Active Energy Group - Chip In Again

Naturally, with developments in Ukraine, it is not surprising that Active Energy Group's (LSE:AEG) share price has dropped in recent weeks to a current price of 1.73p. Indeed, being one of the few listed companies with major operations in Ukraine, it's also not surprising to see a lack of interest in the stock during this period. However, the board has yet again demonstrated its adeptness, to the extent that the investment proposition has yet again been transformed in the matter of just a few months, and in this instance, for the better. For the share price to therefore be significantly lower than the first 2.17p review price, is disappointing, although not unexpected. Despite the Ukraine risks, it is worth taking an updated look at the company, as it could yield substantial upside as the business develops. At the 1.73p share price, Active Energy has 556m shares in issue and a market cap of circa £9.63m.

This article is a follow-on from the below post. For full context and information, read this article first:

Just as a starting point I'll point out that the number of effective shares in issue has dropped. This is due to certain performance criteria at the Nikofeso sub-division not being met, due to the restructuring of the business. Therefore, the shares placed in anticipation of the targets being hit, have been placed back into the company's treasury, thus the number of shares in issue has fallen by roughly 10%. This is good news for shareholders as the market capitalisation has consequently fallen to single digits. Therefore note that the ~£10.6m market cap shown on most websites is now inaccurate.

The spread on AEG can shift rapidly, although to buy, the current ask price hovers around 1.75p/1.78p, which is attractive given that it is towards the narrower end of the normal (ask) spread size. Given the lack of interesting technical points, I'll therefore move straight onto the fundamentals, which really do remain compelling given the market cap in question. Active Energy has released two core updates since the initial review - a Trading Update in April, followed by a second trading update in May.

Just to re-cap the first review, recall that Active Energy Group is a wood chip manufacturer for Biomass (BFE) markets in Europe and (primarily) the Turkish MDF market. The company procured wood from the national Ukrainian business, chipped it, loaded it onto sea vessels, and shipped them overseas to their relevant markets. The company's location in the Ukraine enabled it to ship the material faster than North American companies, meaning that it could offer a 'fresher' product that means the company's wood chip was preferable. The calorific content of the Ukrainian wood also played a role. Of course, operating from one country has its disadvantages, and that has been seen, with major uprest within the country following the annexation of Crimea and separatist groups in some Eastern areas staging armed protests. The company's operations are not geographically close to the areas of unrest, which is positive, although the company has taken steps to mitigate the risks. The events in Ukraine are yet to directly impact the Group's operations and the steps taken have merely been precautionary.

In the site's first quarterly portfolio review I noted that "Any ... announcement to diversify into other countries could spark a major step-change in valuation, but that could take a while". To cut to the point, it has not taken a while as the company has already made transformational inroads into this expansion plan.

The update in April revealed that the relocation of the wood chip operations in Ukraine had completed such that it was now all moved into a single dockside facility at Yuzhny port in the South West of the country.  However, the main changed related to operations being rolled out into two new countries - importantly these roll-outs were not forced by the Ukraine situation, merely catalysed, as they were already part of the board's plans. Firstly, the company signed a processing and logistics agreement in Montenegro to form a setup similar to that in the Ukraine - 46.5% of Montenegro's land area is forested, plus it has an extensive coast on the Adriatic Sea. The deal was able to be done in such a short time frame because AEG partnered a local company, NK Energija DOO. However, rather than being fully staffed and equipped as they are in Ukraine, the company is operating off an 'AEG Lite' model which entails using some AEG equipment, but NK's staff. The process is overseen by a dedicated AEG country manager. This format allows Active Energy to build up a medium-scale project on very low overheads compared to the Ukraine. 13,000 tonnes of chip is expected to be shipped per calendar month, and this can be scaled up over time.

The second country was Spain, where the company has a slightly different business operation. In Spain, there is no equipment, and only one country manager. The operation is to source finished wood chip and forward it on to power plants, primarily in Italy. The fixed costs here are thus minimal as it is essentially a logistics operation. Supply agreements with two of Spain's largest forestry operators was underway, and this should provide the company with around 150,000 tonnes in finished wood chip per annum. Expectations are for up to 250,000 tonnes of wood chip to be shipped for Biomass once operations are scaled up, and this would be at superior margins and timescales to those in Ukraine.

Of course, there was an update on the Ukraine operations. The company had managed to revise some of the earlier acquired contracts to lower the minimum shipping volumes, as part of a risk mitigation tactic. Essentially, the company prepared for the worst. More importantly, the fact that these deals were successfully revised, is testament to the capability of the board, but also the good relationships that are held with customers. Elsewhere in the update, a $2m working capital loan was agreed with $1m drawn down, from the largest shareholder Gravendonck who hold around 30% of the total shares in issue.

Whilst the situation in Ukraine is clearly worrisome, these geographical expansions demonstrate that the business is very flexible and that even if Ukraine were to implode, the company could continue to operate and grow. That is crucial re-assurance for shareholders, and arguably means that the company is in a superior position compared to the position during the original review. Considering the market cap is now materially lower, it is a more attractive proposition from this point of view.

Whilst the Ukraine uncertainty has led to wood chip sales tonnes being cut, there has been a major development in terms of margins. The unrest, combined with various financial interventions in Ukraine has meant that the Ukraine Hryvnia (UAH) has weakened massively against the US Dollar (USD). Considering that Active Energy purchases its Ukrainian wood in UAH and sells its wood chip in US Dollars, the company stands to benefit from much enhanced margin levels. Since the start of the year, the USD:UAH rate has risen from circa 8.25 to 11.60 in the past few months. Of course, there are no guarantees that this weakened exchange rate will stick, but continued uncertainty combined with a likely economic weakness will probably keep levels suppressed - in fact, it could still weaken further. The move by the Ukrainian Central Bank to increase the base rate to 9.5% from 6.5% in April, has not had an overwhelming effect on the exchange rate because sentiment is ultimately the overriding factor. Since the base rate is unlikely to be hiked further again, as it would deter business, if it is cut in the future, that would weaken the exchange rate. However, as noted, sentiment is the overriding factor, so any resolution to the Ukraine crisis would probably see it re-strengthen, albeit not to the extent that it has weakened. At that point in time, AEG can benefit from hiked shipping volumes.

Commenting on the diversification, CEO Richard Spinks commented: "So far, we have prepared for disruption, which could be caused by the political unrest in the East, and to a more limited degree in the South, where we have our Yuzhny port facility. Yet we have seen no disruption. To date we have seen very limited effects on our operations - in May we hope for a strong month and are completing a scheduled loading, with two more vessels booked and confirmed in May, already. Our wood is procured far from any area of unrest, and is brought in via rail through calm areas, down the centreline of the country.

Spain and Montenegro are both performing well in terms of volume and quality, and we are outperforming even our best projections in these markets. If the worst happened in Ukraine, it would affect out hardwood MDF shipments, but not touch our Biomass for Energy (BFE) shipments whatsoever. Spain and Montenegro would take over and we would increase working capital to those two markets. With the short shipping times and new fast payment terms, we should still be in good shape, so this is a significant de-risk for AEG shareholders.

The risk seems to have decreased significantly since the tense month of April. Either way, we are in a good place and likely to be in an even better one shortly, as we further increase our non-Ukrainian business areas and geographies; more announcements are likely to follow over the summer."

The second announcement was released today and informed investors that the deferred consideration pencilled in for the Nikofeso acquisition had been cancelled. This was due to certain performance targets not being hit within this sub-division, but this was primarily the result of the business changing in structure. Therefore, as alluded to earlier, a number of shares were revoked, and the shares readily in issue fell accordingly. Investors were once again informed that Spain and Montenegro were performing well and that full year results for 2013 will be released in early June 2014.

What should investors expect from those results? Ultimately, the main transformation of the company started in 2014, and the results for the back end of 2013 will not fully reflect the current nature of the business - for that reason, they are not particularly useful as an indication of future financial results. However, following the acquisition of Nikofeso, we do know that revenues will certainly be higher year-on-year, and the market could take kindly to that. The key point for investors will be the outlook statement from the board, and any other pivotal areas of progress. The company is fast moving, so further changes are to be expected.

The company has guided that it expects to ship between 325,000 tonnes and 350,000 tonnes of wood chip during the current financial year, across the Biomass and MDF businesses. Using some rough figures provided by the company, we can derive that, at the lower end of that range, revenues should amount to around $30m, give or take 15%. $30m translates at current levels into around £17.81m. The all-important question remains to be the level of margins that the group can attain. Considering that the exchange rate for the group is currently extremely favourable, I have guided the possible margins to be between 12% and 18% - note that the range is rather wide, but that reflects the current uncertainty with regards to margins. The results in June will not provide full clarity on this matter either seeing as:
- The lower Biomass shipping costs due to the Montenegro operations,
- The move from FOB to CIF shipments
- The new arrangement with TIS at Yuzhny port, and
- Significantly better exchange rates
have only really come into effect during the first half of the year. In any case, the company should benefit from good margins.

The company essentially is working across the supply chain, attempting to become as vertically integrated as possible (vertically integrated meaning to have control over different levels of the chain). Therefore the intermediary companies are cut out, and Active Energy can capture the margins. At 12%, the operating profit would come in at £2.14m. At 18%, the operating profit would come in at £3.21m. Evidently, the exact level of the margin can make a large difference to the profit levels, but this does tell us that the company is likely to be comfortably profitable when in full flow. Of course, there are administrative expenses to factor in, but in places like Ukraine, these will be relatively fixed, so if the operating environment does improve, the company can boost shipments and see the revenues fall through to the pre-tax profits.

More importantly, looking further ahead, the company should be looking to ramp up volumes significantly in the years ahead, with a target of 700,000 tonnes mentioned before. I personally expect the company to grow far beyond this target given that the underlying backdrop (particularly for Biomass) remains buoyant. 700,000 tonnes would equate to revenues around $70m taking some of the contract value figures (or £41.6m at current exchange rates). At a 12% margin, that would equate to £4.99m in operating profits, or £7.49m at 18%. Even stripping out likely admin expenses, the pre-tax profits could be excellent. These are currently just estimates, but show the vast potential of the group to deliver very compelling shareholder returns moving forward if they continue on their current path. Further financial clarification is required first.

Below are several other questions I put to CEO Richard Spinks:

- Currently it is the Turkish MDF wood chip side of the business that is being scaled back due to the Ukraine crisis. Does Active Energy have a plan in place to mitigate this should the situation not improve or will the focus then shift to the biomass part of operations?
"We have the option to scale back if necessary. We are not yet exercising this option, preferring to balance risk against bottom line strength in the current crisis, and exploiting lack of competition -outsiders have left the market, leaving us in pole position as a locally operated business in Ukraine, and the exchange rate benefits us; We are likely to see in the future, this period, as our best in terms of profitability and we intend to chip wood while the sun shines, at least economically."

- Aside from the time savings, what are the other benefits to relocating some of the business to Montenegro, versus Ukraine? How does the partnership with NK Energija DOO assist the company?
"It is a new market, with new supplies, and de-risks reliance on Spain for BFE. We are the only exporter from this forestry rich nation and have the only useful berth in the Port of Bar, giving us a real barrier to entry for competition. It opens up Croatia, Serbia and the whole Balkan region for us. We will work to improve volumes - currently we load two vessels a month at 6500 tonnes from Montenegro and expect within two months to get up to 2.5/3.0 vessels with new equipment coming in. We expect to see strong margins in the summer months, so now until Early October, due to the sunny, dry and hot weather. NK Energija DOO saved us the time and effort in the initial 'startup' phase, taking us to immediate volume shipments and existing relationships, which our experience and working capital have taken to the next level immediately in terms of volume and quality increase. It saved us a year or so of hard slog in a new market."

- In May, the company announced that the deferred consideration on an earlier acquisition (of Nikofeso Holdings) had been cancelled due to certain performance targets not being hit. Compared to the overall business, is this significant?
"From the outside looking in, it is a 10% equity kicker for all shareholders in AEG. Otherwise it is simply a mutual agreement in the best interest of the company, bearing in mind the fact that much of our revenue and margin now comes outside the scope of this earlier deal. The team from Nikofeso are working flat out in Ukraine, Spain and Montenegro and have got behind the company as a whole to build a bigger, strong and more diversified AEG that one based purely in Ukraine and supplying purely wood chip to Turkey."

- What was your goal for Active Energy group when you joined the venture. How do you rate your progress to date?
"I wanted to build (from what was essentially an empty shell of a company with a, then, inoperable forestry concession at the western end of Ukraine) Europe’s largest renewable energy business, based around biomass with a focus on controlling our own destiny by focusing on relationships at all levels, not least of all the feedstock and its sustainable use. With the immense effort of my close colleagues, we now have an excellent team and we are well on our way to making this a reality.

Their ability to focus on the core revenue and margin generators as they come online, ensuring the company is stable at the base level allows us to look at other opportunities that fit in well with our current capabilities and relationships. In this way, even those furthest from the newer innovations are making them happen. Our progress is nothing short of spectacular in my opinion.

We started from the lowest base with the lowest of expectations from our shareholders. I am confident we will reach heights with AEG that will make even the real doubters tell others how they always said that AEG would become a really exciting company to be a shareholder in.

Ironically, with the political changes taking place in Ukraine and Poland right now, even that first forest will likely be back in action very shortly, if not several of them in the far west, bringing welcome revenues and margins to the group, albeit 3 years later than expected."

- What is the strategy of Active Energy moving forward?
"We have significant ‘assets’ in the business today. Goal one was a strong, steady, sustainable, profitable wood chip business, whether from Ukraine, Montenegro or Spain; or indeed other markets, which we are developing. It will be our historical starting point when viewed from the future.

The second strategy is raw material control and volume development. This is going well in many locations. We aim to have more than enough volume of raw material formally controlled and available to the company to ensure our long-term future.

The third strategy is to increase margin by becoming as vertically integrated as we can by going as far down the revenue stream as possible to capture additional margins. Our first step here was to move from FOB to CIF shipments across the board and we have achieved this; this gives us much better margin already. The next steps will become apparent in the short and middle term as AEG becomes an ever more powerful business.

The fourth strategy is horizontal integration. there are many ways to generate further higher margin revenue streams from our secure supplies, logistics chain, production capability and customer base. We are working all of these strategies on a daily basis and making great headway, making AEG a company you really need to watch going forward.

All of the above is happening against a backdrop of solid performance in our existing business and each of the vertical/horizontal additions is planned to be a special purpose vehicle below the AEG PLC level; again good for shareholders in AEG plc."

In essence, despite the deterioration in the general sentiment towards Ukraine, the company continues to make meaningful steps in its expansion. The market continues to miss the opportunity that Active Energy Group presents, but that is partly because the underlying financial performance is unclear, and will probably remain that way until the interim results released later in 2014. However, investors willing to construct their own valuation models will notice that the business is robust, and the rate of expansion is extremely encouraging. It is therefore difficult to see the market cap of Active Energy remaining this low, should they continue to deliver in terms of margin growth and geographical expansion. The board continue to demonstrate its ability, and this is likely to be an instance where backing highly competent management rewards shareholders in the long-run. The company is now a much more rounded investment due to it being less Ukraine centric, yet the share price is much lower. Liquidity does remain an issue so taking a trading position would be unwise, however, those willing to take a long-term viewpoint should do very well as the company continues to grow. I am comfortable with doubling up the site's initial portfolio stake in Active Energy Group. I therefore retain the Buy stance and the site's portfolio average price has subsequently dropped to 1.95p. Chip in again.

UPDATE (16/05/14) - I have once again doubled up the portfolio stake in Active Energy Group to the maximum allowance of 2 portfolio slots at 1.63p. The average has therefore dropped down to 1.79p. I expect there to be significant upside from the current level taking any medium/long term view.


  1. This feels like it could be a huge company in time. If it makes £2m in pre-tax profits over the next couple of years then surely it would be valued at £20m plus? Any how, the rate of growth is staggering and it has been on my watchlist for a few months. Sounds exciting!


  2. Great review and questions. I suppose this business is all about the margins. If they become profitable this year then I guess it makes sense for there to be a rerating. I have checked through the rnses and there has not yet been an update regarding the burning of wood chip in italy at a hired out power plant so perhaps that is news that is due to come

  3. Thanks elite , good article . One to watch.

  4. Hi. I just came across your website through google and have to say it is very good. I enjoyed reading this article on active energy plc and it has given me a company to research.

  5. Brilliant article and question and answer

  6. Great article, very promising company.

  7. Hey El1te, what's your take on the final results released today?

    1. Hi there,

      I'll include a short piece in my quarterly review that I will release tonight. 2013 results were murky as expected, but outlook remains positive and the management are capable