Charlie Munger has said that if an investor can't stomach a 50% loss they shouldn't be investing. I'm about half-way there with ADES and Munger's pain threshold. I thought now would be a good time to review the investment and determine future actions. In the efforts of full disclosure, funds I manage are long ADES. I have not backed the truck up though.
Well not much and that is the problem/reason. I think investors were expected a quick acceleration of profits. People are not seeing results and are clearly frustrated. I must admit that I thought things would be moving along faster as well.
Michael Durham highlighted this frustration in the Q3 call:
"But just the optics if you don't look beyond initial quarter what you see is that $3 a ton expense that leads to significant loss this year even though that is creating a $7.57 per ton cash benefit in the future. That doesn't show on this quarter. So if you look at an investor who is only looking at the headline they're going to miss that. So, I think until we get additional monetizations and you see that slip from the big expense to the big segment income and then an earnings the investment community is not going to understand the story."
The key point of frustration came with the company announced results this past quarter and once again it lost money. They failed to monetize two of their plants and several other plants are taking longer than expected. This was seen as a strike against management, and rightfully so. Management has promised to deliver for several quarters now.
The story is still confusing and management is losing credibility. If you listen to the Q3 conference call it's clear that several of the analysts asking questions are confused. And not just about simple things, but about the entire structure of ADES and Clean Coal Solutions(CCS).
Is Mr. Market right?
An investment in ADES is not going to be based on BV, safety of assets or something typical, which I think makes these issues all the more difficult to weather. Is the sell-off due to frustration and only a temporary hiccup, or is the business permanently impaired?
Based on the 12 plants that I have been able to track down and the numbers I have backed into, it doesn't matter if the company gets their RC facilities up today or in 24 months. A company that has an earnings yield of 25-60% is cheap with even the greatest discount over a two year period. There has been no change in the overall numbers, simply the time it will happen. Sixty million tons of RC coal should be processed and management is hunting for larger plants to process even more. So if they fail at 1/2 their plants they'll still process 30M tons. At $1.60/ton flowing through to ADES the company will still see $48M of EBIT.
This assumes that the entire Emissions Control business does nothing. Which is unlikely, they have $100M of bids out there and were recently awarded a $14M contract for DSI systems and expect to announce several longer term ACI contracts soon.
Yes, coal is terrible and Obama is the coal Antichrist, but 42% of electricity generated in the US depends on it. Hurricane Sandy taught everyone on the East Coast just how valuable base load power is. It's not going away.
So right now this seems to be a time issue, and if the plants are monetized in the next couple of years it really isn't a big deal. The question is, how do we handicap the likelihood (or lack thereof) of monetization?
I don't have an answer for that question. It's a difficult one to answer but I can rely on some of my research to back my belief that monetization of RC facilities will occur.
We learned that the two plants that were supposed to be monetized by now, are not. These plants are actually costing CCS ~$3/ton in operating expenses. If they monetize them that's $18M of cash going into CCS(Q3 '12 Call). So that's the basic math there, approximately $7/ton difference between self-monetizing plants, and getting an outside monetizer(CCS sees over $3/ton go to them instead of booking a tax credit and a operating losses).
So why didn't Goldman or the other partner become the monetizer? We know that GS was expected to monetize these two plants. How?
"In October 2012, GS determined that it would not pursue leases on two particular RC facilities on which it had paid deposits totaling $4.7 million and concurrently gave notice for the return of the related deposits. " pg 24 10Q Q3 2012
GS wants their money back, right?
"While, as previously noted, GS has given notice for the return of deposits in the amount of $4.7 million, which we are obligated to return by January 30, 2013, we anticipate that this amount may be offset by deposits for additional RC facilities that we expect to receive from GS in the near future." pg 33 10Q Q3 2012(emphasis added)
GS, a 15% owner in the CCS JV, decided not to pursue two facilities. Facilities which only add up to about 2-3 million tons of coal per year(per ADES management on the Q3 call). We know that CCS is pursuing gulf coast lignite (and pulverized) coal burning facilities that consume up to 8M tons of coal per year. Me thinks that GS is waiting for a bigger and better plant.
Another problem is getting a Private Letter Ruling(PLR). I wanted to figure out how much of a hassle these are so I chatted with a gentleman who has approved numerous Section 29 PLRs and at least five (that I was able to find) Section 45 refined coal PLRs.
"We aren't ruling on who benefits. The only question is does it qualify as refined coal?" -PLR reviewer IRS.
The reviewer wouldn't go into great detail but it literally sounded as simple as this: if the process qualifies as refined coal then the PLR will be granted. This has been done already at multiple plants with Arthur Gallagher/Chem-Mod and CCS.
We know that at least 14 plants have RC facilities built out by Helmkamp. I inquired about a facilities operator job at a PRB coal plant in North Dakota. Although I didn't get the job, I can confirm that there are real people on the phones interviewing people. Several environmental directors of utilities also said it works, they like it, and will keep on using it. These things indicate to me that all the facilities are real, working, and actually staffed.
This looks like a "shoot first, ask questions later" reaction. Listening to the call I was confused too, mostly from the poor questions. It sounded like people have no idea what ADES does as a company. I was surprised that someone asked what kind of technology M-45 uses.With all that said, I also think management has done a poor job explaining how it all works to the community and tends to tell confusing numbers that you have to really dig into.
Overall, the call led me to believe that there are two inefficiencies here. The first is that people don't understand the technology and the structure of the company. That, in turn, leads to the second inefficiency. When things don't perform as expected (i.e. immediately when management says so) the only answer is to get rid of the "failure." I personally don't believe we have to believe in management to see success in this investment. All the wheels are in motion and the success of the projects are not dependent on management.
I think all signs point to good things, if the monetizations occur. I see no reason why they won't occur. Yes, it's taking longer than expected. That's what happens when investment bankers and utilities get together and play Let's Make a Deal. I believe the delay is ultimately for the better though. I believe that GS did not monetize two plants due to a lack of belief or failure, I believe they wanted to be part of better plants with better operating costs. Over the next quarter or two we will see if my belief is correct.
Of course, I could be missing something as well. It is obvious that management was overly optimistic but if the RC facilities aren't monetized the cash flows will never be realized. I have found no information to indicate that the eventual monetization won't occur. For me, this is about patience and reliance on my multiple sources. Long ADES and hoping for continued volatility.