April 2016

Infigen Energy (IFN) – Is a good company the same thing as a good stock?

CVF News

Infigen Energy (IFN) – Is a good company the same thing as a good stock?

Gary Hui

Everyone, it seems, wants to own “good” companies in their portfolio. Often a company is characterised as “good” if it has experienced strong share price performance, management are popular and consensus earnings prospects are perceived to be strong.

The problem with buying stock in a company that is widely perceived as “good” is that popularly perceived quality is reflected in price. Good companies tend to trade at high multiples. When you pay a high price for a stock, your margin of safety is greatly diminished.

A good company is not necessarily the same thing as a good investment.

Neglect is your friend

We spend a lot of time sifting through the detritus of the investment world. Looking at stocks that are neglected; typically in unpopular sectors, with scant research coverage that have often experienced historical challenges.

When you do this habitually you can find gems. This is the truly creative and stimulating aspect of investment research. The crux of this is you are not just looking at what the company is today, but what it can become. When you find stocks that are currently perceived as ugly ducklings, which will transform into market darlings, you can make a lot of money.

A potential example

We stress “potential” because this is a recent investment by the Fund. So it hasn’t played out yet, and as always, there are no sure things!

Infigen Energy (IFN)

Infigen, previously known as Babcock & Brown Wind Partners, is something of a fallen angel. Infigen IPO’d in 2005 with a global portfolio of wind farms, however the 2008 financial crisis forced Infigen to reduce debt by selling all of its international assets.

There is no regular research coverage on the stock. Debt levels are high. Market interest and expectations are low. We think all of this will change over the next one to two years.

The price of the green electricity Infigen sells comprises two elements. Firstly, Infigen receives a wholesale electricity price. Secondly, Infigen receives a Renewable Energy Certificate, known in Australia as an LGC or Large-scale Generation Certificate.

In 2013 when the Abbott government announced a review of the LGC mechanism with a stated desire to dismantle the system, the price of LGCs and thus Infigen’s revenues fell precipitously.
This was a particularly difficult time for Infigen given its very high debt load (currently ~1.9x market capitalisation).

However all of this has now changed. The Renewable Energy Target (RET), was reaffirmed in 2015 albeit at a reduced target of ~23% or 33,000 gigawatt hours of total energy mix by 2020. Importantly, significant regulatory certainty was restored.

Meanwhile other countries are increasing their RET targets, just as the Australian Labor Party recently did by lifting its policy to 50% by 2030. As a result the price of LGCs has recovered very strongly, which we expect to persist for some years.

Infigen is now quickly paying down its high debt load. At the Company’s recent half year result, management increased the FY2016 targeted debt reduction by 43% given strong results. Updated guidance corresponds to ~13% of market capitalisation, which implies a free cashflow yield of a similar level, a multiple of what comparable infrastructure stocks yield in cashflow.

Because Infigen sweeps all cash to debt reduction, nothing flows to shareholders currently as a dividend. We think we are 1-2 years away from the point where that changes. Once Infigen reduces debt to a sustainable level and then refinances its debt facility, we expect shareholders will see some of that very strong free cashflow in the form of dividends.

Meanwhile, Infigen has one of the largest renewable power development pipelines in Australia. Two assets in that pipeline are part owned by a large wind equipment company who will provide free equity carry to Infigen on development. When these assets eventually come into production, we would expect Infigen’s earnings to rise again in step with production growth.

Finally, Infigen is the ASX’s largest renewable energy pure play we can find. We expect, as Infigen continues to repair its balance sheet, it will increasingly capture the market’s attention given its strong earnings growth, strong free cashflow generation, rapidly improving balance sheet and perfect fit for ethical investment mandates.

If all goes well, Infigen has the potential to transform from what was an ugly duckling into a market darling. Our internal price targets imply the stock can more than double from current price levels.