Energy Technologies (ASX:EGY) is a holding company having investments in three companies–Bambach Wires and Cable Pty Ltd, Dulhunty Poles Pty Ltd and Cogenic Pty Ltd. EGY has restructured Bambach’s operations by developing new highmargin products and recently it acquired the assets of rival, Advance Cables. This merger will provide operational efficiencies, expanded customer base and cross-selling opportunities.
Beneficiary of government defense spending
As part of the current budget, the Australian government is expected to spend ~A$100bn in infrastructure projects and A$200 billion in Defence projects over the next 10 years. This is anticipated to accelerate growth opportunities across cable and wire market segments, such as defence, rail and road. These developments are likely to result in significant tailwinds across Bambach’s end-markets. EGY, with its vertical and horizontal expansion, through new low-cost modern production site and recapitalised balance sheet, is well equipped to take advantage of these opportunities.
Valuation range of A$0.34–0.44 per share
We value EGY at A$0.34 per share in our base case and A$0.44 in our optimistic case scenario. Substantial value is expected to be generated after Advance Cable equipment and products are brought on stream. As recapitalisation enhances net cash and operational efficiencies lead to high free cash flow generation, there is significant potential for re-rating.
Introducing Energy Technologies (ASX:EGY)
Energy Technologies Ltd (ASX:EGY) is a Sydney-based, holding company that generally invests in distressed manufacturing businesses in the electric power industry. EGY’s strategy is to invest in businesses in the electricity domain that have a history of more than 15 years, and those that offer the potential to capture significant market share in the niche segments they serve through process revamping (Figure 1). Currently, EGY provides cabling and wire solutions through its wholly owned subsidiary – Bambach Wires and Cables (BWC) – to niche segments such as rail and road signalling cables.
Creating value through investing – the EGY way
EGY’s investment history provides evidence of the management’s capability to identify ailing businesses with significant growth prospects and restructuring their operations to help them realise potential. A case in point is EGY’s investment in Dulhunty Power, which the company acquired in 2003. As a result of the value created by EGY through expansion in Dulhunty’s operations over a span of ~7 years, it was able to sell the business in 2011, at a premium, for A$17m (or ~A$0.49 cents per share). Presently, EGY is pursuing the same strategy with BWC, the investment it made after exiting Dulhunty Power.
In order to create value, EGY employs various organic and inorganic growth strategies, including product line expansion, developing new products, acquisition of similar businesses, expanding geographical coverage and injecting efficient equipment. Notably, in line with its growth strategies, EGY recently acquired the assets of the Advance Cables business on the back of the substantial synergies presented by merging its operations with the BWC business.
Unlocking synergies through Advance Cables acquisition
EGY is currently in the process of merging the assets of Advance Cables, which it acquired in January 2019, with its wholly owned subsidiary BWC. Advance Cables has been operating in the cables industry since 1980s. Its equipment offers significant production capacity and efficiencies. Despite this, Advance Cables’ margins suffered due to a high AUD prior to 2018 enabling cheap imports from China and India, as well as a lack of product development. By combining operations, BWC stands to benefit from the expanded and more efficient production capacity, while Advance Cables product and customer base will provide an extended product portfolio as well as an enhanced customer network (Figure 2).
EGY has substantial upside potential
We believe that EGY’s proven track record of past investments supports its ability to successfully turn around the loss-making operations of BWC. Moreover, the synergies from the acquisition of Advance Cables, relocation to a lower-cost and modern production location, and recapitalisation of erstwhile debt-heavy balance sheet, offers further upside potential to BWC.
Ten reasons to consider Energy Technologies
1) The acquisition of Advance Cables assets is expected to provide capacity and revenue synergiesto EGY The combined product mix, customer base, improvement in cash flows and removal of duplicate overheads are all expected to prove highly beneficial to EGY’s current business.
2) Post the completion of the asset acquisition, the combined market share of EGY’s cable operations has the ability to rapidly increase to 3% (from the current 1%) of the Australian electric cables and wire market.
3) As part of the deal plan, both Bambach and Advance Cables would move their equipment to a common site in Rosedale, Victoria. As a result of the combination of the assets, the combined production capacity of Bambach would increase 9x, to 250 tonnes per month.
4) In addition to the economies of scale and higher production efficiency from state-of-the-art equipment, the new facility will enjoy the benefits of lower rental expenses. Furthermore, EGY recently engaged with Swinburne University to explore a virtual manufacturing system, which would streamline operations at the new site, by deploying the methodologies of Industry 4.0.
5) The federal government’s A$2.9m grant to EGY, under the Regional Jobs and Investment Program, has aided in the setting up of the new facility in Victoria.
6) Under the recapitalisation programme initiated in early 2019, EGY was able to extinguish ~A$9.9m and ~A$4m of current and non-current liabilities, respectively, from its books. This was facilitated by an equityfor-debt swap, under which EGY’s current debt holders agreed to convert the outstanding debt into company’s equity.
7) Further, EGY would be able to fund its working capital needs on the back of facilities enabled by the extinguishment of debt and proceeds from the issuance of equity giving rise to a strong balance sheet. This is expected to significantly alter the current situation where EGY loses ~A$0.5m in sales orders per month due to inadequate working capital.
8) The Australian wire and cable market is expected to experience tailwinds from the increase in government spend on infrastructure – budgetary allocation of ~A$100bn for infrastructure spend to be incurred over the next 10 years and a defence spend of over 200 billion. In our view, this increase in spend provides a significant upside potential to EGY’s current operations.
9) Currently, the domestic wire and cable market suffers intense competition from low-priced imports, especially from China. However, the continued fall in AUD, which is expected to last in the short run, would offset the advantage of cheap imports. Additionally many of the Bambach Cable products are specialised niche products made to order and as such not attractive to large offshore commodity manufacturers.
10) We believe that as National Broadband Network (NBN) continues to expand its network in Australia, the demand for Dulhunty’s Titan poles will also grow in tandem.
EGY’s initiatives to revamp operations
Recapitalisation proposal: turnaround plan in full swing
Operational inefficiencies at BWC’s Sydney manufacturing facility led to erosion of equity. Due to the substantial interest and rent expenses, EGY reported net losses over the past five years. As a result, the company’s equity was severely impacted and stood at –A$6.9m as of 30 June 2018, compared with A$100k as of 30 June 2014. As a result of inadequate funding, BWC has not been able to take advantage of growth in its key addressable markets.
While the business has the required products, it lacks the output capacity to competitively manufacture them. Because the key stakeholders continue to maintain strong conviction in the business, the board, management and debt holders agreed to a recapitalisation proposal with the following key terms:
• Conversion of EGY’s consolidated debt into ordinary shares.
• Acquisition of plant and equipment, and other business assets of Advance Cables Pty Ltd.
• Relocation of production facilities from Sydney to regional Victoria.
• Issuance of new shares via private placement to raise ~A$5m.
EGY has utilised the equity placement proceeds to fund the establishment of a new site in Rosedale (Victoria) and for working capital requirements. This proposal was approved by EGY’s shareholders on 13 February 2019, and provides a much-needed breather to its operations in terms of the following fundamental benefits:
• Improved balance sheet: The conversion of existing debt to equity would substantially improve EGY’s equity, taking it from –A$6.9m (as of June 2018) to +A$13m
Increased production capacity: As the company gains access to Advance Cables’ highly efficient equipment, BWC’s production capacity would increase substantially from 30 tonnes to 250 tonnes per month.
• Enhanced production efficiency: Though BWC has developed many new products, it lacks the tools for their production at the legacy site. The transition to the new site is expected to enhance the production efficiency for the BWC range of products by 250%.
• Expanded product range: The acquisition of the assets of Advance Cables would result in the expansion of EGY’s product range and market presence.
• Revenue and margin growth: The combined operations of BWC and Advance Cables will aid the development of a sustainable workforce, as well as provide EGY access to a larger market, thereby improving both revenue and margins.
The board expects the implementation of the recapitalisation plan to result in a profitable and growing business within the coming 12 months and deliver strong returns to shareholders.
Growth in key end markets underpins BWC’s topline expansion
BWC primarily sells low- voltage cables, whose demand is directly correlated to the expansion in the mining, railway, defence and construction and traffic management industry segments. We believe that as the demand for electricity continues to grow due to industrial/infrastructure expansion, coupled with increase in government spending on infrastructure and defence, demand for BWC’s cables would rise in sync. Notably, in its 2019 budget, the Australian government allocated A$100bn for infrastructure spends to be incurred over the next 10 years, highlighting the extent of growth opportunity that exists for BWC.
Additionally, in recent years, the applications of low-voltage cables have grown across other niche areas, such as in heat pumps, electric vehicle charging stations and solar panels. In our view, as the number of applications for these cables expands, their demand would grow multiple times in tandem. Notably, the latest market report by Research and Markets forecasts that the global wires and cables market would grow at a CAGR of 6.2% over 2018– 2022, reaching a market size of US$173.5bn (from US$136.7bn in 2018). This makes BWC a worthy investment option.
EGY’s renewed strategy for BWC is to develop cabling solutions targeting specific industries, such as rail and road infrastructure, power and transmission, mining, defence, and solar. In our opinion, this approach optimally positions the company to take advantage of growth in the following sectors:
• Rail infrastructure: As part of its population planning, the Australian government is significantly investing in transport infrastructure to decongest the overpopulation in cities. A case in point is the latest budget announcement by the government that included A$2bn investment for the development of a fast-rail corridor from Geelong to Melbourne. As per Deloitte Access Economics, Australia is set to witness a horde of major rail and road projects coming underway till 2023, with the transport project activity peaking at US$19bn in 2021.
For a major project (such as the US$11.5bn Sydney Metro City & Southwest project), the amount of LV cables required for track and signalling is equivalent to ~US$5-6bn. Additionally, for each station ~US$600k of LV cable is required, while each km of tunnel requires US$100-200k of LV. Notably, the Southwest project involves the construction of 6 new stations, as well as 15.5km of twin tunnels. We believe that as more of these projects come online, the LV cable market will witness substantial growth across the industry, including BWC.
• Defence: Since its inception in 1936, BWC has been catering to the defence sector through its specialised cable solutions for military ships and vehicles. Unsurprisingly, the company has gained expertise in serving this industry. In our view, this provides BWC a major advantage to capitalise on the opportunity presented by the federal government’s plan to invest A$90bn in continuous shipbuilding. As part of its Naval Shipbuilding plan, the Australian government has signed various contracts to add 12 submarines, 9 frigates and 33 patrol boats to its fleet. The amount of LV cable required in a single submarine or frigate is ~US$1m, while a patrol boat requires ~US$300k of LV cable.
Road infrastructure: In addition to rail infrastructure, the Australian government is spending heavily on building new roads as well as upgrading the existing ones. In the state of Victoria alone, two major road projects are underway – the A$15.8bn North East link and the A$6.7bn West gate tunnel project. Notably, for every km of tunnel build, ~US$50- 100k of low smoke zero halogen and fire rated LV cables is required. Moreover, on the back of multiple road construction projects currently underway (such as the US$3.3bn Westconnex project) the demand for LV traffic cables is expected to grow by ~US$5-8m p.a.
• Rolling stock: In order to service the aforementioned rail projects, Australia will require >450 train sets. The construction of these train sets translates to a total contract value of ~US$15bn, distributed over a period of 8 years. With each train set requiring US$100-150k of cables, BWC’s addressable market opportunity (assuming the trains are built in Australia) is US$45-70m of cable requirement.
• Power and transmission: Driven by the increasing demand for electricity and grid reliability, the economy is transitioning towards smart grids. As per a report by Northeast Group, a US-based consultancy firm, Australia and New Zealand are expected to invest ~US$6.1bn in the development of smart grids over 2017–2027. As low- and medium-voltage cables form the core technology in distribution networks for smart grids, the cables market (including BWC) is expected to benefit substantially from this transition.
Renewable energy: Recent years have witnessed a shift towards the adoption of renewable energy, driven in part by favourable government policies and consistently declining cost of production. Solar energy, in particular, has witnessed substantial growth. As per the Renewable Energy Index update released by Green Energy Markets (a research and advisory firm) for April 2019, the installed capacity for small-scale rooftop photovoltaic (PV) systems increased 48% YoY to 480MW in Q1 2019. This
increase primarily reflected the success of the Solar Homes programme initiated by the government of Victoria, which offers solar rebates to residential properties, thereby stimulating demand for solar PV systems. We believe that the programme’s target of installing solar PV systems in 700k households (30k already achieved), coupled with the anticipated launch of “FlareX” brand of solar cables, will greatly benefit BWC.
Mining: Even though the mining sector has been experiencing a decline since its investment peak in 2012, the latest ABS Capital Expenditure survey data suggests that the mining investment cycle is in for a trend reversal. As per the capex long-term forecast data released by ABS in May 2019, the second estimate for mining investment stood at A$32.4bn for 2019–20, up 21% from A$26.8bn forecasted for 2018–2019. We believe that this increase in mining investment will significantly contribute to demand for BWC’s cables in the short–medium term.
Valuation: Turnaround story not factored in the current share price
To derive EGY’s long-term value, we have deployed a weighted average valuation methodology, assigning equal weight to relative valuation based on comparable company analysis and a DCF calculation.
Peer-group-based valuation suggests a fair value of A$0.30 per share Given EGY’s core activity of manufacturing specialist industrial cables, we have studied its peer group, which is engaged in a similar line of business. Besides, the acquisition of Advance Cables is expected to widen EGY’s cables portfolio and also give it a boost in revenue.
As BWC (wholly owned subsidiary of EGY) contributes ~100% of its total revenues to EGY, the latter has been benchmarked against the following global firms involved in the electrical cable and wire space, which primarily cater to industrial and residential needs: Prysmian (BIT:PRY), Nexans (ENXTPA:NEX), Belden Inc (NYSE:BDC), Encore Wire Corporation (NasdaqGS:WIRE), NKT A/S (CPSE:NKT), and Daewon Cable (KOSE:A006340). Some other global firms were not included due to lack of earnings forecast
We believe that EGY’s current value at a slight discount to its peers is correct given the substantial equity erosion that has embedded into EGY’s financials. However, as operations gets enhanced from Advance Cables and operating profitability is achieved in FY2020E, we believe EGY will be trading at par with peer multiples. The smooth integration will further enhance EGY’s operating capabilities, attracting premium valuation. Consequently, we have applied a 10% premium in our bull case. Trading at a peer average EV/Sales multiple of 0.64x for FY2021E, EGY will have the implied EV of ~A$27m or an equity value of A$0.30 per share (Figure 21).
DCF calculation suggests a substantially higher intrinsic value
Our DCF model yields a 10.0% WACC for EGY (risk-free rate of 0.9%, a beta of 1.1, and an equity risk premium of 8.5%). Applying this discount rate to our free cash flow projections through FY2020E and using a terminal growth rate of 1%, EGY yields a value of A$0.39 per share (Figure 22).
While there remains an integration risk due to the acquisition of Advance Cables, we believe that the combined operations of BWC and Advance Cables will significantly improve production and inventory efficiencies. The broadbased product portfolio, cross-selling opportunities, cost savings, and selling synergies would provide a leeway for lower discount rates over the medium term. Further, as the product portfolio shifts towards high-margin segments, better utilisation levels at the new low-cost Rosedale site, and significant reduction in SG&A expenses, profitability is expected to improve substantially. This would further translate into a higher valuation.
Fair value of A$0.34–0.44 per share
Our base case value of A$0.34 per share has been derived using a weighted average valuation methodology, which assigns equal weight to our relative valuation and DCF calculation (Figure 23). Our optimistic or bull case calculation results in a valuation of A$0.44 and the mid-point of our valuation range comes out to be A$0.39.
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