Polaris Renewable Energy: Growth at a Very Reasonable Price
And you get a 5.5% dividend while you wait
Back in about 2018 or so, Polaris Infrastructure made its rounds among the Canadian value stock investing sphere. It’s called Polaris Renewable Energy (TSX:PIF) these days.
The thesis was really simple, which is always my favorite kind of thesis. Polaris owned a geothermal power plant in Nicaragua, a fantastic asset that produced a big chunk of the country’s power needs. Here was a pure-play renewable power generator in an era where many other power plant operators were just beginning to go green. It was dirt cheap, too.
So I bought some.
There was a reason the stock was cheap, of course.
There’s always a reason.
Nicaragua isn’t the best place to do business. The country is ruled by Daniel Ortega, who was first elected President in 1985. He ruled until 1990 before losing the election. He hung around Nicaraguan politics for a while, eventually being reelected in 2007. He’s held power ever since. He’s spent much of the last 15 years consolidating this power, including getting rid of presidential term limits, installing his wife as Vice President (the most qualified person, obviously), and taking every opportunity to arrest opponents of his regime. Nicaragua does hold elections, but most agree they’re about as fair as the ones held in Soviet Russia.
Ortega has pivoted from a far left politician during his first term in office to someone more center or even a little right of center today. He dropped the Marxist talk and started to make amends with the Catholic Church. But that still wasn’t enough for the people of Nicaragua, who started massive protests around the country in 2018. No wonder Polaris’s stock tanked. Who knew what was going to happen?
It turns out not a whole lot happened. Ortega violently put a stop to the protests and has consistently squashed any opposition since. He arrested opposition leaders shortly before a November, 2021 election, and then cruised to victory. In response, the United States and European Union slapped sanctions on the country and on prominent members of Ortega’s government, while Ortega shifted focus to ally the country with countries like Venezuela, Russia, and North Korea. Although, to his credit, Nicaragua is seen as more of a pro-business country than those allies.
Getting back to Polaris, the company’s foray into Nicaragua hasn’t suffered at all. It continues to sell power to the nation’s electric utility, even gaining approval to construct further capacity. It did renegotiate its power purchase agreement (PPA) with the government in 2020, taking a small haircut in exchange for almost a decade of additional term. That’s not such a bad deal.
When I first bought the stock management had a plan to pay off the debt and increase the dividend as earnings from San Jacinto increased. It instead embarked on a diversification project, using cash flow from Nicaragua to expand into other Latin American countries. Polaris now plans to become a regional player, setting itself up as one of the go-to renewable energy developers in Latin America.
Is this a legitimate business opportunity? Or is there just too much risk in Latin America? Let’s take a closer look at Polaris and the growth path forward.
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Polaris’s expansion plan
Polaris is bullish on Latin America for a few reasons. They operate without a lot of competition because larger operators won’t touch the region. The perceived political risk scares away many would-be competitors. But these larger operators also don’t like the area because there are few opportunities to build huge projects. Polaris is happy to acquire smaller assets. A company like Algonquin Power or Brookfield Renewable isn’t. They just don’t move the needle.
Per capita power consumption — which is anywhere from 10-20% that of Canada or the United States — should also rise as these nations industrialize. Combine that with population growth and it translates into nice long-term potential.
Perhaps the most important reason why Polaris is bullish on Latin America is these assets represent a certain amount of security for local governments, which in turn gives the operator a certain amount of leverage.
Many of these nations have struggled to generate power for decades now, turning to imperfect solutions like burning fuel oil. These projects are very visible indicators local politicians are doing something to deal with power problems. Any improvement in the user experience should help these folks get reelected, too.
Or they can just pull an Ortega and rig the election. Hey, whatever works.
The first part of the expansion plan happened in 2018 when Polaris acquired 100% of Union Energy in Peru. It purchased a total of nine different assets which consisted of one completed hydro plant and eight different locations in various stages of development. Three of these projects are now operational, producing a combined 33 MW. The acquisition cost 600,000 Polaris shares plus an additional 300,000 warrants.
The Peru assets currently generate US$8-$9M in revenue. Compare that to Nicaragua, which will do more than US$50M in revenue in 2023 after a new binary unit expansion comes into production. In other words, the first deal didn’t move the needle that much. But the company has been busy since.
Polaris has made several other acquisitions since the Peru assets, including:
A 10MW hydro project in Panama in 2021
A completed 6.3MW hydro project in Ecuador (with 7 years remaining on a PPA) in early 2022
Two construction ready solar projects in Panama in early 2022
A 32MW solar asset in the Dominican Republic with 18 years left on the PPA, which closed in June, 2022
It also added a new binary unit to San Jacinto in Nicaragua that began producing in January
Put all these assets together and Polaris should see net production increase from 100MW in 2022 to 150MW in 2023, or close to a 50% increase. 2024 should see an additional 20% growth from a proposed Dominican Republic expansion alone, plus further growth potential from other acquisitions.
To pay for these acquisitions, Polaris took on some additional debt, assumed debt on some projects, and, to their credit, issued approximately $50M in new shares when the stock was trading at above $20 per share. Shares are closer to $14 each these days.
EBITDA should come in somewhere in the range of US$60 to US$65M in 2023. Add in a few other planned projects as well as potential acquisitions, and Polaris thinks it can do US$100M in EBITDA by 2027 or 2028. Hell, the company thinks it can eventually grow into a platform with 500-1000MW under management, which would translate into $250M+ in EBITDA. There’s some potential here, but that’s likely a decade (or more) in the future.
When 2022’s results are announced in March, the company will generate somewhere between US$40M and US$45M in EBITDA. We’re looking at an increase of approximately 50% for 2023. That’s nice growth.
Despite all this, shares have cratered since hitting all-time highs north of $22 each in August, 2022. The stock is currently at $14.58, which I think represents a pretty compelling opportunity.
These assets are cheap
Polaris has an enterprise value of approximately US$400M. Say it can only hit the bottom of its EBITDA range for 2023, which is US$60M. That gives us a EV-to-EBITDA ratio of 6.67x. That’s among the cheapest power producers on the TSX, along with my old favorite Capital Power. CPX also trades at under seven times forward EV-to-EBITDA.
Most comparable companies are in the 8-12x EV-to-EBITDA range.
US$60M in EBITDA should translate into approximately US$50M in free cash flow, assuming Polaris can convert EBITDA to free cash flow at approximately the rate it has over the last couple of years. We’ll ignore any growth capex for this exercise.
The stock has a current market cap on the Toronto Stock Exchange of $306M. Convert that to USD and you get a USD market cap of $226M. The stock trades at 4.5x forward free cash flow.
Yowza. That’s cheap.
I’m the first to admit I have no idea when the stock will go higher and what will push it up. Will it be improving sentiment towards Latin America? Will Ortega die? Will the market wake up to the company’s growth plan? Or will it be something more benign, like interest rates slumping lower?
However long it takes, at least you’ll get paid a very handsome dividend while you wait. The current payout is US$0.60 per share on an annual basis, which converts to a hair over 80 cents in local currency. That’s a yield of 5.5%.
It’s well covered by free cash flow, too, with a payout ratio of approximately 25% of free cash flow. That leaves plenty of cash flow left over to reinvest in the business.
A quick note that this company has big depreciation expenses which make headline earnings numbers pretty much useless. You’ll want to focus on EBITDA and free cash flow when analyzing it.
The bottom line
It isn’t very often investors get a growth company trading at a value company valuation, but Polaris is exactly that. It’s among the cheapest independent power producers trading on the TSX, yet it has what I view to be an achievable plan to double earnings over the next five years.
The only problem is the assets are located in areas many investors don’t like.
I’m personally quite comfortable with those risks, and have been for a long time now. As I mentioned, power is important for the long-term health of these companies. If some new government shows up and starts nationalizing assets then they have no hope of attracting investment in the future. Venezuela’s neighbors have (hopefully) learned from its mistakes.
This will never be a huge position for me, simply because of the risk. But I’ve owned it for years now, and I’ve nibbled on a few more shares lately. Position it appropriately in your portfolio just in case the you-know-what hits the fan and then sit back, relax, and collect your dividends while waiting for the geopolitical situation to improve. That’s what I plan to do.
Disclosure: Author owns shares of Polaris Renewable Energy
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Nice write-up, enjoyed it.
I've been burnt from LATAM stocks before and think the discount is there for a reason. The political stability problem means you only need one crazy to get elected to turns things around for shareholders. I agree with you I doubt they will nationalize the grid but frankly Polaris got extremely lucky in 2020 getting a haircut with something in return instead of nothing. Perhaps Polaris will flourish once it's country diversification is more complete but personally in terms of preserving capital I plan on avoiding LATAM based assets