Infigen powers up

Make no mistake: This is a quirky but speculative investment opportunity. But if you don’t mind a bit of risk in your portfolio, the situation concerning this wind farm owner and developer offers an unusually attractive upside with limited downside.

If price-insensitive tax loss selling occurs before the end of the financial year this week, that ratio may fall even further in your favour.

As highlighted in Infigen an energetic spec buy (Speculative Buy – $0.24), the value in this business is easy enough to spot.

First, Infigen has a pile of unencumbered cash—$112m as at 31 December 2011. The company incurs costs of about $5m a year maintaining (but not currently building) its pipeline of development opportunities, as well as some other costs related to listing and operations.

The group has received as yet unknown cash inflows from its new and unencumbered wind farm at Woodlawn. The company reports in August but, our guess is that by year end, cash will stand at about $107m—the ‘upside’ valuation for our sum of the part analysis in table 1. The ‘downside’ lops $12m from this figure.

The second consideration is the value of the new Woodlawn wind farm near Bungendore, NSW. In February, at the time of the half-yearly profit announcement, management said, ‘Availability to date is in line with expectations’. Let’s hope the full year commentary is more useful.

The ‘upside’ valuation for Woodlawn is a small 10% discount to book value. The project, which cost $115m, was funded with $60m of Infigen’s cash and a $55m non-recourse project finance loan. The ‘downside’ valuation uses a larger 35% discount.

As the central columns of table 1 show, even if Infigen’s cash pile and sole unencumbered asset is valued very conservatively and the company’s other wind farm assets are discounted to zero, a fair valuation is perhaps 18 cents per share.

With a current stock price of 22 cents, there’s clearly more than a little blue sky in this situation. Let’s examine what that might be.

The upside

Infigen also owns five large Australian wind farms with a total production capacity of 510 megawatts (MW). In the US, it owns 18 more, producing up to 1,090MW. Consider for a moment that these assets dwarf Woodlawn’s 48MW capacity. And yet in our downside valuation they’re marked as a big, fat zero.

There’s a very good reason for that. These 23 farms sit in a single pool of assets, acting as security for a loan of just under $1bn (as at 31 December 2011). Whilst the loan is non-recourse to Infigen, if the company fails to pay interest or principal when due, it could lose all 23 farms, leaving only Woodlawn and the cash pile as its only assets.

As part of a loan refinancing deal arranged in early 2007, these assets are under what’s called a cash sweep. After deducting operating expenses, including some management costs from the revenue of these farms, the remaining cash flow goes to the bankers. That cash flow is first used to pay interest whilst the remainder amortises (reduces) the loan amount.

In plain English, this means the assets generate no immediate cash flow for the company. But they do generate enough surplus cash to slowly pay down the loan. This, in turn, increases the future equity value for shareholders. The more that time passes, the greater the value to Infigen and its investors, assuming of course that interest and principal repayments are always met.

There’s a good chance the assets will fund their own interest and principal repayments. And, when the loan matures in 2018 if not beforehand, a much lower level of outstanding debt can be more easily refinanced. By then, Infigen shareholders will have very significant ‘equity’ in the pool of assets.

It’s easy to explain why if Infigen doesn’t meet its debtor obligation these assets will be worth nothing to shareholders. Placing a number on their worth if the company does meet them is more difficult. For reasons outlined in greater detail in Infigen an energetic spec buy, we’ve used a figure of $650m.

If all goes well, that’s not at all unreasonable. At that point, Infigen could be worth $1 a share or more.

Caveats

Remember, though, that the ‘downside’ valuation of 18 cents is not a worst case. There are some further risks to even this pessimistic thesis.

The biggest has nothing to do with the weather, interest rates or government policy. Instead, it’s the unavoidable risk ever-present in underpriced, growth-orientated asset plays like this.

The case for building new wind farms right now is weak, although that could be changing, as explained on 4 May 12 (Hold – $0.26). The group’s cash balance is available to invest in an appropriate new project but the company actually has the opportunity to invest a lot more than $100m over the next decade.

Unless the group is able to sell its US assets at a hefty price, new development may mean capital raisings.

Assuming the projects are attractive and the shares aren’t issued at a steep discount to intrinsic value, that’s fine by us. But right now, today’s stock price is far too cheap to be issuing new shares to invest in new projects. We’re relying on management to appreciate that basic fact and exercise restraint.

The risk of a dilutive capital raising is heightened somewhat by the presence of a major shareholder, The Children’s Fund’s 32% stake. Deeply dilutive capital raisings aren’t uncommon where the position of the major shareholder/s are protected or even enhanced through priority access to the raising. Smaller shareholders get stiffed from not getting a pro-rata opportunity to commit fresh capital, suffering dilution as a result.

Thus far, management appears wise to these concerns. Managing director Miles George’s 650,000 ordinary shares and 7m options and performance rights should keep him alert to the dangers (although there’s little that a fresh, juicy options issue can’t overcome). Management behaviour so far is reassuring but the potential risk is clear.

Caviar on toast?

On the upside, this recommendation could work out faster than expected, although a long-term view is a prerequisite for acting on it.

If the group’s US assets were quickly sold at the right price, there would be sharp and substantial capital gains for today’s buyer. Closer to home, the TrustPower wind farm development at Snowtown, South Australia, described on 4 May 12, is the first large scale wind farm development after the GFC-inspired hiatus.

It reaffirms the value of Infigen’s existing assets. For an energy company looking to add to its renewable portfolio, Infigen is a big, tasty carrot.

There’s enough risk in this situation to call it ‘Speculative’ but as far as High Stakes stocks are concerned, the downside is pretty tame and the upside potentially quite large.

The stock is unchanged since 25 May 12 (Speculative Buy – $0.22) and remains attractive. Interested buyers should keep an eye out for any weakness due to tax loss selling prior to 30 June. SPECULATIVE BUY.

Note: The model Growth portfolio owns Infigen shares.