Ameresco: Awaiting Key Factors Evolution In 2024 (NYSE:AMRC)

After analyzing some of the most important IPPs (Independent Power Producers) globally, with today’s article I want to bring your attention to Ameresco (NYSE:AMRC). If you are interested in companies dealing with renewable energy, on my profile EuroEquity Research you will find several analyses. AMRC is a major American EPC (Engineering, Procurement and Construction) energy company, also engaging in O&M and asset management. It owns a total capacity of 508MWe (Megawatts equivalent) obtained through small-scale solar systems, storage systems, and RNG (renewable natural gas). Since November 2021, the stock has experienced a 78% drop, mainly imputable to the delay in the construction of a 537.5 MW storage plant for SCE (Southern California Edison) scheduled for August 2022 and not yet fully completed. This caused an overall pipeline slowdown, probable financial compensation to SCE, as well as market attention to AMRC’s covenants and, consequently, its financial position. Ameresco, however, represents one of the major players in the industry, with all-around exposure to energy transition and a business capable of being very positively affected by the increased demand for renewable-related services. A normalization of interest rates between FY24 and FY25 could be the right catalytic event for the company. Increased funding availability will translate into revenue growth, supported already now by record levels of backlog at $3.9B, including $1.3B fully contracted, as of December 2023. The tax credits introduced by the Inflation Reduction Act, particularly Investment Tax Credits, and new investments in energy systems will have a positive effect on OCF’s operating results and production, containing debt and enabling implementation of the investment program undertaken since 2022, focused on organic growth with a focus also on the dynamic European segment. To support the investment thesis, I conducted a DCF analysis that returned a valuation of $23.32 a share. Although I find the stock price attractive, I assign Ameresco a Hold rating, at least until the release of further positive developments regarding the SCE project.

Business Overview

Ameresco’s business is mainly divided into 3 segments:

Project is the main activity, consisting of the implementation of energy projects aimed at reducing the energy consumption of buildings through

Energy Savings Performance Contracting (ESPC), acting as an ESCo (energy service company). In FY23, 72% (vs. 46% FY22) of its revenues were indeed derived from federal, state, provincial, or local government entities, including public housing authorities, public universities, and municipal utilities. In FY22, the segment experienced a spike in revenues due to the recognition of the SCE project. The above-mentioned problems with the project, however, led to a slowdown in AMRC’s operations in FY23, resulting in a 32% YoY decrease in project revenues, still above FY21 levels. I expect revenues to accelerate again between FY24 and FY25, in line with increased demand for new renewable plants. Barring further delays on projects, I anticipate a return to FY22 highs as early as FY25. This business area is also dedicated to the construction of small-scale renewable systems, often combined with energy efficiency operations.

Main competitors: McKinstry, CM3 Building Solutions, SitelogIQ, ABM Industries (ABM), Southland Industries, Energy Systems Group, Johnson Controls (JCI), Schneider Electric (OTCPK:SBGSF),and Honeywell International (HON).

O&M, through which the company offers Operation & Maintenance services, at the customers’ discretion. This feature enables recurring revenues through contracts, usually on a multi-year basis. Although the segment was worth just under 7% of total revenues in FY23, it reached $92m, up steadily from $79m in FY21. I expect the same level of growth to be maintained in the coming years.

Main competitors: EMCOR Group (EME), Comfort Systems USA (FIX), HON, JCI, and Veolia Environment (OTCPK:VEOEY).

Energy assets, a segment through which revenues are obtained mainly through PPA contracts, for the sale of photovoltaic or wind power (Energy Supply Agreements), and for the sale of gas and RNG (Gas Purchase Agreements). This segment, in which AMRC operates much like an IPP, is characterized by steady growth stimulated by the commissioning of new RNG and PV plants. Management anticipated that approximately 200 MWe of energy assets will come into service during 2024, including power battery assets. In addition, 3 more RNG plants are scheduled to be completed, one of which will be operational as early as January 2024, positioning itself as a major player in the industry. As of Dec23, energy assets are worth 119% of net debt, down from 150% in Dec22, but in line with what was found in previous IPPs analyses.

Main competitors: Archaea Energy, Montauk Renewables (MNTK), Vanguard Renewables, Opal Fuels (OPAL) in the RNG business. NextEra Energy (NEE), Engie (OTCPK:ENGIY), and the various IPPs analyzed in previous articles regarding solar & storage businesses.

Latest Investments & Future Developments

The investments undertaken by Ameresco in the last 2 years were aimed at increasing the share of recurring revenues, particularly the Energy assets and O&M segments, which are currently worth about 24% of total revenues. To understand the importance of them, however, it is necessary to look at EBITDA, with the two segments accounting for 64% of total FY23 EBITDA. This makes them indispensable to ensure greater stability to economic results and cash flows, which, for the time being, are characterized by high volatility due to the Project segment weight on total revenues.

Another important development concerns the expansion in the European market through the purchase of the Italian company ENERQOS, which has contributed to a 148% YoY increase in revenues in Europe with an 11% share of total revenues. It should be noted, however, that much of this revenue is project-related and therefore not a recurring source of revenue. It could therefore experience significant negative changes in the future, following a potential decrease in demand.

As regards future developments, management reiterated during the last conference call that the strategy continues to be to retain for themselves an increasing share of the projects developed, so as to increase recurring revenue and make margins more robust and less volatile. They also stated that they may consider some disinvestment, should they need liquidity. Overall, I believe this is the right approach to deploy, in line with that implemented by companies in the industry.

Status on the SCE Project

In October 2021 AMRC closed a contract worth $892m with SCE for the EPC of a 537MW storage systems, including 2 years of O&M to be completed by August 2022. Problems related to inclement weather and supply chain disruptions led to a significant delay in the delivery and assembly of components needed to build the plant. As of February 2024, two of the three units planned for the project have been completed, exceeding the ultimate deadline imposed at the end of 2022, which called for final completion no later than 2023. Failure to complete it on time contractually carries a penalty of up to $89m.

The overall results of the operation were negative for Ameresco and, I am convinced, some of it is yet to be reflected in the company’s financial statements. The operation was accounted for in FY22, and the estimated costs of completing the plant were subtracted from total revenues. In addition, the delay in work slowed the implementation of other projects, depressing revenues in FY23 and, at the same time, had a negative impact on costs for transportation and logistics. Even more significant is the negative impact on FY22 and FY23 FCFs, which may persist to some extent in FY24.

In addition, I expect a possible one-off cost due to the penalty in the coming years, for a maximum charge of $89m. To support the operation, as well as the implementation of the other projects, the net debt increased by $1B between FY21 and FY23 reaching $1.4B (corporate debt: $280m), also due to the higher amount of funding needed to finalize the SCE project. The latter indeed required significant investments that were not offset by an increase in adjusted OCF (obtained by adding advances on Federal ESPC projects to OCF), which bottomed out in FY22 at -$100m and then recovered in FY23 to $84m.

In FY24, I expect an improvement in operating cash generation, but this will not be sufficient to meet the $350-400m Capex announced by management. The heavily negative FCFs of the past 2 years and the negative FCFs expected for the coming years have and will require new debt to be taken on, with a consequent increase in net debt. However, raising the necessary liquidity will be partly facilitated by the introduction of the ITCs, which may allow the company to raise tax equity financing by reducing capital requirements for some projects by 30%, especially those to be held in the energy portfolio.

Moreover, failure to complete SCE by January 2024 resulted in the issuance of a $100m subordinated bond as an alternative to the capital increase, as can be read in the FY23 financial statement:

The amendment also added a covenant that requires Ameresco to use commercially reasonable efforts assuming normal market conditions to raise and, by April 15, 2024, close on a minimum of $100,000 equity or subordinated debt financing if the Cathode site under the Southern California Edison (“SCE”) contract does not achieve substantial completion by January 31, 2024, which was not achieved. Net proceeds from such financing would be required to be used to repay outstanding amounts on the senior secured credit facility.

Considering the above, I believe this transaction to be a missed opportunity for Ameresco, from a possible opportunity to a likely source of problems in the coming months. I also question management’s words on whether a capital increase may become essential to avoid possible liquidity shortages in the short term. I believe that the main people responsible for the deal are management, which entered into an agreement with too short a deadline for the construction of a plant significantly above the historical target of Ameresco’s previous projects. This resulted in a large expenditure of resources in an already particularly difficult economic environment due to high inflation.

Commentary on Economic and Financial Data

In FY23, Ameresco’s revenues decreased by 24.6%, below the guidance released at the beginning of the year. The EBITDA margin showed an upward performance though, reaching 11.2%, close to the highs achieved during the 6-year period under review. EBIT and Net Income margins, on the other hand, have both hit lows (6.1% and 4.5% respectively) mainly due to increased D&A and interest expenses.

Now turning to 2024, management expect revenues and adjusted EBITDA to grow by 20% and 38%, respectively, although I personally expect revenue to increase by c.a. 18%, to consider issues related to the completion of the SCE project. In Q1 2024, revenues and adjusted EBITDA should be in the range of $225-275m and $20-30m respectively, with negative non-GAAP EPS. In FY25, I expect revenues to reach FY22 results, with an increase in operating margin, aided by economies of scale and the overcoming of problems related to the Californian project. The net income margin, on the other hand, weighed down by higher interest costs and by possible one-off penalties costs, is likely to grow more slowly and remain below the historical average value observed in the period under review.

Main Risks

Although the considerable opportunities associated with the business in which Ameresco operates, the company has certain risks, both exogenous and endogenous, that can have serious repercussions on the solvency of the stock and consequently on its share price:

A continued high interest rate environment can have serious repercussions on financial performance, especially after the recent significant increase in debt, with interest expenses that could surge heavily affecting profitability.

The SCE project has highlighted problems with project scheduling, a fact that may be repeated in the future, again damaging economic performance as well as its reputation.

AMRC may be economically responsible for the failure to increase planned energy efficiency in projects in which it operates as an EPC. Although the performance calculation is usually based on technical production data rather than economic data, thus not affected by electricity price volatility, this factor could be an additional cash drain in the future.

The industry in which it operates is highly regulated, especially the Project segment for which specific procedures regulated by the U.S. Department of Energy must be followed. Changes in regulation could therefore have a heavy impact on its economic results.

Discounted Cash Flow

I conducted a DCF analysis to assess AMRC’s intrinsic value, returning a fair value of $23.3 per share, about 10% above the current market price. I included within the estimates a reduction in operating results due to the possible economic impact of the SCE project. For the evaluation, the following assumptions were made:

Beta: 1.54x, obtained by Investing.com.

MRP (5.87%) and Risk-Free rate (3.81%) were obtained by using 2023 Fernandez’s data, weighted by the geographic breakdown of the company’s revenues. A cost of equity of 6.98% was obtained.

Cost of debt (5.34%) was obtained from the ratio of interest expense to AMRC’s total debt as of December 2023.

WACC = 5.76%, quite a low value because of the weight of debt, which currently has a higher value than market capitalization.

G = 2% in line with the inflation target in the US.

Conclusion

I believe Ameresco is a good long-term investment opportunity, especially following the recent price drop. The business appears to be diversified, with good positioning in the development and EPC sectors. I judge positively the management’s plans to try to increase recurring revenues to stabilize financial control, which is currently marked by great volatility. In addition, the DCF and prospective multiples analysis show a slight undervaluation of the stock, especially regarding PE, which is expected to improve from 17.64x in FY23 to 12.75x in FY25.

Nonetheless, the mistakes made in the SCE project are a strong negative factor both in economic and reputational terms but, most importantly, in financial terms. That is because they are causing serious repercussions, such as the need to provide for the issuance of a subordinated bond or, alternatively, make a $100m capital increase due to covenants linked to the project debt.

I currently assign a Hold rating to AMRC as, although I believe Ameresco is undervalued in terms of price, I think it is fundamental to closely monitor SCE project evolution, FCF and debt level in FY24.