Active Energy Group - Chipping towards success

Until recently, Active Energy Group (LSE:AEG) is not a company I had ever heard of and I suspect that will have been the case with most investors. After transforming the nature and scale of the business model over the past year, the company operates a wood chipping business in Ukraine, where they deal with the associated logistics of their business. The transformation has been nothing short or remarkable - a loss making set of businesses being replaced with one that promises to generate substantially rising revenues in the year ahead. That transformation has been spearheaded by the appointment of Richard Spinks as CEO, who has brought together a seasoned management team to restart Active Energy Group (shortened to AEG from here on). AEG currently trades at 2.175p - with ~619m shares in issue, the company is capitalised at £13.46m.

Due to AEG's illiquidity, the spread is quite wide. However, with the mid-price currently at 2.18p, the ask price is only slightly higher at 2.23p versus 2.05p on the bid. I should note at the start of this review, that AEG is a very high risk option especially due to this liquidity. If for whatever reason, volume were to drop off significantly, getting a price quote could become tricky, and investors would probably be forced to take a much lower price that at the mid. That said, on this occasion I believe that risk is not particularly likely, and AEG actually represents a speculative and interesting opportunity. There isn't too much that can be said about the technical position, save for that the long-term downtrend has been broken, and a more positive uptrend has started (on the back of excellent fundamental news). Richard Spinks and chairman Colin Hill have 54m share options between them, which carry a 3p vest price. Given the liquidity issues, I am only comfortable with putting a 50% buy on Active Energy for now with a view to double up should the share price drop.

Before the management shake-up outlined earlier, the AEG was performing poorly as an eco-engineering consultant and a supplier of voltage optimisation components. When these two businesses were running, in November 2011, AEG acquired Bioenerho which it later renamed as Active Energy Ukraine (AEU). AEU was involved with providing biomass energy resources to industrial power facilities in Poland, primarily through their flagship project with the state-owned forestry company. The loss-making eco-engineering and voltage optimisation businesses, whose tasks were performed by Red Line Engineering Services and Active Energy Limited respectively, were liquidated in February 2012 - the corresponding results showed revenues sharply lower at £0.9m (vs. £3.0m) and a hefty loss of £2.5m being booked.

The key point about AEG, which makes it so interesting (but equally speculative), is that its last FY financials don't at all reflect the financials going forward. The latest set of figures (the 2013 HY report) show minimal revenues of ~£106,000 with a £630,000 operating loss. There are similarly dismal figures from the latest full set of results (the 2012 FY). The point with AEG is to look over that for now, and whilst it is extremely difficult to forward-forecast the financials in the light of no supporting broker material, or financial guidance, the figures will be in a whole different ballpark to the historic figures.

The first move in changing AEG's fortunes was to appoint Richard Spinks as CEO. He has had extensive experience of operating in Ukraine and surrounding countries, speaking fluent Ukrainian, Russian and Polish. This appointment led to the formation of a strong management team who have already demonstrated that they know the operating environment very well - this should become clearer later. The second step was to implement a comprehensive strategic plan which outlined that AEG should acquire Nikofeso Holdings. Nikofeso is the largest Ukrainian supplier of wood chip for Turkish MDF (an engineered wood product). The acquisition enabled AEG to become a fully-integrated provider of wood chip with 'the opportunity to become the pre-eminent operator in the Black Sea and Balkans'. The acquisition partly complemented the AEU business, but opened up a whole new play for the company.

The produced wood chip is for two principal uses. The first is for the manufacture of MD, the second being that it can be used for the biomass renewable energy industry. Biomass energy is generated when organic matter with high calorific content is burned - a process similar to a coal-fired fireplace but on a much larger scale. The burning of the matter (in this case wood chip) generates heat and is more carbon-efficient than many other sources of energy creation. "Working with wood chip allows companies to plan and stock pile and, although the actual process of energy creation is by its incineration, the gases thus emitted are only those absorbed during photosynthesis. [This means] biomass wood is a carbon-lean fuel". An increasing number of biomass plants are set to become active between now and 2016 as part of the EU plans to boost the renewable energy method. The EU renewable energy council has estimated that biomass based energy production will grow from 43TWH in 2005 to 250TWH in 2020, so this is clearly a growing market.

The acquisition of Nikofeso involved a total considering of £3.75m that was paid to owner Windstar in shares rather than hard cash. However, to fund working capital and associated acquisition costs the company raised £3.07m gross (£2.77m net) through a 165.8m share placement. The details themselves were far more complicated. A mixture of initial and deferred consideration shares, and initial and deffered consideration warrants made up the deal with one deferred warrant being issued per 5 consideration shares. These all had an exercise price of 3p which was far in excess of the share price at the time. The deferred shares are released on certain performance levels being met:
- 31.25m upon adjusted EBITDA for 2014 of $2.5m (circa £1.53m) plus another 31.25m upon adjusted EBITDA of $5m (circa £3m) in 2015
- 62.4m upon adjusted EBITDA of $7.5m (circa £4.60m) being maintained across any 3 consecutive years before December 2018

These numbers are interesting as they imply that if the company continues its strong progress to date, the adjusted EBITDA figures start to look very interesting indeed, and certainly attractive for a company valued at just £13.46m. That confidence is backed up by the 3p exercise price attached to the shares, and this carries a 1 year lock-in unless transactions are completed through the company's broker in an orderly manner. The number of shares issued to Windstar are not huge in terms of the 600m+ shares in issue, but had that lock-in not been implemented, the disposal of those shares would probably influence the share price notably. If the company continues to meet its internal targets, there is no doubting that a buyer should be easily found should Windstar want to dispose. The AEG placing was backed by cornerstone investor Gravendonck Private Foundation who subscribed for over 130m shares and a further ~45m warrants. Gravendonck is a connected party to the already invested shareholder, Eastwood. In addition, a £1m loan was also converted to equity during the deal and directors took £133,000 of fees in terms of shares which is a good vote of confidence. Now that those numbers are out of the way, onto the business itself.

What was the rationale behind the acquisition? At the time, Nikofeso had a low cash balance of £67,674 with net payables of £42,481 when accounting for inventories. This weak working capital position meant that the company was not fulfilling its potential. But what was the rationale behind taking a stake in Ukraine? The advantages seem abundantly clear when you look at what the company is saying. Currently most of the wood chip demanded from Europe is shipped from the Americas. That takes roughly 15-20 days, over which the quality of the wood chip declines. Operating in the Ukraine has a number of geographical advantages. Ukraine is bordered by numerous countries to the North, East and West including Belarus, Russia and Poland, but importantly it has the Black Sea to the South which allows for the wood chip to be shipped to countries as far away as Italy, and beyond.

The shipping times to these European markets is therefore just a fraction of 360 hours+ typically required for the Americas' wood chip. At just 24-30 hours, AEG can market a 'fresher' product that is more attractive to the customers, especially since it can be mixed with lower quality wood chip to raise the overall grade. The cargo sizes are admittedly different with the Americas cargoes typically being 40,000MT, compared to 4,000-8,000MT from AEG. However, the times are still favourable given that customers would likely prefer more smaller shipments of fresher product. The shorter trade times are also better for high-volume manufacturing businesses where inventory control is key. The sacrifice that AEG is having to make, is to move away from the spot charter market, and into the long-term contract market where volumes can be more carefully managed and visibility is greater.

The numerous land borders it has is also beneficial as the excellent cross-border rail into these countries opens up more long-term target markets. Ukraine itself had an abundance of available forestry, and moreover, this forestry is excellent quality for the biomass market. The biomass market requires matter with high calorific content as noted earlier - Ukraine's trees fit the bill boasting superior energy content to those found in numerous other European countries. In essence, the geographical placement means lower logistic costs per metric tonne (MT) than the equivalent long-haul shipments and lower financial exposure on smaller shipments, for shorter periods of times. This aids both the cash flows of both AEG and the customer which is a significant benefit. There are of course downsides of operating in Ukraine. Corporate governance issues have arisen in the past, and many investors would cite issues over transparency, but the experience of Spinks and the management team should mean that a tight ship is able to be run. Indeed, the recent riots on the country have had no impact on the business and the company believes that operating in Ukraine should be seen as a benefit rather than a drawback.

After the deal for Nikofeso was completed, Matteo Girlanda was appointed as COO of the enlarged group having headed Nikofeso beforehand. Girlanda has had extensive experience within the same industry having set up his own steel and wood trading company in the past. His previous experience has seen him handle volumes in excess of 50,000MT of logs/wood chip per month and sell into markets such as Turkey, Greece, Italy and Austria. The starting focus for AEG is Italy and Turkey, although they have commented that demand continues to outstrip supply and that they have had to expand strategically. The flow map for the wood chip is as follows; Logs supplied from the Ukrainian Forestry Agency to AEG by rail -> Logs processed into the specified grade of wood chip at AEGs processing facilities located close to ports in Mykolaiv -> wood chip loaded onto ocean-going vessels and sent to the destination (or via alternative transport routes).

Upon completing the acquisition, CEO Spinks said, "This marks the start of the new Active Energy Group. I am confident that we have identified a very exciting and growing market around which to continue to build a significant business. AEG shareholders have had to be patient but having spent the last 10 months working alongside the Nikofeso Group team, the last six months of which in a joint funded partnership, operationally, I believe there is a great opportunity in front of the new Enlarged Group now. The demand for wood chip/biomass is strong and expected to increase. We have the expertise and advantageous geographic locations to procure, process and ship quickly and efficiently and this will form a stable and profitable base upon which we can build."

"So what?" you may be wondering. After all, Nikofeso only traded approximately 39,000 MT of wood chip in 2012 and that only brought in £1.88m of revenues - hardly stellar figures or anything to justify a £13m market cap. Except, that is where the step-change in operations has come in. Indeed in the past, Nikofeso has supplied wood chip at peak volumes of over 300,000MT/year. At the date of the acquisition, the directors believed that there was the potential for 350,000MT+/year to be shipped for the MDF market and a further 350,000MT figure to the biomass market by the end of 2015. Those figures are substantially larger than the sort of volumes that Nikofeso has been dealing with over the past two years, and at the time those figures may have been considered to be fantasy. What the management have proven since is that they are anything but fantasy.

In August 2013, AEG signed a contract with Biomasse Italia SpA (BMI) - unsurprisingly, as the name suggests, it's a biomass business. As part of the deal, AEG will ship a minimum of 240,000MT of wood chip over a two period commencing in January of this year. That is a huge deal and is testament to the management's vision of rapidly scaling up the business. 160,000MT of that is estimated to be delivered in 2014. That contract win followed a number of encouraging share transactions by directors earlier in the year. Although the amounts involved are small, CEO Spinks bought 250,000 shares at 1.9p in July and later went on to capitalise £85,000 of directors fees into shares along with chairman Colin Hill. Furthermore, COO Matteo Girlanda bought 360,000 shares at 2.5p in July and a further 500,000 at 2.65p. During this period, Ruffer LLP (an institution) also took a 5% stake in the company.

In the September interim results (H1 2013), Spinks noted that the company were ahead of their plans on a number of fronts and that "business initiatives put in place since late June 2013 and following the acquisition would deliver increasing margins on shipments". A Swiss based trading company and office had also been set up to handle activities and future expansion. Elsewhere in the report, it was mentioned that new port and production facilities in Odessa were coming on-stream and that will facilitate larger volumes of wood chip. Impressively, it also read that "The company has now fully established direct communications with a number of Turkey's leading manufacturers of MDF", who could potentially demand volumes of 250,000MT to 600,000MT. Cash on the balance sheet totalled £3.6m with net payables (minus inventories) of £527,000.

The first real financial reference for investors came in October in the form of a trading update. It revealed that in the 3 months ended September 2013, 50,000MT was shipped versus 53,000 in the first 6 months of the year. Q3 shipments alone generated gross revenues of £3.25m and that only included revenues for biomass. Shipments to MDF clients were to restart in Q4 2013. Taking that at face value (which is a very rough estimate) and using the 700,000MT/annum possibility that the management set, that means that AEG could be earning revenues of £45.5m/year during 2016, which is £11.38m/quarter. Of course, being conservative, and halving the figures still retrieves an attractive figure. The vital question is, how much of that is profit? Any decent profit margin and the company will look an extremely good investment at the current levels. It would be inaccurate to speculate on that front so it is best to wait and see what sort of forward-looking profit margins the new broker WH Ireland come up with in their research. One thing that AEG did point out in the update is that there is the possibility that its own Italian subsidiary could burn the wood chips itself at a facility in Italy. Spinks commented that, "We might earn significantly more per ton burning it". The reason is that it may allow AEG to receive government clean-power subsidies. The idea puts an interesting new twist on the outlook of the company and is worth keeping an eye on.

Interestingly, Fulghum Fibres (another wood chip supplier) had ~$95m in revenues last year and EBITDA of ~$20m. Fulghum have a 70% stake of the entire US contract chipping business. If it does hold true that roughly 1/5th of the long-run revenues generated are EBITDA, then, once again, the valuation of AEG looks low on a long-term perspective.

Following the trading statement, Spinks and a Non-Executive director bought around 140,000 shares between them. Once again, these are small trades but it is much better to see ongoing director commitment than not. 3 major milestones were then reached in the last week of November with record production and shipping volumes (of 20,000MT) and the simultaneous loading and dispatching of 3 vessels. Another test batch of wood chip was also sent to a potential major client in Turkey. "[AEG is] in advanced negotiations with several major European wood chip buyers", investors were told.

By far the best news to be announced was in January 2014. AEG had won two major contracts with Turkish MDF manufacturers. Under the contract, AEG are to supply 228,000MT over the course of 2014, generating revenues of £14.72m from these alone. Elsewhere in the news, there were encouraging signs that the company was finding solutions any potential obstacles that could lay ahead. AEG's shipments are being done with MV Sider King who they have signed an exclusive time charter arrangement with, for the whole of 2014. Furthermore, AEG are also negotiating time charter agreements on a further 2 bulk carrier vessels - if this isn't a vote of confidence going forward, I'm not entirely sure what is. Spinks commented, "Discussions with other major Turkish producers are at an advanced stage and the company is confident of making additional announcements of further contract wins in the near future".

What is clear is that revenues this year will be substantially ahead of those booked last year. Realistically the company is looking at well north of £20m - the precise figure is far too difficult to calculate given that the contracts that are coming in completely change the dynamic. The bottom line is what will ultimately matter to investors, although I expect that it will be the long-run profit margins that will be of greater interest. It's fair to expect exceptional costs associated with the scaling up of the business this year. The operational risk that AEG needs to overcome is how it can ensure an uninterrupted service to customers. The only way that can be ensured is if they are well prepared logistically. Progress to date suggests that they have been so far.

The only obvious financial risk is that the company may need to seek sources of additional working capital in the future, especially if they keep securing these highly prospective contracts. I'd imagine that the preferred method of securing that working capital would be through a low-interest loan rather than an equity placing, for both shareholders and management. At the current point in time, if funds are sought and they are in excess of circa £2m, then doing an equity placing doesn't seem the most sensible option and I'd imagine that debt should be available to the company on fairly attractive terms, especially since the scaling up has been done expertly (to date). Investors should of course, keep an eye on the political situation in Ukraine.

The orders to date prove what management are saying, in that doing this business in the Ukraine has significant advantages for the customers and ultimately that is what matters, and should allow AEG to prosper moving forward. The new management have done a phenomenal job of turning around the business, and the confidence they have in continuing to move the business forward is clear to see. Financials this year should make for much better reading, with the FY results due at the end of March/early April. "The board believes that AEG is optimally placed to deliver sustainable long term growth in shareholder value". Whilst there are a lot of uncertainties for investors at the current point in time, the outlook for AEG looks brighter than ever before. Despite being highly speculative for a number of reasons, with a capable management team at the helm, AEG seems an interesting medium/long-term choice. If they deliver on their outlined targets, then this should continue on higher. Further contract wins could prove to be additional catalysts. I have put a Buy tag on AEG at 2.175p.


  1. You finally managed to find a company I haven't heard of before! Well done!!! Joking aside, this looks like a very intriguing company. Thanks for the heads up


  2. Thanks el1te, its good morning reading as always. I like the look of the management calibre and what they have done so am planning to shore things up tonight. Regards.

  3. Really interesting company. A hidden gem if I may say so but Spinks cant afford to take his foot off the pedal by the sounds of it. If they get Active EG right this will be much higher later in the year. Of that I have no doubt! I look forward to the WH Ireland broker report


  4. Really excellent article and company!