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Why Invest in AMRC: Yale Investment Thesis
Posted by: Byron Ye, Anna Ching, Mingxue Zhao (IP Logged)
Date: May 9, 2012 11:05AM
Contracted backlog catching up: Federal ESPC market is improving after Obama’s “Better Buildings Commitments” which announced nearly $4 billion in combined federal and private sector energy upgrades to buildings in next two years. Also the FEMP of DOE is making strides to shorten the duration of the approval process of contracting with service providers. We are expecting to see improving project release in 2012 where the primary drivers of new activity are traction at this initiative and improving conditions in both MUSH and Federal markets.
Strong track record
Ameresco (AMRC) was awarded with 1/3 of the total Department of Energy’s ESCO service contracts in 2011. It received its final Acceptance Certificate for the $795 million ESPC award from the DOE for the completion of construction of the DOE Savannah River Site Biomass Cogeneration Facility on Dec 2011. AMRC was selected over Honeywell for its engineering expertise and full-service model.
Industry Leader in ESCO market
The ESCO Market size is rapidly growing from $5.1B in 2011 to $16B by 2020. The $5B ESCO market is growing at 12-14% annual rate, but we believe that Ameresco can grow faster through market share gain to deliver on its long-term top- and bottom-line objective of 15%-20% per year.
Unique expertise underestimated
Some of investors view the AMRC as a construction company rather than an energy efficiency solution provider. The technologies in this space are mature and not difficult to learn. However, appropriately applying those technologies to the specific project requires the engineering expertise, practical experience and track record. AMRC has all those competitive advantages, the barriers to entry for existing and new competitors.
A full ESCO services provider, and the largest DOE ESCO contractor
Company Description and Operations
Ameresco was founded in 2000 by George Sakellaris and added to the NYSE in July 2010. Sakellaris operated the first energy efficiency company, called NEES Energy Services, which was founded in 1979 by the New England Electric System. Currently, Ameresco operates 62 offices in 34 states in the U.S. and 5 provinces in Canada. As of December 31, 2011, they had about 947 employees, of which about 24% are comprised of development engineers. They provide full-service energy efficiency solutions to governmental, utility, educational, healthcare, and other institutional, commercial, and industrial entities. They develop, design, engineer, and install projects that reduce energy consumption and operations and maintenance (O&M) costs for their customer’s facilities. In many cases, the NPV of these cost savings make up for most of the up-front costs.
Ameresco also helps their customers obtain third-party financing for energy efficiency projects. This allows the customers to pay reduced (or zero) up-front costs, and enable them to realize some of these efficiency benefits as they are servicing their debt. The typical sales, design, and construction process for a client takes between 1 to 3 years.
The sales cycle at Ameresco begins with the Request for Proposal (RFP). Once selected, they take between 6 to 12 months (“Awarded Backlog”) to conduct a thorough energy audit, determine the scope of the project, design and engineer a plan, select a sub-contractor, and assist the client in obtaining third-party financing. The client reviews the plan, then signs the contract – at which point it becomes “Contracted Backlog.” Finally, construction takes place over one to two years – “Construction Backlog.” A lot of the actual construction and installation work is done by sub-tractors. After the project is completed, Ameresco may maintain ongoing service contracts (O&M Contracts) that continue the client relationship.
One of the keys to Ameresco’s success is that they help their customers develop comprehensive energy efficiency plans, which may include financing, renewable energy installations, construction of small-scale renewable energy plants, and facility upgrades. While there are many competitors that do installations or provide other energy efficient solutions, Ameresco’s comprehensiveness enables them to build a stronger, and longer, relationship with their clients.
Their competitors include: Chevron Energy Solutions, Constellation Energy, Honeywell, Johnson Controls, Siemens Building Technologies, TAC energy solutions, and local utilities. However, none offer the range of solutions or the in-house expertise. Johnson Controls, for example, is an equipment manufacturer, but lacks the engineering expertise. Many utilities offer ESCO services, but they do not offer continued O&M services.
Demand for energy efficiency projects have been on the rise in recent years due to increasing electricity prices, access to third-party financing, legislative support, state adoption of Renewable Portfolio Standards (RPSs), and organizational focus on energy cost reductions. Energy Services Companies (ESCOs) provide energy efficiency measures through Energy Savings Performance Contracts (ESPCs).
McKinsey & Co. (2010) estimated that the economically viable and commercially available energy efficiency potential through 2020 in the United States is $1.2 trillion, and requires an upfront investment of $520Bn. Pike Research (2012) and the Lawrence Berkeley National Lab estimated that the ESCOs market is currently about $5.1Bn, and will reach $16Bn by 2020 [see chart below]. By 2020, economically viable and commercially available energy efficiency measure can save over 1trillion kWh of electricity, which equals 23% of U.S. demand. 
Regulations on coal-fired power plants have also been on the rise; inducing organizations to upgrade or replace existing power plants. One example of this is Ameresco’s Savannah project in South Carolina. They are replacing an old coal-fired power plant with a 20.8 MW cogeneration plant that accepts fuel from forest residue, scrap tires, and other clean wood. This $183.4 million project also comes with $17 million of O&M services annually for 19 years.
We looked into the business nature of AMERESCO in order to understand its business potential and competitive advantages. It surely has some strengths that would promise profitability and certain level of growth in mid-term expectation. The core strengths of AMERESCO are:
1. Comprehensive solution provider. AMERESCO provides a wide spectrum of services in renewable energy generation and energy efficiency improvement, from building biogas plants, to improving the efficiency of HVAC (heating, ventilation, and air conditioning) and lighting systems. It acts as a one-stop shop for customers: rather than going to several different providers and trying to balance the different proposals, they only need service from Ameresco. This strength is an important advantage in this customer-centric service industry.
2. Well established reputation. Its founder, George Sakellaris, helped the New England Electric System (NEES) establish the first energy efficiency company, NEES Energy. He is also the former president of NAESCO, a national trade association. He is able to garner support from both third-party financiers and customers, which are two critical factors in this industry.
3. Customer relationships – currently government agents and affiliates are key customers of ESCO industry. 80% of AMERESCO’s revenue comes from that. Strong relationship with those customers allows AMERESCO to attain more projects and expand its territory in the future
Income Statement Analysis
Ameresco recognize revenue from the installation or construction of a project on a percentage-of-completion basis. The percentage-of-completion for each project is determined on an actual cost-to-estimated final cost basis. We haven’t seen the warning sign of aggressive sales and revenue recognition by studying the historical DSO and receivables.
1. Shifting focus to renewable energy. Energy efficiency revenues and expenses have been on the decline, while renewable energy revenues and expenses have been increasing. An interview with the Director of Investor Relations, Suzanne Messere indicates that this 75/25% split will likely stay the same.
2. Gross profit increased between 2007 and 2008, decreased during the recession from 2008 to 2010, and showed signs of recovery in 2011.
3. Operating expenses have generally been on the decline, although they increased during the recovery in 2011.
4. Income before provision for income taxes has been on the rise as a percentage of revenue.
Balance Sheet Analysis
Ameresco has totally $196m long term debt (less current portion) on its balance sheet. However there is a $109m non-service debt from Federal ESPC (Energy Savings Performance Contracts) receivable financing. After the appropriate adjustment, the adjusted long term debt is about $87m. We calculated the credit rating measurement based on adjusted long term debt as following:
§ Free Operating Cash Flow / Total Debt (%) is 9.3% (BB rating)
§ Total Debt / EBITDA (2011) multiple is 1.3x (A rating)
§ Total Debt / Total Capital (%) is 24.7% (AA rating)
Ameresco has $60.6m of goodwill and other intangibles asset on its book. Its intangible assets ratio (intangible assets/total assets) is only about 9%, which is well below the 20% threshold over which Hewitt Heiserman views anything as worrisome. Ameresco’s tangible book value is $175.7m, so no yellow flags here as well. Since 2009, the company adopted fair value measurements for all its non-financial assets and non-financial liabilities
In past eleven years, Ameresco has made over 15 acquisitions. The biggest transaction was the $6.1m acquisition of Quantum Engineering & Development Inc. in 2010. And all the acquisitions were made in cash. According to management, Ameresco will continue to use cash for the future acquisitions. It carries $46m and $26m cash on its balance sheet in 2010 and 2011 respectively.
We should be aware of the limitation in its speed of expansion in long term. Given the breadth of its business, AMERESCO does not have the core technology advantage that enables it to significantly stand out from competitors. Furthermore, Ameresco behaves less like manufacturers and on-line service providers, but more like consultants. The project-based nature makes it hard to grow their business rapidly. Third, in the expectation of revolutionary technology breakthrough in renewable energy, AMERESCO may not be able to attain the rapid expansion in those areas, given specialized and sizable companies exist in almost every energy type.
1. Lack of core technology. AMERESCO is providing a width of solutions by using new but not far-reaching technologies. This means it will have to fight hard to gain new territories, gradually. It also has to fight hard in order to sustain current customer pool, which would have no big loss if switch to other similar providers. They did, however, develop software that helps organizations measure the condition of their facilities, utility data collection software, and carbon emissions tracking software.
2. Project-based business. AMERESCO’s growth may be limited by available projects. These projects are nurtured mostly by government support, and provide less commercial value. The indication is that both the amount and scale of the projects are limited by how strongly the government pushes forward. Yet before there’s substantial improvement of current technologies, it’s hard to expect any significant increases.
3. Threat from technology breakthrough. Someday, when the technology breakthrough comes, the market would move rapidly towards new energy and create a huge growth opportunity. However, it’s hard for AMERESCO to catch this kind of growth. There are specialized companies in every energy area, Suzlon, for example, in wind power. If one day, technology breakthrough makes wind power practical and affordable (even preferable) in huge scale production, we should expect Suzlon, instead of AMERESCO, to gain a rapid growth with the trend.
4. Internal Controls. The latest 10-K states that they identified a material weakness in their internal control over financial reporting. The problem, they state, is that they do not have sufficient personnel in place to operate internal control procedures. As the company grows, we do not want investors to doubt the validity of their financial statements.To remediate this issue, they have hired additional Directors, business analysts, and accounting personnel; plus they have automated several of their processes.
Ameresco’s Enterprise value includes the $109m non service ESPC Federal financing debt. As a result, it’s EV to EBITDA multiple is slightly higher than the comparable companies’ multiple. Since Ameresco has the faster year over year growth rate than the industry average, the company deserves the higher P/E and EBITDA multiple.
 “It’s Earnings That Count” by Hewitt Heiserman
Stocks Discussed: AMRC,