Since Abengoa hosted well- attended investor presentations in NY and London two weeks ago, the share has sold off and then traded sideways.
A higher than normal turnout of credit analysts made it clear going into the meeting that the audience would focus on three key points:
- A heavily leveraged balance sheet that might hamper future growth, especially when interest rates are rising,
- The management risk inherent in such an unwieldy, vastly diversified group that absolutely must generate free cash flow to ensure leverage will fall in the future, and
- The quality of disclosure, a risk for minority shareholders since Abengoa is 56%-owned by one family–the Benjumeas.
Our conclusion is that the sell-off is unwarranted. Most of the underlying businesses are in sectors growing strongly today; management seems infused with a new, clear dynamic; and the valuation is reasonable. Looking more closely:
- Energy is the larger of two broad divisions (76% of sales) and we think this division could surprise (although the other division, Environment, also has this potential). The biofuel business is now in the right spot, namely second-generation, non-food biofuels. The co-generation and transmission businesses are more strategic than ever, as new energies proliferate and demand more efficient grids and power blocks. And the solar business may be on the cusp of an explosion of new contracts for tried and tested solar thermal power plants. Even nuclear experts, such as Areva, are now claiming solar thermal expertise and projecting solar thermal growth to be 20% per annum (average, installed), reaching more than 20GW by 2020.
- The second division, Environment, is composed of water treatment and niche, high margin recycling businesses in which Abengoa is a market leader and very international in scope.
- Management’s growth targets are compelling (though not new) and we feel there could be upside: low teens revenue growth and double digit EBITDA growth in 2011 and from 2011 to 2013 an EBITDA of 1.5bn euros, 68% from recurrent activities.
- The balance sheet will naturally deleverage. Management promises no additional financing needs in 2011 (despite corporate debt and project finance of 5.2bn euros in 2010 and planned investments of 2.4bn euros in 2011) and expects to generate positive free cash flow from 2013 (after already planned investments of 2.4bn euros in 2011, 1.4bn euros in 2012), when capex will fall to 500M euros and EBITDA is expected to reach 1.5bn Euros. Management is also open to using more outside equity project financing if necessary to meet financial targets and has hedged 90% of its interest exposure on debt (average cost is 6.1%).
- In 2013 the dividend payout could increase from the relatively low level of 10% today.
Our conclusion: even taking into account the corporate governance risks associated with family majorities, the current share price of 22 euros looks attractive on under 7 times 2011 EPS and around 7.5 times EV/Ebitda for 2011. (Sandtiago Seage, CEO of Abengoa Solar claims the Solar business alone is worth 20 euros per share.) We feel more confident in management following this detailed presentation and following newsflow on the relevant business areas since. Proof of adequate cashflow generation will require patience so the investment horizon must be long rather than short-term.