Ormat Technologies: New Geothermal Projects, Good Guidance, And Undervalued

Geothermal energy player Ormat Technologies, Inc. (NYSE:ORA) is operating in growing operating markets. Management recently delivered beneficial guidance for 2023 and 2025, and noted a significant number of projects near completion. Considering the recent backlog increase, conservative growth of free cash flow, and lower capital expenditures, I believe that ORA stock is currently undervalued.

Business

Ormat Technologies operates in the geothermal energy industry. The company offers solutions on reuse and storage through traditional systems and solar panels as well as hybrid devices between these two formats. The company's current objective is to position itself as a global leader in the generation of renewable energy and its derivative services.

The operations are geographically diversified. Management reports twenty geothermal energy extraction plants in the United States, spread over California, Nevada, and Hawaii, as well as other plants in Guatemala, Kenya, Honduras, and the Guadalupe Islands.

The company's business is currently divided into three segments: the electricity segment, the energy and storage segment, and the product segment. The electricity segment is the most consolidated in terms of sales and revenue percentages, and the business is more established in the United States than internationally. This segment consists of the generation of electrical energy through its solar panel and geothermal energy facilities, for its subsequent sale to different local and international markets.

The electricity segment is oriented to design, develop, produce, and market products for application by geothermal installations or solar panels as well as remote power units, mainly in the United States.

Finally, the energy storage segment is the least developed to date, and is oriented to the storage and sale of electrical energy. It is currently operating in California, and the management intends to build six new plants in Texas, Ohio, and New Jersey.

Recent Results Are Quite Beneficial, And Guidance For 2023 And 2025 Appears Quite Beneficial

The company reported a backlog of $148.1 million, which represents an increase of 177% as compared to Q4 2021. Besides, in 2022, the company signed the new product contracts worth close to $163 million. Considering the growth in backlog, I would be expecting substantial revenue growth in the coming years.

Management also stated that it operates in target markets that are expected to grow at a significant growth rate. Geothermal and solar energy market is expected to grow to 1,300MW-1,330MW in 2025. Besides, energy storage is expected to grow to close to 500MW-530MW by 2025. In both cases, we are talking about double digit Megawatt growth.

The guidance given for the year 2023 is quite impressive. Total revenue is expected to be close to $823-$858 million with electricity revenue close to $670-$685 million. The adjusted EBITDA would be close to $480-$510 million.

Management also provided some information with regards to future growth from 2022 to 2025. The company expects total capacity to grow at a CAGR of close to 16%-17%. I believe that we could expect sales growth close to this figure.

Competitors Are Large Corporations With A Significant Amount Of Resources

Competitors vary for each segment although some companies are present in all three. For the electricity segment, we find, as competitors, CalEnergy, Calpine Corporation, Enel S.p.A (OTCPK:ENLAY), and Cyrq Energy Inc. within the United States, Mercury and Contact Energy (OTCPK:COENF) in New Zealand, Energy Development Corporation in the Philippines, Meridian in France, and Enel Green Power in Italy.

In the production segment, we find, as competitors, Mitsubishi (OTCPK:MSBHF), Fuji Electric Co., Ltd. (OTCPK:FELTY), and Toshiba Corporation (Toshiba Corporation) of Japan, GE (GE) and Ansaldo Energia of Italy for turbines, and Mitsubishi Heavy Industries through Turboden, TICA, in the development of binary technologies,

Assets

As of December 31, 2022, the company reported cash worth $95 million with marketable securities worth $130 million. I also anticipate trade receivables less allowance for credit losses of $128 million, inventories worth $22 million, and prepaid and other expenses of $29 million. In sum, total current assets would stand at $456 million, more than 1x the total amount of current liabilities. I believe that the company does not seem to have liquidity issues.

With deposits of $39 million, deferred income tax of $161 million, property of $2.493 billion, construction in process stands at $893 million. Operating lease rights of use of assets stand at $23 million with a finance lease rights of use of $3 million. Intangible assets stood at $333 million with goodwill of $90 million. Finally, total assets stand at $4.611 billion.

Liabilities

The list of liabilities included accounts payable of $149 million with billings in excess of cost of $8 million. The current portion of long term debt includes limited and non-recourse debt of $64 million, full recourse of $101 million, and a financing liability of $16 million. Operating lease liabilities were equal to $2.3 million with total current liabilities of $343 million.

Long term debt includes full recourse debt of $676 million, convertible senior notes of $420 million, and a financing liability of $225 million. Deferred income taxes stand at $83 million accompanied by an asset retirement obligation of $97 million and the other long-term liabilities of $3.31 million. Finally, total liabilities stand at $2.58 million.

I believe that the company’s total debt is not small, so some investors may be interested in getting to know the list of contractual obligations. Management noted long-term debt and financing liabilities of $2.05 billion. With that, it is worth noting that most debt payments are expected from 2027. In my view, management may find new debt investors, or may renegotiate its debt agreements from now to 2027.

Expectations From Analysts Include 2025 Sales Growth Of 15%, Net Income Growth, And 2025 EBITDA Margin Of 56%

Market estimates include 2025 net sales of $1.101 billion together with a net sales growth close to 15.41%, 2025 EBITDA of $621 million, and EBITDA margin of 56.40%. Finally, with an operating margin of 31.60% and a net income of $164 million, it is worth noting that expected net income growth from 2023 to 2025 appears quite impressive.

Assumptions In My Model

In my model, I assumed the successful construction of new geothermal generation plants and successful implementation in new markets for the sale of electricity, including South America, the Caribbean, Indonesia, the Philippines, Chile, and China.

I also expect reduction of costs thanks to energy efficiency plans and perhaps further diversification of its customer base. Besides, I would be expecting new acquisitions of technological capabilities or development of new technologies in-house. In this regard, management offered a lot of commentaries.

Leveraging our technological capabilities over a variety of renewable energy platforms, including solar power generation, energy storage and recovered energy generation. We may acquire companies with integration and technological capabilities that we do not currently have, or develop new technology ourselves, where we can effectively leverage our expertise to implement this part of our strategic plan. Source: 10-k

Under my financial model, I also assumed that capital expenditures would follow some level of cyclicality. The company reported capex of more than $501 million recently. Under my DCF model, capex would fall in the coming years, which could bring significant free cash flow generation.

My Cash Flow Model

My cash flow assumptions include small growth of net income from $105 million in 2023 to approximately $113 million in 2033. I also assumed D&A close to $34 million, stock based compensation of $22 million, some modification of impairment of long-lived assets, and losses on disposal of properties. My numbers are pretty much close to what I saw in the future.

Further figures in the cash flow statement include 2033 changes of receivables of -$145 million, 2033 costs and estimated earnings of -$93 million, and changes in accounts payables of $29 million, which imply cash flow from operations worth close to $515 million. Capital expenditures would include 2033 capex of $25 million and 2033 FCF close to $485 million.

My results included 2024 FCF of $62 million and 2032 FCF close to $462.5 million. If we also assume a WACC close to 9.45% and an EV/FCF close to 35x, the implied enterprise value would be close to $7.85 billion. Now, if we make adjustments in debt and cash, the implied equity valuation would be close to $5.985 billion, and the implied target price would be $105 per share.

Risks

Ormat competes and operates in a highly competitive nascent market, and depends directly on the adaptation of a large number of industries and populations to the use of renewable energy. For this reason, technological developments are still uncertain, and could be detrimental to the commercial needs of your product. In addition, the company declares that it has a high concentration of income in a few clients, some of which represent almost 15% of annual revenue. If one of these clients decides to stop working with the Ormat, the decline in revenue will likely be substantial.

There are also many risks with regards to legal issues and the requirements for energy exploitation. New laws are still being implemented or developed, and it is possible that Ormat has to adapt its type of production in this sense. New requirements could force the company to increase its capex, which may lower potential FCF margins.

International political risks may also lower the company’s revenue expectations. In certain jurisdictions, politicians may nationalize production of electricity, or they may increase taxes. Let’s keep in mind that the company does not always cover political risks with insurance companies.

We generally, but not always, purchase insurance policies to cover our portion of our book equity exposure to certain political risks involved in operating in developing countries, as described below under “Insurance”. However, insurance may not cover all political risks or coverage amounts may not be sufficient. Source: 10-k

In the last annual report, Ormat reported 11 projects under construction. Many of them expect significant developments in 2023, and may accelerate revenue expectations. It may explain why the company’s 2023 guidance was that beneficial. With that, with many projects near completion in 2023, if the company fails to properly scale up its resources, some of them may fail to deliver the revenue expected. The list of projects is given below.

Conclusion

Ormat Technologies operates in markets growing at a double digit, and has geographically diversified assets. In addition, very recently, the backlog increased significantly. Also, with a significant number of projects under construction and near completion in 2023, I believe that revenue growth will likely trend up soon. Considering the company’s guidance for 2023 and projections for 2025, I designed my own discounted cash flow model, which implied a valuation that makes the current market price too low.