PIF.TO - Polaris Infrastructure

[peterHK]

Basic thesis:

 

Very high quality geothermal asset in Nicaragua which has a PPA with the state owned utility in USD with inflation escalators for up to 72MW (which equates to ~$72mn USD in revenue). The project supplies about 15% of the country's energy, and was funded by a host of international bodies (World Bank, Canadian government etc.) meaning it would be foolish of the Nicaraguan government to seize the asset as it would likely halt FDI into the country.

 

PIF has engaged in a very successful drilling program adding a number of MW of capacity to the plant, and has largely wound down its capital program with the exception of the potential for a $30mn binary unit that would add ~5MW to production.

 

The basic math is this: there is a 5MW parasitic load, so any gross production is reduced by 5MW. Every additional MW of production comes at extremely high incremental margins and generates ~$1mm of free cash flow.

 

The company trades at about 1/2 the valuation of peers, and using their estimate of ~$5-6mn in maintenance capex, they trade at a 15% FCFF yield, and currently pay out USD $0.60 per share in dividends, though they could easily go up to $1/share (implying ~7% yield).

 

The reason shares have sold off so hard is because of the unrest in Nicaragua. I believe there are several mitigants to this risk:

1) The number of international bodies who are senior lenders to this project make it difficult politically for the current or future governments to seize the asset.

2) The fact San Jacinto (their project) is a major part of the electric grid for the state means anything threatening the plan (protestors/strikes etc.) would hamper the delivery of an essential service.

3) As of their last operational update (http://polarisinfrastructure.com/wp-content/uploads/2018/07/Q2-Prelim-Nica-Press-Release-2018-07-03v2.pdf), they had not been impacted at all by the political unrest, and reported record revenues (and by extension free cash flows).

 

There is also additional upside for the company to allocate capital in the future as there are a number of smaller hydro/wind assets in Latin America that are owned largely by HNW individuals and are too small for a pension fund to go after. Hydro assets in particular are highly attractive as they are very long life (if you want to learn about hydro as an asset class, check out Brookfield Renewables), so there is further opportunity here, once San Jacinto is truly finished, to deploy capital elsewhere to broaden the asset base and diversify country risk.

 

I think the company is worth between $25-30/share based on a mix of multiples and also a DCF. The nice thing about this business being a single asset is that it is fairly easy to model, and management has been very open about the economics and dynamics of the business.

[valuedontlie]

I feel like the combination of risks around customer concentration (i.e. one) and country stability make this a security that should permanently trade at a discount. Which is why they are probably better off returning as much capital as possible via large dividends or buybacks (a plan they seem to be pursuing). The efforts to add business outside Nicaragua might be an attempt to garner a better multiple but I'm skeptical they'd see that. On a total return basis, most of the performance might come from the dividends....

 

Just a thought...

[SafetyinNumbers]

I feel like the combination of risks around customer concentration (i.e. one) and country stability make this a security that should permanently trade at a discount. Which is why they are probably better off returning as much capital as possible via large dividends or buybacks (a plan they seem to be pursuing). The efforts to add business outside Nicaragua might be an attempt to garner a better multiple but I'm skeptical they'd see that. On a total return basis, most of the performance might come from the dividends....

 

Just a thought...

 

Perhaps but the company would fit well and be accretive to any diversified global utility. Further, the project debt could be refinanced at the corporate level by an acquirer thus increasing the free cash flow yield even further.

 

That being said, the feedback they have received from institutional investors is that removing the single asset risk would allow some of these players to invest thus reducing their cost of capital. It can quickly become a growth engine if the valuation arbitrage is big enough.

 

Peter, you mentioned the dividend could get to $1 but not sure if you meant US$1.00 because that’s what they have targeted in the next 12-18 months which is over a 9% yield and represents about half of forecasted cash flow.

 

At the AGM, they mentioned they are actively considering an acquisition and/or an NCIB/SIB and a potential dividend increase in line with when they report next month.

 

Thanks for starting this thread!

[peterHK]

I feel like the combination of risks around customer concentration (i.e. one) and country stability make this a security that should permanently trade at a discount. Which is why they are probably better off returning as much capital as possible via large dividends or buybacks (a plan they seem to be pursuing). The efforts to add business outside Nicaragua might be an attempt to garner a better multiple but I'm skeptical they'd see that. On a total return basis, most of the performance might come from the dividends....

 

Just a thought...

 

Perhaps but the company would fit well and be accretive to any diversified global utility. Further, the project debt could be refinanced at the corporate level by an acquirer thus increasing the free cash flow yield even further.

 

That being said, the feedback they have received from institutional investors is that removing the single asset risk would allow some of these players to invest thus reducing their cost of capital. It can quickly become a growth engine if the valuation arbitrage is big enough.

 

Peter, you mentioned the dividend could get to $1 but not sure if you meant US$1.00 because that’s what they have targeted in the next 12-18 months which is over a 9% yield and represents about half of forecasted cash flow.

 

At the AGM, they mentioned they are actively considering an acquisition and/or an NCIB/SIB and a potential dividend increase in line with when they report next month.

 

Thanks for starting this thread!

 

Even at a 30% discount to comps, this is still a 20-25% IRR position from here. I don't disagree that this deserves a discount as a single asset company in a troubled jurisdiction, but I think the discount is way overdone, and partially based on transitory factors.

 

You are correct I did mean $1USD, and forgot to make the currency adjustment as I was writing this out fast!

 

At the current share price, a NCIB would certainly be a low risk way of deploying capital. Long term, I'd actually like them to diversify as I think Mark is fairly disciplined capital allocator and I think in the hydro space in particular there are likely assets that would be interesting for him to purchase.

 

How I see this playing out is that PIF grows to a multi asset company that then becomes large enough for institutional interest and a pension fund/Brookfield etc. buys them (though BAM likely won't be interested unless there's some sort of issue/mispricing, so I wouldn't count on an attractive exit to BAM).

[SafetyinNumbers]

I would say from a valuation perspective it might even be less than half of the peers when you look out to 2019. It appears to trade around 4.5x EV/EBITDA 2019E with every multiple point worth over C$5/share so you can see how some multiple expansion can move the stock significantly higher.

 

 

[wisowis]

Are things getting worse in Nicaragua?

 

This continues to slide (to another 52-week low), and at today's closing price of $12.09, if they raise their dividend to $1 US, that represents an 11% yield.

[doc75]

Are things getting worse in Nicaragua?

 

This continues to slide (to another 52-week low), and at today's closing price of $12.09, if they raise their dividend to $1 US, that represents an 11% yield.

 

I was wondering the same thing.  There could have been an all out civil war there and we'd never know it since Trump wasn't involved.

 

Or was he?

 

Hmm...

 

(I'm joking, if it's not clear.)

[Foreign Tuffett]

Are things getting worse in Nicaragua?

 

This continues to slide (to another 52-week low), and at today's closing price of $12.09, if they raise their dividend to $1 US, that represents an 11% yield.

 

I was wondering the same thing.  There could have been an all out civil war there and we'd never know it since Trump wasn't involved.

 

Or was he?

 

Hmm...

 

(I'm joking, if it's not clear.)

 

I know little about Central America, but things look very bad. Nicaragua's President Daniel Ortega is pretty far to the left. In the 1980s the US (stupidly) funded and armed the Contras, a movement that attempted to violently overthrow Ortega's Sandinista party.

 

http://time.com/5343856/nicaragua-daniel-ortega-crackdown/

 

I don't know how you handicap the possibility that Ortega nationalizes all electric utilities or unilaterally "renegotiates" all contracts. It may not be economically rational, but that doesn't mean it won't happen.

[Pelagic]

Are things getting worse in Nicaragua?

 

This continues to slide (to another 52-week low), and at today's closing price of $12.09, if they raise their dividend to $1 US, that represents an 11% yield.

 

I was wondering the same thing.  There could have been an all out civil war there and we'd never know it since Trump wasn't involved.

 

Or was he?

 

Hmm...

 

(I'm joking, if it's not clear.)

 

I know little about Central America, but things look very bad. Nicaragua's President Daniel Ortega is pretty far to the left. In the 1980s the US (stupidly) funded and armed the Contras, a movement that attempted to violently overthrow Ortega's Sandinista party.

 

http://time.com/5343856/nicaragua-daniel-ortega-crackdown/

 

I don't know how you handicap the possibility that Ortega nationalizes all electric utilities or unilaterally "renegotiates" all contracts. It may not be economically rational, but that doesn't mean it won't happen.

 

Some things to consider. Yes, Ortega is a leftist, but it was his government that welcomed Polaris in the first place and signed the power purchasing agreement with them.

 

I've read at least a dozen articles on the Nicaragua situation since the Polaris topic was posted two weeks ago and the lack of in depth analysis in them is frustrating. Either western news sources don't have a good grasp on the situation or the situation is so chaotic it's hard for them to present a concise picture of why things have deteriorated since April - probably a mix of both.

 

What seems to have triggered the most recent protests (starting in April) is an inadequate response by the government to forest fires in the country. Ortega responded too harshly and protesters began airing years of pent up anger about a wide variety of issues, most relating to over taxation and reduced benefits although there are plenty of other grievances to choose from as well.

 

How this relates to Polaris: Protesters are protesting because they see the government as ineffectual and want it to provide more or tax them less. I think the last thing Ortega would want to do is nationalize a major power generation asset and deal with the resulting lapses in production that would stem from such an occurrence. Taking a major source of power off the grid would only make the problems worse and provide more grievances (blackouts and lack of electricity) for protesters. Polaris' plant's isolated nature makes it relatively immune from the violence of protests so the fear is a direct response from the government against them and the possibility of a new government deciding to renegotiate the terms of the PPA.

 

My biggest concern with Polaris isn't a new government stemming from the current crop of anti-government protesters, or continued operations under Ortega. Rather, Ortega has taken to arming pro-Marxist youths as counter protesters which are responsible for much of the violence against anti-government protesters. Who's to say that Ortega can control these groups he's armed and let loose on anti-government protesters, or should Ortega negotiate concessions with the anti-government groups, they don't take matters into their own hands and try to replace him. Arming and letting loose groups of pro-Marxist youths against relatively peaceful anti-government protesters is a recipe for disaster and something I don't think Ortega has control over at this point.

 

The situation in Nicaragua will likely get worse before it gets better and I think Polaris' share price will continue to reflect that. However, the two most likely outcomes 1) Ortega remains in power or 2) concessions/new government comprised of anti-government protesters bode well for Polaris' asset long term. The third and least likely outcome of increased power exerted by pro-Marxist youth groups that have been let loose on the country would likely result in Polaris' asset being nationalized. Again, a highly unlikely scenario but Ortega opened Pandora's box by arming them and letting them loose on anti-government protesters so there's no telling what will happen.

 

The Wikipedia entry has a decent timeline of events that includes events as recent as yesterday.

 

https://en.wikipedia.org/wiki/2018_Nicaraguan_protests#Background

[FFHWatcher]

Personally, I have always lost when investing in, what looks like good companies at good valuations but in bad countries. 

 

I have lost because the laws in those countries have not supported the wrongs that the governments and/or insiders have inflicted on the companies I invested in.  The governments expropriated or insiders 'expropriated' the businesses away from rightful shareholders and the shareholders had virtually no recourse.  I believe if something occurred in this country, as a shareholder, you would get a very small % of your investment returned to you, but most likely you would get $0.  The downside just isn't worth the potential upside and there are a lot of other good businesses at reasonable valuations to invest in that are in countries where the legal system and shareholders have reasonable rights.  What would your upside in your share price at Polaris have to be, to justify a total loss?  How do you justify allocating a reasonable % of your capital in a country where expropriation without reasonable compensation is a possibility?  Just my 2 cents.

[SafetyinNumbers]

Personally, I have always lost when investing in, what looks like good companies at good valuations but in bad countries. 

 

I have lost because the laws in those countries have not supported the wrongs that the governments and/or insiders have inflicted on the companies I invested in.  The governments expropriated or insiders 'expropriated' the businesses away from rightful shareholders and the shareholders had virtually no recourse.  I believe if something occurred in this country, as a shareholder, you would get a very small % of your investment returned to you, but most likely you would get $0.  The downside just isn't worth the potential upside and there are a lot of other good businesses at reasonable valuations to invest in that are in countries where the legal system and shareholders have reasonable rights.  What would your upside in your share price at Polaris have to be, to justify a total loss?  How do you justify allocating a reasonable % of your capital in a country where expropriation without reasonable compensation is a possibility?  Just my 2 cents.

 

I’m curious FFHWatcher, what were the businesses that were expropriated from you?

[writser]

The situation in Nicaragua looks horrible but it wouldn't surprise me if the market is overreacting a bit. $100m disappeared into thin air in a few weeks. I'm being super simplistic but if you assume the price during the beginning of 2018 was 'fair' the market is implying that there's suddenly a 30% - 40% risk of the company getting nationalized? Did the political landscape really shift that quickly? Granted, less if you take into account the whole EV (but it was supposed to be undervalued to begin with).

 

Anyway, ignore my ramblings, just trying to make some sense of the numbers vs. the situation. Haven't spent too much time on this but looks like an interesting idea to follow.

[NoCalledStrikes]

Here is one way of looking at the expected value.

 

In the short term (1 year or so), I expect the stock price in the "good" outcome will need to be lower than fair value since investors being recently reminded of the risk of investing in a country run by a dictatorship will want a bigger margin of safety than they asked for earlier this year.  I owned it as RAMPF so I am partial to the USD figures.  At one time, I thought $20 was a reasonable value for a company worth $26-30 if located in the US. Now I think a larger margin of safety is warranted until the new peace is proven to last for a couple years at which time if the contracts are honored, $20 USD may be a realistic value again, but not the first year of the new government.

 

I will confess that living in Houston, my views are colored by the large Venezuelan expat community living out here who are dealing with their own worst case scenario and so I am probably dealing with some availability bias.

 

Scenario Share (USD) Likelihood(%) Expected Value (USD) Best Outcome - Peaceful resolution, new or old govt honors contracts, but investors will want a bigger margin of safety and higher yield going forward     $14 50%   $7 New Government -  less friendly than to business than Ortega, invents new taxes and fees $10 25%   $2.5 New Government collapses & chaos resumes       $4 5%      $0.2 New Government - Nationalizes immediately       $1 5%     $0.05 Civil War - property destroyed or heavily damaged      $0 15%    $0                                                                                           $9.75

 

A better estimate would include the dividends.

[SafetyinNumbers]

I’m curious what examples of power assets that people have witnessed be expropriated?

 

Any links would be appreciated.

 

[FFHWatcher]

Oil business in Venezuela. Coal company in China.  Do not expect property laws in other countries to work like the US, Canada, Europe, etc.  I have learned my lesson. 

[SafetyinNumbers]

Oil business in Venezuela. Coal company in China.  Do not expect property laws in other countries to work like the US, Canada, Europe, etc.  I have learned my lesson.

 

All I have seen so far are companies that sell resources outside of country for hard currency. I haven’t found an example of a power company that sells in country yet but will keep looking and doesn’t mean there can’t be a first time.

[NoCalledStrikes]

http://www.washingtonpost.com/wp-dyn/content/article/2007/02/08/AR2007020802261.html?noredirect=on

 

In Venezuela, Chavez bought out AES in 2007 for half the value AES paid ten years prior.  AES CEO called the price “fair”.  Given the destruction to the Venezuelan economy Chavez had done in the prior 10 years, the  price was fair. Given the destruction to come, the CEO was a genius for getting bought out.

 

Big difference with Venezuela and Nicaragua was that in 2007, Venezuela was exporting high volumes of crude at over $100/bbl and could still afford to pay for assets it wanted to nationalize.

 

I’m more concerned about the return of stability than nationalization.  If you could buy a basket of 10 of these, globally dispersed, you would do just fine, but generally speaking I am not a basket type investor.

[Pelagic]

I’m more concerned about the return of stability than nationalization.  If you could buy a basket of 10 of these, globally dispersed, you would do just fine, but generally speaking I am not a basket type investor.

 

My thinking as well. I don't see Ortega nationalizing their assets, and I think the anti-government protesters are likely to be more pro-business than Ortega so I don't see much risk of nationalization should they assume power. However, I don't see things getting better in Nicaragua any time soon given the groups of pro-Marxist youth Ortega has armed to fight against anti-government protesters. The share price will likely continue to decline as the country becomes more unstable.

[SafetyinNumbers]

I’m more concerned about the return of stability than nationalization.  If you could buy a basket of 10 of these, globally dispersed, you would do just fine, but generally speaking I am not a basket type investor.

 

My thinking as well. I don't see Ortega nationalizing their assets, and I think the anti-government protesters are likely to be more pro-business than Ortega so I don't see much risk of nationalization should they assume power. However, I don't see things getting better in Nicaragua any time soon given the groups of pro-Marxist youth Ortega has armed to fight against anti-government protesters. The share price will likely continue to decline as the country becomes more unstable.

 

The company hinted at an NCIB or SIB at the AGM when they report in a few weeks if they don’t close on an acquisition that uses of their excess cash. Perhaps that could have a positive impact on the share price.

[Spekulatius]

So this goes for 6.5x EBITDA and a 5% dividend yield. I can buy a pretty decent utility company operating in the US and the UK with a 6% dividend yield and 9.5x EV/EBITDA (PPL). Seems to me that PPL may beat better bet. I can see the attraction her, but I think if you operate in an unstable country, a 50% discount isn’t really unreasonable.

[SafetyinNumbers]

So this goes for 6.5x EBITDA and a 5% dividend yield. I can buy a pretty decent utility company operating in the US and the UK with a 6% dividend yield and 9.5x EV/EBITDA (PPL). Seems to me that PPL may beat better bet. I can see the attraction her, but I think if you operate in an unstable country, a 50% discount isn’t really unreasonable.

 

I get closer to 4x EV/EBITDA for 2019E and a stated goal of US$1.00 annualized dividend in 12-18 months is north of a 10% yield. Each multiple point is worth north of C$5 to the share price so decent upside if it can get to a 50% discount to peers.

[Foreign Tuffett]

I’m curious what examples of power assets that people have witnessed be expropriated?

 

Any links would be appreciated.

 

"Upon seizing power in 1979, the Sandinista leadership implemented a series of confiscatory measures,

initially limited to members of the Somoza regime but quickly expanding beyond, including anyone who left the country for more than six months and account holders and shareholders of the nationalized sectors, including banking, electrical power, and insurance. The legal and factual bases for most of the confiscations were questionable."

 

http://etheses.lse.ac.uk/481/1/Dille_Ill%20fares%20the%20land.pdf

 

Same country. Same political party.

 

I will admit that I didn't "witness" these assets being nationalized. I usually try to leave before the technicals filled with armed militia show up.

[SafetyinNumbers]

I’m curious what examples of power assets that people have witnessed be expropriated?

 

Any links would be appreciated.

 

"Upon seizing power in 1979, the Sandinista leadership implemented a series of confiscatory measures,

initially limited to members of the Somoza regime but quickly expanding beyond, including anyone who left the country for more than six months and account holders and shareholders of the nationalized sectors, including banking, electrical power, and insurance. The legal and factual bases for most of the confiscations were questionable."

 

http://etheses.lse.ac.uk/481/1/Dille_Ill%20fares%20the%20land.pdf

 

Same country. Same political party.

 

I will admit that I didn't "witness" these assets being nationalized. I usually try to leave before the technicals filled with armed militia show up.

 

Same country and same political party but very different situation. It’s interesting that payment of net book value of the assets was supposed to be paid and eventually some compensation was provided. Obviously, this would not be a good path to go along under any situation.

[petec]

This strikes me as a classic slide into dictatorship. First extend term limits, then get increasingly brutal cracking down on opposition. The "usual" Latin American aftermath is a long slide into economic oblivion. Even if the asset isn't confiscated, political risk isn't likely to go away, which might be necessary for a rerating.

 

Can you share your figures for how you get to 4.5x ev/ebitda? Because at first glance I'm closer to the 6.5x level.

[SafetyinNumbers]

This strikes me as a classic slide into dictatorship. First extend term limits, then get increasingly brutal cracking down on opposition. The "usual" Latin American aftermath is a long slide into economic oblivion. Even if the asset isn't confiscated, political risk isn't likely to go away, which might be necessary for a rerating.

 

Can you share your figures for how you get to 4.5x ev/ebitda? Because at first glance I'm closer to the 6.5x level.

 

Current market cap is around US$150m, net debt is around US$130m and the EBITDA forecast for next year is US$67m. Production really stepped up in May so trailing EBITDA is not representative of current and future earnings power.