At a glance, Rurelec (RUR) could easily be mistaken for a small dull electricity company - take a closer look and it quickly becomes apparent that this is not the case. Rurelec was the first electricity company to list on AIM but so far the reception has been muted. ?Pretty understandable, this isn?t exactly yer average AIM type of company,? we might say, and then puff on our pipes and add sagely, ?hmm ?well usually, utility companies tend to be favoured by pension funds and other large investment entities that are looking for defensive stocks with steady but unexciting growth and nice dividend year in year out?. But is that a fair depiction? Well not in the last few years it hasn?t been! In Europe, big utilities companies have strong cash flow growth, and have been part of the mergers and acquisitions action as the sector consolidates, and they have also shown that they are quite capable of passing on input costs to customers ? something that is harder to do than most of us would imagine.
Come to think of it, Warren Buffett?s Berkshire Hathaway has been spending US$ Billions on utility companies over the last couple of years, including Northern Electric and Yorkshire Electricity. ?Mmm? we say ?mmm? ...pensively!
Rurelec (rural electricity) is quite a different beast from the large European utilities. The company is currently focused on power generation in Argentina and Bolivia, countries which are not only experiencing strong gross domestic product (GDP) growth but also have access to vast amounts natural gas. This offers an interesting combination of growing demand for electricity combined with a source of cheap gas with which to generate it. Also, Bolivia generates a high proportion of its export revenue by selling electricity to Northern Argentina and South Western Brazil ? two markets that are energy hungry and keen for more!
Since listing on AIM, Rurelec has made two key acquisitions in building its power generation portfolio.
In Argentina, the company acquired a 50% stake interest in Energia del Sur (EDS), which owns and operates in Argentina?s isolated Southern electrical generating system. Here generating capacity is 76MW(Mega Watts), and plans have been approved by the Argentinean authorities to up-rate capacity by 60MW to 136MW using combined cycle gas turbine (CCGT) technology. Combined cycle plants are considerably more efficient than traditional open cycle turbines as they capture and recycle waste heat during power generation. The net result is a 40% reduction in carbon dioxide emissions per kilowatt of power produced. This greener type of power generation means that the reduction in carbon emissions is recognised under the Kyoto Agreement on carbon emissions. (We will come back to this later)
In January this year, Rurelec announced a second and considerably larger acquisition when the company took a 50.01% controlling stake in Guaracachi, Bolivia?s largest utility company, which was paid for by issuing 47 million shares at 42p. Guaracachi?s capacity at the end of 2006 is anticipated to be 440MW. Part of the increased capacity with Guaracachi will, once again, come from the installation of a combined cycle plant.
Follow the link here and it can be seen that the two plants Rurelec have an interest in, have applied for carbon credits under the Kyoto Agreement for a princely 163,000 tonnes and 351,000 tonnes. Carbon credits are measured in ?units of certified emission reductions? (CERs). Each CER is equivalent to one tonne of carbon dioxide reduction and CERs can be traded. Carbon credits currently trade at 11-15 Euros per CER, which implies significant value to Ruralec if the UN signs off on the company?s submission ? the application should be processed before the end of 2006. What makes the carbon credits even more interesting to Peter Earl, managing director of Rurelec, is the potential to use the credits as a debt swap whereby creditors will take carbon credits instead of cash repayments. Regardless of what Rurelec does with the carbon credits if they are granted to the company when the combined cycle plants come on line, they will provide an additional material change in the company?s balance sheet in 2007.
If there are concerns, they involve not so much Rurelec?s operations, but the region they are in. ?Bolivia!? I hear you say. Indeed, President Evo Morales of Bolivia has been highly vocal in his rhetoric about foreign energy companies controlling most of his country?s gas production. However, despite the threats and showmanship of Mr Morales, not one inch of private assets has been nationalised. The so-called ?nationalisation? is in reality a switch from production sharing agreements to operating agreements. The investment of the oil and gas companies is protected and Occidental Petroleum, Total, Petroleo Brasileiro, Repsol and others have signed up to Boliva?s new energy law with Total, Petroleo Brasileiro and Repsol pledging further investment.
Outside observers repeatedly expressed scepticism that Bolivia could ever create a serious plan to acquire a controlling stake in the privatised assets, the country simply doesn?t have the financial muscle to carry out such a sweeping change. Far more likely is that Bolivia, like many countries, simply wants to reap more benefits from surging commodity and energy prices. Bolivia has, in effect, demanded that tax rates on hydrocarbons rise from 18% to 50%, which would bring them in line with ?the UK North Sea!
Peter Earl is keen to point out to investors that Bolivia is quite ?Thatcherite? in its law making. Rurelec has an excellent relationship with the government and is working on several new developments to help fulfill Bolivia?s domestic and foreign energy ambitions. Beyond current plans in Argentina and Bolivia, Rurelec has a stake in a Bolivian plant due to be commissioned in 2008, which will export electricity to Northern Argentina.
In the long term Rurelec intends the core of its operations to be in the Southern Cone of Latin America (Cono Sur), and has some projects in Brazil and Peru pencilled in where combined cycle plant installations would lead to increased generator capacity and possibly to carbon credits.
Why plan to centre an electricity generating business on Cono Sur? Cono Sur is the southern macro-region of South America; it includes Argentina, Chile, Uruguay, Paraguay, and the four southernmost states of Brazil - with Bolivia as a sort of ?honorary member?. A distinguishing characteristic of Cono Sur is the relatively high average standard of living and quality of life, comparable to the more developed countries of Eastern Europe such as Poland, Croatia and Hungary ? with Argentina and Chile?s level of development topping many European countries on some measures of development. High life expectancy, access to health care and education, and significant participation in the world's economy make Cono Sur the most prosperous macro-region of Latin America. In other words it offers a portfolio of countries over which risk can be spread, and consists of the kind of countries that can be expected to keep the lights on if there is a slowing of the global economy.
Rurelec board members have some worthwhile credits on their own cvs too..
A former Managing Director of Lazard Brothers
A founder of a company that operated over 2,400 MW of power plants and developed over 1,000 MW of new capacity
An investment banker who has operated in the electricity sector since 1994
A chartered engineer who has led technical due diligences for acquisitions of over 1,500 MWs of generating plant
A a chartered engineer and manager who has written papers on power system economics and control, tariffs, substation switching and planning and operational reliability standards
A company general counsel who worked for the corporate finance department of London law firm, Bird & Bird for ten years.
Two of the board have consulted to, or for, the World Bank and one has served as deputy chairman of a United Nations Economic Commission group.
Ah yes, and the company says it intends to take advantage of suitable opportunities to trade in portfolios of power generation equipment. This must be what the company was doing when it recently bought nine gas generators each for £1M and sold six of them on for a gross profit of three generators and £333.000.
Perhaps one area where Rurelec is like a normal utility company is in its progressive dividend policy. Analysts are forecasting a 3p dividend this year and Peter confirms that the company is comfortable with this, and is keen to continue to pay a high yielding dividend. Interim results for the year ended 30th June 2006 make interesting reading. Group after tax profits (excluding one-offs) were £1.3 million and Net Asset Value (NAV) rose to 42.1p per share after the acquisition and revaluation of Guaracachi, rising to around 50p a share when the new plant is installed. This means the company is essentially trading at around current NAV, which seems a bit odd considering the growth potential in South America, a progressive dividend policy and last but certainly not least the potential value of carbon credits in 2007 and beyond.