Is First Gen an Overlooked Power Play That Deserves a Re-Rating?
The post was originally published here.
Highlights:
- Resolving gas supply issues ensures longevity
- A pioneer in renewable energy should be future proof
- Undemanding valuation could lead to re-rating
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First Gen’s revenue breakdown 2020
Price and volume turned bearish
- Throughout the past year, the share price fluctuated around PHP30
- Recently, the 50DMA has fallen below the 200DMA, suggesting a bearish signal
- Volume RSI has fallen below the 50%-line; hence, not providing a support for a turnaround
Resolving gas supply issues ensures longevity
- Natural gas is widely accepted as the transition fuel for the mid-term future
- FGEN derives 58% of its revenue from gas
- The main problem is that the country’s only gas field Malampaya is about to deplete over the next 3 years
- Hence, the market raised huge concerns about the longevity and profitability of FGEN’s business to compensate for the lack of gas supply
FGEN substitutes domestic gas with imported LNG
- FGEN currently constructs the country’s first liquefied natural gas (LNG) terminal with a capacity of 5.2m metric tons
- The terminal allows to store imported LNG and turn it back to gaseous form to generate energy
- So far, the construction progress is on track and the terminal could start operations by late 2022 already
- By resolving the supply issue, FGEN dispels any doubts about its longevity
A pioneer in renewable energy should be future proof
- For now, the Philippine gov’t still has a high tolerance for coal-fueled energy generation
- Cheap coal is likely to remain the dominant fuel source in the near term
- However, the gov’t rewards the usage of renewable sources through long-term contracts with favorable prices
- Philippine energy companies are required to start green transition soon
Largest independent renewable power producer
- It makes up 20% of the country’s total renewable energy capacity
- The company runs indigenous renewable sources like geothermal, wind, and solar
- Its early shift towards renewable energy gives the company a timing advantage
- Therefore, I expect a stable and strong gross margin over the next few years
Undemanding valuation could lead to re-rating
- The stock currently trades more than one standard deviation below its historical average on PB
- FGEN regularly has beaten analysts’ forecasts in the past
- With the LNG terminal, FGEN does not only solve supply issues, but might also sell excess LNG, creating additional revenue
Interest of institutional investor could provide support
- In 2020, the US-based investment company KKR acquired a 12.6% stake in FGEN
- In October 2021, KKR announced to acquire another 7.3% stake for PHP33 per share, which is a 20% premium to market price
- I consider the follow-on investment of KKR as a positive signal that the share price could provide further upside
FVMR Scorecard – First Gen
- A stock’s attractiveness relative to stocks in that country or region
- Attractiveness is based on four elements
- Fundamentals, Valuation, Momentum, and Risk (FVMR)
- Scale from 1 (Best) to 10 (Worst)
Analysts see strong upside
- Almost all analysts have a BUY recommendation, with only 1 analyst staying on HOLD
- Consensus expects solid revenue growth for the future given the growing demand for energy
- Also, margins are expected to stay stable at a high level, meaning that analysts are positive about the LNG substitution
Get financial statements and assumptions in the full report
P&L – First Gen
- FGEN has delivered remarkably stable profits and there is no reason to assume differently in the future
- Long-term take-off agreements ensure stable margins
Balance sheet – First Gen
- Currently, there are no concrete expansion plans in place
- I believe that FGEN might add a few smaller renewable energy projects over time but does not undergo aggressive acquisitions
- Its strong cash flow generation allows FGEN to reduce its debt over time and fund CAPEX internally
Ratios – First Gen
- FGEN paid out stable and growing dividends
- The small payout ratio of less than 15% still delivers a dividend yield of around 3%, which is above Philippine average
- There is potential to pay out more and it could turn into a dividend play over the next few years
- Strong margins translate into stable return on assets
Long-term share price performance potential
Free cash flow – First Gen
- FGEN cash flows on a consistent basis and the market might not have appreciated that fact yet
Value estimate – First Gen
- My short-term outlook is roughly in line with consensus
- I am bit more optimistic on the long-term future and believe the company to maintain a great ROIC of 10-12% over time
World Class Benchmarking Scorecard – First Gen
- Identifies a company’s competitive position relative to global peers
- Combined, composite rank of profitability and growth, called “Profitable Growth”
- Scale from 1 (Best) to 10 (Worst)
Key risk is delay in resolving gas supply
- Delay in building the LNG terminal could disrupt its gas production
- Unexpected outages of production (e.g., weather conditions, transmission constraints)
- High dependency on Meralco, which makes up 50% of its revenue
Conclusions
- FGEN to remain a cash flow machine as supply problem seems to be resolved
- Early shift to green energy fives it a timing advantage in a coal-dominant country
- Valuation is cheap; institutional interest could unlock upside
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