Montauk facing the big question
Has the energy-from-methane company fallen to a realistic valuation or is there now an opportunity for investors?
Montauk Energy*, which produces gas and electricity from landfill sites across the US, has reversed the astounding price gains made in 2018 when the counter was one of the JSE’s few big gainers.
In 2018 Montauk shares moved from around R51.13 to peak at R98.99 in mid-September, before finishing the year at R82.80. This year Montauk has lost 48% of its value to settle (at the time of writing) at around R40.
At the R98.99 peak Montauk briefly carried a market capitalisation that was larger than Hosken Consolidated Investments (HCI), the empowerment investment company from which it was unbundled five years ago.
The big question now is whether Montauk has corrected to levels that better reflect fundamentals, or whether the price represents a great opportunity to buy an "overcorrected", "green" growth story?
The Montauk share price peaked after the announcement of an intention to seek a primary listing on the Nasdaq. The Nasdaq listing is long overdue, with all Montauk’s operations based in the US and a general lack of interest in the business from larger institutional investors in SA.
The share cooled off slightly after the Nasdaq announcement, but then slipped markedly in February after Montauk — citing prevailing market conditions — opted to postpone its listing application.
Montauk indicated that the listing process would be reassessed later this year, but the recently released year-end results made no mention of the matter.
Montauk nonexecutive chair and significant shareholder Johnny Copelyn says a listing is still on the cards — and is most likely, if market conditions are not adverse, for some time during the next financial year.
On paper, Montauk is an investment that will find traction with an environmentally conscious generation. Simply, the business converts biogas from waste sources into renewable energy through the capture and beneficial use of organically generated methane. Methane has a global-warming potential 25 times greater than carbon dioxide, and is a potent greenhouse gas that has been tagged as a major contributor to climate change.
In short, Montauk captures the methane from the landfill sites that would have otherwise leaked into the atmosphere and converts it into pipeline-quality renewable natural gas (RNG) for use as vehicle fuel (as compressed natural gas or CNG) and liquefied natural gas (LNG) as well as for electricity generation.
Montauk, however, is not without risks. In its year-end report, it notes that despite all its social and environmental benefits, the business is "challenging at times due to high capital costs, environmental attribute pricing volatility and the variable nature of the biogas derived from organic waste that we collect and process".
Montauk adds that the production cost of RNG is inherently higher than fossil fuel-based energy products such as natural gas because of the extra steps required to process the biogas.
The costs are usually more than offset by the market value of renewable energy products — especially once the incentives paid by federal and state governments are factored in.
Montauk says the pricing of the various types of renewable energy produced is an ever-changing balance between the underlying energy commodity price and the environmental attributed premiums that can be realised.
Steph Erasmus, an analyst at Avior Capital Markets and one of only a few investment professionals that cover Montauk, says one of the biggest risks is that the group needs the renewable fuel standard (RFS) — which determines the incentives or credits granted to green gas producers — to remain in place.
He reckons that without the RFS, Montauk would be loss-making.
Montauk reported that market prices of D3 cellulosic renewable identification numbers (RINs) softened during the third and fourth quarters of its financial year.
The group said 312.3-million D3 RINs were produced in calendar 2018, against the renewable volume obligation (RVO) of 288-million.
Montauk CEO Martin Ryan says the RNG industry was responsible for generating 97% of these D3 RINs. "While these production numbers evidence the continuing growth and viability of the industry, overproduction relative to the RVO has an adverse impact on pricing in that vintage year."
What also hampered pricing was that during 2018 the US Environmental Protection Agency granted a record number (35, to be exact) of small refinery exemptions for 2017. This caused additional volumes of 2017 RINs being carried forward by obligated parties into 2018, and having a negative impact on demand.
Erasmus argues that the Montauk share price has fallen by markedly more than the pricing of RINs has dropped. "This does not really make sense."
Montauk is trading at a roughly 20 times earnings multiple, based on rand earnings of around 220c a share. That, at face value, is a fairly demanding market rating. But its steady expansion plans — which now include a shift into RNG production from digestibles (dairy cow manure) — and long-term landfill contracts should produce growing revenues and sustainable cash flows.
Operationally, Montauk has proved a dependable project developer — though in the past financial year there were delays in bringing the Atascocita RNG facility (Humble, Texas) and the Apex RNG facility (Amsterdam, Ohio) to full production. Ryan insists that the underlying causes of the technical issues have been fully identified and are either completely resolved or in the process of being addressed.
The big projects under way include an agreement to build an RNG facility at the Galveston County Landfill in Santa Fe, Texas, commencing in the second quarter of the 2020 financial year and lasting for 20 years; and to convert an existing renewable electric project to an RNG facility at the Coastal Plains Landfill in Alvin, Texas, for a term of 20 years starting in the fourth quarter of the next financial year.
The most intriguing thrust is the acquisition of Pico Energy — the owner of a manure digester, two Jenbacher engine generators and a manure supply agreement with a large dairy farm in Jerome, Idaho. Montauk plans to convert this existing electricity-generating project by building, owning and operating an RNG facility at a dairy farm for 20 years. The project is planned to start in the third quarter of the 2020 financial year.
The manure play is promising as certain US states pay incentives on top of the federal government incentive to green energy producers.
The strong development pipeline does prompt questions about the timing of the Nasdaq listing, which will presumably include a material fundraising exercise to cater for demand from US and international investors.
Reading between the lines, it seems Montauk — which, despite its strong operational cash flows, skipped its dividend payment — is in a hurry to lock in opportunities that will ensure critical mass and long-term viability.
In this regard, there might be a worry that there is an increasing possibility that landfill site owners might opt to build their own RNG plants rather than contract-in established players like Montauk.
Cash flows from operating activities came in at a solid $38m in the past financial year, with the cash balance sitting at a healthy $48m. The sense is that if conditions are not conducive to a Nasdaq listing, Montauk could comfortably gear up its balance sheet by between $40m and $60m if there are attractive opportunities.
Uncertainty about the timing of the US listing — especially in the context of a volatile American political climate and the risk of a higher oil price (which does not suit RNG players) – is likely to suppress sentiment for Montauk in the short term.
But more patient investors might concur that taking a larger (and more diversified) green energy play to the Nasdaq might well be the prudent option over the medium term.
* The writer holds shares in Montauk Energy