Active Energy Group - Operations Stacking Up

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The outlook for Active Energy Group (LSE:AEG) is finally closer to being clarified as various assumptions made in previous reviews have been confirmed, and infill data has been provided by house broker WH Ireland ("WHI"). WHI released their initiation note on the company recently, citing a 6p price target versus the current price of 2.275p - at this level the company is valued at £12.7m as there are 556m shares in issue. Further developments since the last review in early May, legacy issues seemingly resolved, and with more progress concerning the political situation in Ukraine, the company's outlook continues to improve to the extent that WHI's 6p target price does not look especially optimistic - indeed, there are several factors not included in their own estimates, that are crucial to the company's long-term outlook. Despite the 2013 legacy results being read negatively by the market (in particular due to the use of debt), those numbers do not paint an accurate outlook for the company, which is becoming increasingly positive.

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

As always, its important to point out that technical analysis on illiquid stocks like Active Energy Group ("AEG" from here on in) does not carry high levels of reliability. However, it does help form a picture of the company's progress and the market's reaction. Since the last review, there was an important announcement regarding the formation of a new sub-division called Active Energy Pelleting. Whilst I'll cover the details regarding that a bit later, the reaction from the market was clearly positive, with the black rectangle highlighting the sharp rise in share price despite events in Ukraine. That rise was backed by above-average volumes and led to the formation of a higher-high off the previous low. That positive sentiment is reflected through the recent formation of a golden-cross (as the 50-day SMA crossed over the 200-day SMA). That said, as noted earlier, the 2013 results were not taken well, and the share price recently dipped sharply to circa 2.30p.

Liquidity is of course an issue given the low free float, but I reckon this is another case where 0.10p now is relatively immaterial 6-12 months down the line, when the liquidity situation may be much better. The low valuation is more than sufficient for the spread to not act as a deterrent.

So what is Active Energy Pelleting ("AEGP")? AEGP is a new business based in Northern Ireland that seeks to utilise technology that has been developed for over a decade, and apply it to AEG's sphere of activity. Described by the company as "potentially game-changing", the technology uses sawdust and other predominantly waste by-products to create fuel granules for the Biomass industry - these fuel granules are burnt to generate energy. AEGP was formed after two British inventors entered into an exclusive global licensing agreement with AEG, and there are legacy patent applications in place covering certain parts of the technology. Admittedly, the technology is early-stage, but a pilot plant was used to demonstrate the technology to industry specialists from Asia, Europe and the Americas, with the company later noting that interest has exceeded their expectations. Assuming that the technology can be successfully commercialised, the benefits of the technology are widespread and could have substantial implications for AEG.

AEG's new mobile wood chipper operating at Yuzhny Port
One of the most important aspects is that the technology uses waste material such as sawdust - companies usually pay to dispose of this, and it is a drain on resources. However, with biomass demand in Europe expected to rise sharply, the technology is capable of creating a high value product that would actually turn waste into revenue for the companies. Presumably a whole host of companies could use the technology, with sawmills being one outlet as up to 50% of output is in the form of sawdust. There are further benefits in addition to that. The new technology is expected to cost less than 50% of existing pelleting technology and importantly the OPEX is low since no gas/heat is required for drying thus power requirements are low. That is evidenced as AEGP's technology uses less than 2kWH per tonne versus 400kWH per tonne that conventional methods use. Furthermore, the technology is mobile hence requires no permit (and so can be installed on-site), and the end product burns with less smoke than conventional pellets - in an interview with the Belfast Telegraph, CEO Richard Spinks noted that payback for the system could be less than a year, which would make the technology highly desirable. It's therefore less than surprising to see the share price react so positively. What could previously be described as a logistics business now has a blue-sky aspect with major potential that is likely to attract investors and provide a more rounded investment opportunity in that respect.

Alongside the inception of AEGP, having an understanding of the political situation in Ukraine is imperative - after all, it is that situation that is likely to have stemmed interest into the company despite diversification into other EU countries. Currently, the unrest is limited to two Eastern regions in Ukraine: Donetsk and Luhansk. Unrest had previously been seen in other regions, but that was sporadic and of not major significance. The unrest is taking place as a rebellion against the government in Kiev, although there are a multitude of other underlying reasons. Donetsk and Luhansk are characterised as having a large Russian-speaking population and are geographically distant from the capital Kiev - there have been pushes from separatists within the regions to break free of Ukraine and form their own independent state, or even join Russia like Crimea did earlier in 2014. However, the backing for the separatist movements appears to have faded in recent months as the separatists have become increasingly armed and violent, albeit there are reports of that occurring in both directions.

Essentially, Luhansk and Donetsk are where the separatists are currently holding out - the rebellion against government is not overwhelming but is carried out by heavily armed separatists who have secured ammunition and weapons from domestic territory (and it is alleged, Russian territory). The conflict has been raging for several months now, to the detriment of the two areas, but with Petro Poroshenko taking the helm and installing new defence ministers, the situation appears to be swinging into the government's failure as they seek to weed out (and in many cases kill) the separatists. Several important towns were recently taken by the government including Slavyansk - the area of conflict is actually shrinking as the government makes progress on taking back separatist towns. Concerns have always revolved around whether Russia will enter Ukraine and become heavily militarily involved, but that has not occurred and recently Putin revoked his right to intervene. Of course, that right could be reversed, and the situation in Ukraine remains volatile, but importantly the conflict remains limited to the Luhansk and Donetsk regions, and there has not been any real separatist spread for a couple of months, perhaps indicating that support for the movement is not present in other parts of Ukraine.

The characteristics of other areas in Ukraine are different and are probably less likely to be areas where separatist uprisings will occur. The bottom line is that AEG has not been affected by the crisis to date, and with the area of conflict shrinking, the probability of them being affected continues to fall. As alluded to in recent reviews, the conflict has led to a rapid devaluation of the Ukrainian Hryvnia, which continues to benefit the company as it has remained weak since May. To put it into perspective, the distance from Yuzhny port (where AEG operates) to the closest point on Donetsk's regional border is around 450km or 275 miles. That is a similar distance from Liverpool to Calais in France. The topography of the Eastern areas of Ukraine is mostly flat with the Dnieper River running down the centreline of the country. Wood stock for the operations is collected and brought in by rail from the Western and North Western areas, once again where there has not been conflict and where the characteristics, that brought about conflict in the Eastern areas, are not shared. The changes in Ukraine's crisis have therefore improved for AEG and are unlikely to impact operations unless Russia launch a full-scale entry into Ukraine. With the EU and US ready to impose more damaging sanctions on Russia's economy, that is probably unlikely.

Indeed, the company is putting those concerns behind them and is actually expanding operations in Ukraine. A new set of working capital and debt facilities was announced in June, which firstly comprised a $1m facility with the largest shareholder Gravendonck at an interest rate of 15%/year. The interest rate is on the high-side, but given the company's financial outlook, it is not overly concerning. The proceeds were used to purchase a new wood chipping machine and a new rotor for the existing machine. A further $1.7m facility was opened with Ukranian company Ruteks under the domestic Fiscal Incentive Programme. The company noted that the funds enabled them "to take advantage of various highly attractive opportunities being presented to [them] in Western Ukraine."

The MV Sider King vessel
After that news, AEG released its Final Results for 2013 that cleared its legacy issues. Revenues and losses were inline with my expectations at £5.2m and £2.2m respectively, with an adjusted operating loss of £1.2m when catering for exceptionals - the H2 operating loss exceeded £0.5m and was related to the collapse of AEG's shipping partner during the period, shortly after the acquisition of Nikofeso. This led to the company having to re-jig its operations completely. However, as noted earlier in the year, improved operations and efficiencies across the board have greatly boosted margins. Notwithstanding the positive comments from CEO Spinks, the market reacted cautiously to the take-up of debt at the same time as not having clarity about future financial expectations and the early part of 2014 being disappointing. After all, if a company is loss making as per the last set of results, and is taking up debt, an investors' instincts would lean towards the company being too high risk and the shares sold off on results day despite the outlook being described as 'extremely positive'. It's not particularly useful to analyse the segment-by-segment results as they won't be in any way a reflection of the business moving forward - in 2013, there were losses across the board.

There were numerous other points of note from the results:
- Indications of a westward expansion in Ukraine to address the biomass markets of Poland, Hungary and Romania
- Montenegro trial was not immediately furthered as high levels of moisture in the material decreased net calorific values and resulted in lower margins. This is likely to have been a result of the country experiencing highest levels of rainfall since records began
- Total assets = 3.15x total liabilities (as at YE)
- Tangible assets = 1.50x total liabilities (as at YE)
- Current assets = 4.6x current liabilities (as at YE)

Richard Spinks commented: "Global demand for wood chip, and for the other products and services that AEG is currently developing, is growing at an exponential rate, and the Group is now operating in four countries: Ukraine, Spain, Montenegro and Northern Ireland. Despite our capacity in the first few months of 2014 having been constrained by the political situation in Ukraine, we succeeded in achieving a substantial increase in shipping volumes in H1 2014 versus H2 2013. Our current operational performance is even more positive, with increased volumes at enhanced margins, which bodes extremely well for greatly improved financial results from the Group in 2014."

At a first glance, a company valued at over £12.5m making £1m+ in losses per year is hardly attractive, even when factoring in the AEGP potential. Importantly, that won't be the case going forward, and the future looks increasingly bright, especially since the estimated brackets from past reviews have been confirmed through WH Ireland's broker note.

They have initiated a Buy stance on AEG with a 6p target price, which implies 164% upside on current levels. Importantly, that target is based on a number of assumptions, which are worth criticising later. In headline terms, WHI expect £20.3m in revenues in 2014 through the shipping of 310,000MT of wood chip this year, which is slightly below the previous 325,000MT - 350,000MT I had forecast, but nonetheless represents a huge uplift on 2013. They expect that revenue to jump again in 2015 to £27.8m through the shipment of 432,000MT. They expect those revenues figures to filter down to £1.5m EBITDA in 2014 and £3.4m EBITDA in 2015 respectively, giving an adjusted pre-tax profit of £1.1m in 2014 and £3.2m in 2015. Those give EPS readings of 0.19p and 0.51p respectively.

Those numbers are clearly very encouraging indeed. Not only do they confirm the rapid growth expected, but they place AEG on very low multiples currently. AEG is supposedly trading on a 2015 EV/EBITDA of 3.9 and 2015 adjusted PER of just 4.5, which is far from demanding for a rapidly growing company with blue-sky technology. Of course, there is the Ukrainian risk to factor in, but as described earlier, those concerns appear to be significantly overstated within the market (at present). WHI's 6p target price is based on a 2015 PE of 11.7 and an EV/EBITDA of 10.4.

As before, there are some crucial assumptions that WHI's models are based on, and I reckon those are too conservative too in some respects. The estimates:
- Exclude any revenue/profit figures from the Spain/Montenegro operations
- Exclude any revenue/profit figures from the commercialisation of AEGP's technology
- Assume £1.5m in CAPEX for the development of AEGP's technology in 2014 alone
- Work off a UAH:USD rate of 9.0

Each of those assumptions can be scrutinised, although what is good is that the estimates are thus using a low-case scenario, which arguably means that AEG is even further undervalued. In particular, the first assumption will not be accurate, but reflects the uncertainty regarding how Spain/Montenegro will be progressed - there is clear upside from that avenue. I do however agree with modelling no revenues/profits from AEGP's technology. The upside from that technology is very difficult to quantify at the moment, so it's best to keep that potential sidelined and then factor in as progress is made - realistically revenues and profits from that avenue could be very substantial. On that point, WHI commented:

"This could prove far too conservative if the Group's new fuel granulating system, which is not factored into our revenue and profit estimates, is successfully commercialised."

AEG's wood chip being loaded onto the MV Sider King
The third point I'd say is that the CAPEX for the development looks on the high-side, and that AEG are more likely to overspend on the forecast £0.6m Yuzhny CAPEX than spending £1.5m on the technology this year. I'm sure several different pathways of development for that are being pursued, and there is the potential for work to be subsidised. The final point is difficult to argue with as forecasting the future exchange rate is notoriously difficult and not really worth attempting. The current rate is around 11.7 UAH:USD, so the modelled rate is far lower. That is once again a conservative estimate - if anything, it is likely the exchange rate will stay higher than 9.0 than drop below it. After all, the Hryvnia has devalued significantly since the crisis started, and the economic scene in Ukraine is weak. If the exchange rate averages above 9.0 in the medium-run, then there is material further upside to WHI's estimates. 9.0 is only about 10% higher than the level pre-crisis, and although revaluation is likely if the fighting cools, a rate of 9 is likely to be conservative for the foreseeable future, given Ukraine's economic situation and outlook.

There are other important numbers alluded to as well. Although tax rates are expected to trend upwards (as tax losses are used) from 5% in 2014 to 10% in 2015 to around 15% thereafter, profit after tax for 2015 is expected to be £2.7m, giving the 0.51p adjusted EPS. Depreciation and amortisation is modelled to be minimal hence reported EPS are only slightly lower at 0.48p. Putting AEG on a forecast PER of 10 for 2015, suggests a share price of 5.10p. Once again, I reckon this could be on the low side given the assumptions that WHI modelled. Net debt at year-end in 2014 is expected to be around £2.4m, falling to £0.6m in 2015, although if the CAPEX level is lower, than net debt would also be lower. Gross margins are also within the 12%-18% target range estimated in previous reviews. FY14 gross margin is expected to be 12.6%, rising to 16.6% in 2015. Barriers to entry give optimism for the margins to be maintained at those levels and improved over time.

To derive their estimates, WHI used a few larger players that cover a range of commodities: Stobart (LSE:STOB), Glencore Xstrata (LSE:GLEN) and Noble Group. Stripping out the outlier, which was Stobart, Glencore and Noble were trading on an average 2015 PE of 11.35 and a 2015 EV/EBITDA of circa 8.5. I would argue that these comparators are not particularly close, but that is because AEG's operations are usually part of a much larger business, rather than as a core public business.

I therefore revert back to my own comparison with Fulghum Fibres, who were bought up in 2013 by Rentech, Inc. (NASDAQ:RTK). Rentech is still much larger, but has a business aligned more closely to that of AEG. Although it has a fertiliser side of the business, that is easy to strip out since it is held through a 60% stake in another public company. With a market cap of £324m, net debt of £200m, and a stake in the fertiliser business worth circa £230m, it's possible to generate a valuation using an EV ex-fertiliser of £294m. Rentech's two other areas of operation are with 'Wood Fibre', which is split up into Wood Pellets and Wood Chipping, so areas that are similar to that of AEG albeit on a large scale. The Wood Fibre business is expected to generate $146m in revenues for FY2014 and is targeting an EBITDA run-rate of $55m by the end of 2015. Since $55m is roughly equivalent to £32m, that gives a forecast EV/EBITDA of 9.2, without factoring in changes in net debt up to that date. However, that is roughly in-line with other companies so it of use. It compares to AEG's forecast EV/EBITDA of 3.9. A rise up to 9.2 would indicate a share price of 5.43p. Once again, this number converges towards WHI's 6p target, which is encouraging.

One crucial issue that is imperative to these targets being hit, is to ensure that AEG has scalability and room for operational expansion in:
- Accessing wood for chipping per state laws
- Being able to get the wood moved from forest to their Yuzhny port through state rail
- Chipping capacity at Yuzhny
- Having shipping capacity to move the wood chip to Turkey and other locations

WHI have noted that there is clear room for the first point, and that Yuzhny port has one of the largest East European rail terminals, capable of taking up to 1,500 rail wagons per day. AEG currently takes up to 30 rail wagons per day so point two is cleared. Previously, AEG had one relatively old chipping machine at their Yuzhny port facility, but with the debt proceeds they have purchased a new higher-specification model in recent weeks. With these two machines alone, the company has 1,000,000MT of chipping capacity - that is more than current contracted levels of shipments, so there is not a restriction from this front. Indeed, the company is planning to bring online a stationary machine and add further machines once it makes known its Western Ukrainian expansion. Point three is cleared. Lastly, the company has plenty of port capacity at Yuzhny should that be needed - indeed, the berths are capable of docking Panamax ships that could carry much larger loads of wood chip (40,000MT) versus the MV Sider King and other vessels. Therefore, scalability is excellent, and it's simply a case of having sufficient management and robust logistical processes to oversee the whole system. That scalability is within Southern Ukraine alone too - Spain, Montenegro and Western Ukraine all provide expansion opportunities for the current model with AEGP addressing a different type of opportunity. There is near-term financial scalability as the company also appears to have access to funds through major shareholder Gravendonck. Those funds will be useful until critical mass is achieved.

AEGs older wood chipping machine in action at Yuzhny
It is for these reasons that the outlook for AEG continues to look bright, and the broker forecasts have given much needed validation to previous expectations. They point towards a very promising few years for AEG, especially amidst a backdrop of growing biomass pellet demand and obvious 'easy-wins' for Turkish customers using AEG's wood chip for MDF. Those 'easy-wins' include having a fresher product and decreased shipping times, risk and costs. The Ukrainian part of operations will no doubt continue to deter some investors, but with the company geographically distant from the areas of conflict, with the conflict area shrinking and with a new government outlook, the probability of AEG being affected is ever diminishing. The forecast multiples in the years ahead are very low, and use conservative estimations as well, which give room for upside to those numbers. I would also point to the management's previous 700,000MT/year initial objective stated at the time of acquisition. Using a 16.6% margin, that would give gross profits of over £7.5m, which would lead to even more significant post-tax profits given that administrative expenses are relatively fixed once the operations are set up.

Alongside the core business, AEG Pelleting now offers investors a speculative twist with a product that could potentially justify the current valuation by itself with supposedly very material cost savings for the customer. However, much remains to be done on that front. One point noting on that front is that there are many companies who boast a large market capitalisation premised on having blue-sky technology alone. One example of a company is Inspirit Energy (LSE:INSP) who is seeking to commercialise micro-CHP boilers (ironically, these can burn the pellets that AEG is proposing). Despite having a low cash balance and no profitable division, the company is valued at well over £8m - that valuation is based on potential and AEG's pelleting technology carries considerable potential. Indeed, with a highly experienced management team who have already transformed AEG into a soon-to-be profitable business notwithstanding disruptive domestic conditions and the collapse of AEG's shipping partner is nothing short of phenomenal. Continuing to back the management is likely to pay off especially given the current undervaluation versus Rentech and other comparators - I foresee AEG growing into a significantly larger company in the years ahead. I retain my Buy tag on Active Energy Group.

UPDATE (August 2014) - I have moved one slot (1.95p slot) off AEG from Buy to No Rating at 2.63p as part of re-organisation of the portfolio. I remain very confident with the other slot and have no intentions to reduce that to a No Rating. To re-iterate, the move is due to broader portfolio re-organisation and is not related to my confidence in AEG.

UPDATE (September 2014) - In light of the increase in forestry hectares in Canada, I have re-opened the second slot at a higher price, taking the second slot average to 2.10p from 1.96p.


  1. Brilliant detail and insight. Thank you and I have bookemarked your website. It is good to see proper research for once

    Todd M.

  2. Hi El1te,

    Thanks for another great piece. I was starting to worry that you had gone cold turkey on us after the portfolio review. Only joking...! Nice pics too


  3. Hi El1te - really interesting write up, thanks.


    Montenegro - So rainfall directly impacts moisture content? (sounds like common sense!) This implies that Montenegro operations may come back online this summer or perhaps Autumn?

    Sider King - Do you know if AEG are still using several ships for the black sea crossing or just the Sider King as reported by AEG sometime back?

    Western Ukrainian Expansion - Is the intention to set up mobile units close to forestry areas and then transport directly into new markets (Poland, Romania & Hungary) or to transport feedstock to Yuzhny and use this as the "base" for woodchipping before transporting end product?

    Thanks again for taking the time to assess AEG, great pics also.


    1. Hi OD,

      - Rainfall does impact upon moisture content, so the operations there will be used when margins are better. As you say, that could well be when conditions are drier
      - Regarding the second point, a previous RNS comments: "...on the MV Sider King, which the Company has secured under an exclusive time charter arrangement for the whole of 2014. MV Sider King will service clients in both Turkey and Italy on a constant basis. To supplement this fixed price shipping capacity, AEG is currently negotiating time charter agreements on a further two bulk carrier vessels, removing the uncertainties associated with its previous spot charter arrangements."
      - I believe that they will set up mobile units in Western Ukraine, but will seek clarification on that. After all, the feedstock would be close to them


  4. I think that is also worth mentioning that the Company is also working towards its Forest Stewardship Council (FSC) Chain of Custody Certification. This certification may prove to be vital in accessing European end markets.