Sydney based Energy Action (EAX) is a leading energy management company that has a strong competitive positioning through its unique online reverse auctions.
The industry is trending towards outsourcing of its contract management and sustainability solutions, with demand for Energy Action’s services driven by increasing awareness of its cost-saving value proposition to customers.
EAX, which has a market cap of $85 million, has three main divisions that service large commercial and industrial (C&I) companies.
Source: company presentation
The company’s Australian Energy Exchange (AEX) division is the market leading energy procurement exchange. The online site enables an effective reverse auction, allowing both electricity and gas suppliers to competitively bid against one another to supply a C&I company’s energy. EAX is completely independent, with all pricing information visible online to both the retailers and the energy customer. Once a settling price has been reached, Energy Action facilitates the contract to the retailer of the customer’s choice. The complete process reduces the time and effort for a customer, and can generally save 7-8% of costs when compared to negotiating directly with a retailer.
While a majority of EAX’s earnings are from its “Activ8” energy management division (60%), the Energy Exchange provides a strong competitive advantage and lead to build customer relationships.
With 10-14 online auctions per day, the company has by far the largest online energy exchange. There is one new market entrant (Bid Energy) that currently has approximately one auction per week, and it has a lot of catching up to do in regards to providing a comparative solution. The strong competitive advantage that EAX has over Bid Energy or any other new entrant includes more than 10 years of industry experience and development of its intellectual property. It also has an Australian Financial Services Licence (AFSL), and its ASX listing has increased awareness of its capabilities.
With a successful online auction, EAX also attempts to sign the customer for its contract management and data monitoring service “Activ8”. Given the average contract length for Activ8 is 50 months, the division provides a strong annuity revenue stream. With this independent monitoring EAX again saves the customer time and money through contract administration, network tariff analysis and bill validation.
Source: company AGM presentation
The third division is Sustainability Solutions - previously Activ8 and the acquired Ward consulting. While the Coalition government’s recent removal of sustainability grants was a hit to expected growth, the outlook remains positive.
The change in federal government and “Direct Action Plan” is resulting in continuing changes to the energy market. Ongoing confusion in this space virtually underpins future business flow as customers seek to outsource and benefit from EAX’s market knowledge.
Scott Wooldridge, from the global Schneider Electric, commenced as CEO in October 2013, and the ex-CEO, Valerie Duncan, remains on the board. Wooldridge’s experience includes running the large industrial division at Schneider, where he led corporate acquisition and integration. He also has more than 15 years of relevant electrical and IT industry experience. The board has remained stable, with a high level of company ownership and industry knowledge. Paul Meehan (director) is the largest shareholder with 21% of the company, and the chairman Ronald Watts is also a substantial shareholder with 8.3%.
Critically, the recent challenges created from the carbon tax uncertainty are set to transform into a major positive share price catalyst and earnings growth driver for EAX. Approximately 90% of large companies in its target market need to renew energy contracts before the end of 2015, compared to a historical 25% per annum.
The contract renewal situation has been created because previously the market would not price contracts past 2015 due to uncertainty with the carbon tax. Traditionally the average procurement auction contract length was 32 months; however it declined to 27 months last year.
In response EAX led the industry with a “carbon exclusive” priced contract. Now the average contract length has risen back above 30 months, with nearly all procurement auctions priced on a carbon exclusive basis. Under this basis there are now contracts priced into 2017 and 2018, and the uncertainty of the carbon environment is no longer a headwind for the company.
EAX currently procures energy contracts for about 8% of the estimated target market of 80,000 C&I businesses. Given the industry positioning, EAX can increase its market share to 15-20% within five years, driven both organically and via acquisition.
The company’s first acquisition, Ward Consulting has been a success and there are many similar smaller competitors that would be a logical fit within the business.
To qualify as a target customer, management estimates annual energy spends of at least $25,000 is required. Of this target market, the percentage that outsource has increased from 20% to 50% over the past six years, and it is expected that this will continue to rise.
While I am comfortable with the business model and growth opportunity, there are some key risks that need to be considered. These include a loss of key staff, superior technology from a competitor, government legislative change, acquisition risk, ongoing technology reliability and competitor behaviour impacting margins.
The current contracted revenue is $76.5 million, with $67 million from Activ8 and $9.5 million from the energy exchange.
To position for the market growth management increased sales staff by 20% and completed a restructure of the sales team into two major divisions - customer retention and customer acquisitions.
At the full-year result and AGM management guided towards the expectation of 10-15% net profit after tax growth for FY14. However, in late December management downgraded this guidance to a flat year for two key reasons. Firstly, traction from the sales team restructure took a couple of months longer-than-expected to complete. Secondly, the sustainability division has grown at 40% rather than the budgeted 100% due to the new government removing sustainability grants.
Financially the company is in an excellent position with net cash, a high return on equity and the ability to sustain a 50% dividend payout ratio. The low capital intensity of the business ensures strong cash flow conversion and high earnings margins.
My forecasts assume the company gains traction in FY15/FY16 due to the large percentage of customers renegotiating energy contracts.
EAX - $3.33
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My price target is based on a discounted cash flow valuation of $4.55 with conservative assumptions. The outperform recommendation is based on the discount to valuation, and my confidence that management will gain market share in a very supportive industry environment.