CA - Polaris Renewable Energy: Growth High Dividend And Potential Buybacks

2023-10-30 14:59:22 ET

Summary

• Polaris Renewable Energy owns and operates renewable power production assets in five Latin American countries.
• The company has diversified its asset base and is recovering from a setback in profitability, with higher revenues and profits expected.
• Polaris is considering stock buybacks and offers a high dividend yield covered by its cash flow.

Polaris Renewable Energy ( PIF:CA ) is a Canadian-listed company which owns and operates renewable power production assets in five Latin American countries.

Polaris has diversified its asset base in the past two years and is recovering from a setback in its profitability. A larger asset base and higher prices have increased its revenues and profits, and the company is potentially about to initiate significant buybacks. This combination should lead to higher cash flow per share. Meanwhile, the company pays a juicy dividend, well covered by the cash flow.

Fashionable assets in unfashionable jurisdictions

Polaris has power production assets in the Dominican Republic, Ecuador, Nicaragua, Panama and Peru. The company has seven geothermal, hydroelectric and solar power plants. Polaris has revenues of approximately $60 million, 200 employees and a market cap of $190 million. All the company’s revenues are in the United States dollars.

Nicaraguan geothermal production brings in the majority of the company's revenues. In 2020 Polaris faced realization of political risks involved, when it accepted a 15% reduction in price in negotiations with the Nicaraguan ministry of energy. In the following year, the company's revenues declined by as much. In return, Polaris got, for example, a permission to construct a binary power production unit, which is now in operation, and an increased tax holiday.

According to the company, renewables play a key role in electricity production in its target markets, where the power consumption is rising but significantly below the developed markets. An investment in Polaris involves obvious risks related to its operating countries and rather small size.

The earnings potential to be realized

Higher capacity leading to higher revenues and diversification

After several acquisitions Polaris is more diversified than before. In 2022 the company made following acquisitions:

• March 2022: Vista Hermosa Solar Park, Panama.

• June 2022: Canoa 1, Dominican Republic.

• September 2022: 83% of San Jose de Minas, Ecuador.

As a result of acquired assets and higher production in Nicaragua, the power production was 26% higher during the first six months than the year before. The revenue rose 31% and earnings grew from $1 million to $9.3 million. Adjusted EBITDA grew from $23.3 million to $30.7 million. In addition to higher capacity, Polaris benefited from higher pricing in many of its operating countries.

Currently, in Nicaragua Polaris is optimizing the operation of a couple of its geothermal wells, which it expects to add power production 1-2 MW per well on top of the 72 MW total capacity. In addition, Polaris is making minor investments into energy storage at some of its sites, which will add another, however small, revenue stream.

In Q1 2024 the company is expecting the production in Ecuador to increase by 20-25% as a result of an expansion project. Polaris is also working with their Canoa site, where they expect to add more solar panels and increase the EBITDA potential. In 2025 Polaris expects to have Canoa 2 online, which would double the production capacity in the Dominican Republic from 25 MW to 50 MW.

The management appears to be investor friendly, having sound capital allocation principles in mind. In the Q2 earnings call management appeared cautious about leverage and frugal about different financing options in the current interest rate environment.

On the other hand, one important task for the management is to further diversify the asset base of the company to be less reliant on Nicaragua. The management also appears opportunist about acquisitions, as some owners of assets financed by loans with floating interest rates could become pressured sellers.

Subdued earnings combined with healthy balance sheet

For a utility, Polaris has a relatively strong balance sheet. According to the company, it will achieve net debt to EBITDA level of 2.3x by the end of the year. The debt maturities are rather evenly distributed until 2037, however in 2027 the company faces a significant repayment of one of its project loans. Furthermore, its loans are secured by the individual assets, which shields the company in a case of unforeseen and major risks.

Polaris’ earnings are subdued due to high and increasing depreciation and amortization expenses. In the first six months, D&A increased from $12.3 million to $14.4 million. In the first six months, the finance costs decreased from $11.3 million to $10.5 million. The company’s debt position decreased by $6 million down to $178 million and the cash position increased by $2 million up to $41.9 million.

As a result of higher power production, higher pricing and lower finance costs, earnings are back on the growth track. Polaris aims to achieve $100 million EBITDA by 2028 from the current $60 million level.

Potential stock buybacks

I believe the company perceives the shares to be undervalued and considers buybacks to be the second-best alternative for capital allocation after high-return expansion and development projects. Polaris was preparing for potential buybacks as highlighted by the CEO Marc Murnaghan in the latest earnings call:

And then lastly, it was not in the disclosure, but the board did approve that we will institute a normal course issuer bid, at least just have it. It is still subject – it would be subject to TSX approval. So we don't have that, but we'll work to getting that in the next two weeks, and then there would be a separate announcement there.

We just think that it's prudent to have that option in place. We still – we think that there's very good return in our shares, and if depending on where the market moves, I think it's always good to have that arrow in the quiver, because if there's obviously a great return on our share price, then I think it makes sense to take advantage of that as well, given that we are building some cash here, and the net debt to EBITDA is quite low.

According to the press release a few weeks after the earnings call, the company announced an issuer bid authorizing the company to purchase 10% of its public float. In October Converium Capital pushed Polaris to buy back its own shares, highlighting nearly 20% free cash flow yield. Converium believes the company should buy back at least 10% of the outstanding shares and believes the stock should be worth CAD $30.

Valuation has become interesting

The current share price represents a compelling buy opportunity. Polaris’ stock has traded down below its five-year average multiples. Although that’s expectable in the current market environment, Polaris’ higher earnings and growth potential, better diversification and the recent business trajectory could justify higher multiples than historically in my view.

On the other hand, based on the chart above, Polaris’ valuation could be in a process of rerating downwards in the prevailing market environment. In 2021 its EV/EBITDA multiple expanded rapidly along with declining EBITDA and rising share price, likely explained partly by the boom in the renewable energy stocks.

Based on the peer group suggested by Seeking Alpha, Polaris' valuation is also significantly lower than its peers, without compromise with business quality and balance sheet. Polaris’ growth profile appears lower, but is compensated by better returns on capital and a healthier balance sheet. Two of the peers operate outside of the United States.

Four analysts have given the stock an average price target of $18.

High dividend yield covered by the cash flow

Polaris stock offers an attractive dividend yield for income seeking investors. The current annual payout of approximately CAD $0.8 which translates to a dividend yield of 6.4%. The dividend is well covered by the company's cash flow. For now, an investor shouldn’t expect dividend increases, while the company is considering buybacks and investments into new projects to fuel growth.

Conclusion

Polaris Renewable Energy owns and operates fashionable assets in unfashionable jurisdictions. The stock is attractively valued and provides a high and secure dividend. The business is on a growth path and the prudent management believes buybacks are the second-best use of capital at the moment. As the company executes on its ongoing projects, the stock could also gain upward momentum.

Polaris will report its quarterly results on 2nd of November.

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