Cheapest stock of the week: Elverket Vallentuna Ab

Elverket Vallentuna is a Swedish regulated electricity distributor which due to recent court order has right to charge according to my estimation about 70 mkr of unbilled electricity charges from its customers in coming years, which can be thought as extra cash as all the costs of delivering the energy has already been incurred.

Cancelling the 70 mkr unbilled electricity charges from 260 mkr market value leaves 190 mkr valuation for the operations, which main owner EON offered to buy for 360 mkr in 2007, making the stock look extremely cheap.

There is also potentially more hidden value in receivables if distribution segment’s cash conversion period could be reduced from current 200 days to more typical 60 days, releasing about 40 mkr of working capital in between.

If I’m right that the 360 mkr EON offer reflects fair value of the operating business,  that the unbilled electricity charge backlog really is 70 mkr and that it would happen that the 40 mkr could be released from the receivables, then total equity value of Elverket could be about 470 mkr, which is 80 % more than the current market capitalization.

The estimated 70 mkr unbilled electricity charge backlog relates to implications of recent court order which concluded that the energy regulator had used wrong methods to calculate revenue cap for distributors in 2012-2015 regulatory period.

Updating the parameters of the model used to calculate the revenue cap to reflect the court decision, mainly that allowed earnings on regulated asset base is 6.5% instead of the original 5.2% and that certain “transition method” originally meant to prevent too fast price hikes will not be used, it can be calculated that Elverket is allowed to charge about 484 mkr from its customers in 2012-2015 regulatory period.

As Elverket’s run rate revenues for the period are some 370 mkr it implies around 484-370=114 mkr revenue deficit for the period. There is how ever “after the fact” adjustments to the revenue cap to prevent over charging if distributor for example doesn’t invest to network as much as it originally planed to or if it delivered below minimum standard electricity, among other things.

My estimation is that these after the fact adjustments to the revenue cap will be about 40 mkr, mainly because the electricity quality has been below benchmark and because electricity loss costs have been lower than expected, making the estimated final revenue cap about 440 mkr and concequently the unbilled electricity charge backlog to about 440-370=70 mkr.

There is some uncertainty in the 70 mkr deficit estimate as there is still one year left of the current 2012-2015 regulatory period and because two years of technical data needed to estimate the after the fact adjustments has not yet been published. How ever stable nature of the business and extrapolation of trends from the data that is available it is possible to make reasonable estimate that the actual deficit is not very likely to be significantly below the 70 mkr estimate.

The 40 mkr potential hidden value in receivable account relates to Elverket’s electricity network operating subsidiary. In 2013 sales of the sub was 92 mkr and the receivable account 59 mkr implying 241 days receivable turnover period while industry standard seem to be some 60 days on average.

If cash collection period could be reduced to normal some 40 mkr could be released from receivables and invested to growth or paid back to shareholders. I have tried to talk with the company about the issue but haven’t been able to verify what is the reason for the slow cash collection and therefore how realistic it is that the 40 mkr really could be released for better purposes. It is source of potential value nevertheless.

The 360 mkr valuation relates to EON’s, one of the biggest energy companies in Europe and main owner of Elverket, offer to buy the whole business in 2007. They were only able to get 43% of the shares until municipal politicians with 10% ownership blocked the buyout but the offer still sets good benchmark of value of the business.

At the time the 360 mkr offer implied 12x EBITDA multiple which is consistent with some of recent transactions in directly comparable companies. Although 2014 EBITDA was at similar 30 mkr(ish) level as it was in 2007 today the company is probably more valuable as the network has been updated, asset base grown and the rules for 2016-2019 regulatory period points to higher EBITDA than what historically has been the case. In addition the current EBITDA might be below “normal” because the electricity sales segment is not (temporarily?) contributing to earnings due to low electricity prices.

My best estimate for the distribution segment’s forward EBITDA is 38 mkr vs.36 mkr last year and in normal year the sales segment could potentially earn historically averageish 7 mkr vs. 2 mkr last year. Cancelling concern costs the forward EBITDA of the company could be the  some 38+7-5=40 mkr and with EON’s 12xEBITDA multiple the operating business worth 480 mkr. Add to that the 70 mkr unbilled electricity charge backlog and the potential 40 mkr release from working capital in best case the company could be worth 560 mkr or 86 kr per share  (115% upside).

On the other hand Elverket is not likely to worth below the 360 mkr EON’s offer price because the business has grown since then and because the regulated asset base (roughly equals  inflation adjusted book value) is probably somewhere around 300-400 mkr. With 260 mkr market cap currently downside seems protected.

With new profit oriented management I’m happy to own this 4% dividend paying small stable debt free electricity network operator located in vicinity of Stockholm, which is one of the fastest growing regions in Sweden.

Disclosure: Long the stock with 16% position.