what a real buyer paid for this kind of business.

That said, we will make a weighted average - 65% for Archaea and 35% for MNTK - to compute the fair EV/EBITDA multiple. The result is a 12x multiple, which leads to an EV of around $2.2 billion, a fair equity value of $1.2 billion, and lastly a fair value per share of $24. This represents a downside of more than 40% from the current price of $43.

Conclusion

Ameresco is accumulating debt and burning a lot of cash. We also have concerns about key aspects of their business model, such as the extensive use of environmental credits that affect net income. After careful analysis and a comps-based valuation, we find Ameresco, Inc. stock is considerably overvalued by around 40%.

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