Montauk: When hot air makes sense
Harvesting methane from landfills and cow manure in the US is paying off for JSE-listed Montauk Holdings
In one of the most painful years for investors on the JSE, alternative energy group Montauk — which produces gas and electricity from US-based landfill sites — has been a standout performer, with its shares up almost 90% to date.
For those not familiar with this remarkable story, Montauk was unbundled from empowerment company Hosken Consolidated Investments (HCI) and separately listed on the JSE in late 2014. The market was not interested initially, and the shares traded as low as 220c in early 2015, when Montauk held a market capitalisation of just R300m.
But investors gradually started to grasp Montauk’s commercial advantages — especially the considerable incentives paid to US-based companies for producing "green energy". The comparative (attractive) valuations on Montauk’s peers also made deep-value investors take note.
Today Montauk has a market value of close to R13bn — which makes it bigger than former parent company HCI (with a market capitalisation of about R12bn). This has been an epic value unlock for those HCI shareholders — notably CEO Johnny Copelyn and other executives — who were willing to back this energy play.
The share is trading on a trailing earnings multiple of nearly 40 and on a forward multiple of more than 25, if an earnings forecast for the full year to end-March 2019 can be considered realistic.
Traditional fundamentals aside, the decision by Montauk to apply for a primary listing on the Nasdaq — though always on the cards — appears to have persuaded the market to focus more intensely on longer-term prospects.
Montauk’s half-year numbers to end-September, released last week, were no great shakes — though the payment of a 43.5c a share interim dividend suggests the group’s electricity and gas production from landfill sites scattered around the US are ticking over reassuringly.
Revenue slowed 3.5% to $51m, with profit before tax falling 7% to $14.5m. Cash generated by operations was down at $24m, compared with $27m the previous year.
Revenue from Montauk’s renewable natural gas (RNG) facilities dropped 1.4%, with higher volumes offset by decreases in both commodity and renewable identification number (RIN) pricing.
What is encouraging, though, is that Montauk produced 2.2-million MMBtus — or million British thermal units — of RNG, an increase of almost 12%. What’s more, from the start of October the commissioning of two new RNG facilities was substantially complete, and this production should kick through meaningfully in the second half.
Revenue from Montauk’s electricity generation facilities decreased by almost 13%, mainly due to the conversion of one of these facilities to RNG production. A technical problem at a Bowerman Power facility in Irvine, California, also had an impact.
A note from independent research house Cleveland Capital estimates that the new Atascocita and Apex RNG production plants will boost capacity by 36%.
But Cleveland Capital also expects operating margins to decrease slightly in financial 2019, due to a lower RIN price than the previous year. "We thereafter forecast expanding margins as a result of increased volumes from the development sites, expected to be fully operational, which should provide for operational leverage to have an impact on the financial results."
Cleveland Capital forecasts a strong finish for Montauk when the new production sites are in full swing, pencilling in more than double the earnings for the second half, and full-year earnings coming in at about US25c a share.
"These sites will add substantially to the gas production and we expect these sites to add over $10m to ebitda [earnings before interest, tax, depreciation and amortisation] for the second half. This will be a combination of additional revenues as well as margin expansion on the back of additional volume output."
Cleveland Capital also expects growth in earnings for the 2020 and 2021 financial years, as additional sites come into production.
Another possible X-factor for Montauk is the recent shift into "digestibles" through investments in dairy farm projects. Put crudely, cow manure is used to produce green energy.
Cleveland Capital says the possible output from the dairy farm thrust is not known at this stage, but thinks a significant initial investment should result in a meaningful contribution to ebitda. Commercial operations are set to start in the fourth quarter of the 2020 financial year.
A research note from Avior Capital reckons the recent acquisition of 100% of Pico Energy will mean additional production late in 2020, and estimates that pipeline-quality RNG from dairy farms can sell for 2½ times the RIN price from landfills.
Avior also points out that the dairy-farm gas is 60%-80% methane, compared with 46% for gas from landfill sites.
At the time of writing Montauk had pushed up to R100 (albeit in thin volumes) and seemed set to challenge its high of R105. There appears to be talk that the Nasdaq listing should rerate the share, with the FM noting forecasts of medium-term target prices on the JSE of between R128 and R168. A head of steam seems to be building.
Perhaps at this stage investors would do well to weigh the benefits of a Nasdaq listing against the long-term risks associated with sustaining green energy profits — most notably the fluid regulatory environment in the US, energy pricing issues and operating challenges.