Is solar in or out of fashion this week? What about wind? Is hydro cool today?
Few sectors are as cyclical as renewable energy. One day we’re hearing about feed-in tariffs sparking a frenzy in the Chinese solar industry, the next we are hearing about its imminent demise.
Longueuil, Quebec’s Innergex Renewable (TSX:INE) was one of the few cleantech stocks that made investors money last year. The company knows all about the fickle nature of the renewable energy investor. After IPO’ing at $11 a share, the company’s stock immediately rose to $14. But the seemingly inevitable losses that saddle many with expansionary ambitions in the space happened smack in the middle of the worst recession of a generation, and investors had little patience for the than $48 million, or $.94 cents a share the company lost in in 2008. Share of Innergex plummeted to less than three dollars.
After 2009, however, the company began to hit its stride, beginning an ramp up in operations to today’s level of nearly two-dozen hydro projects, several wind farms, even a solar project in Ontario. With a focus on carefully choosing the right projects, Innergex has grown its revenue from $6 million in 2007 to more than $91 million in fiscal 2010. Cantech Letter’s Nick Waddell talked to Innergex CEO Michel Letellier about what the company expects in 2012.
Michel, Innergex is involved in wind projects, hydro projects and solar projects. Is there a percentage mix of types of projects you are looking for see or do you take each project on its own merit?
That’s a very good question, Nick. I think the way to describe it is that we like wind and solar but we love hydro. We started the company by developing hydro projects, we did small hydro in Quebec and then we moved into Ontario, to British Columbia, and we have one project in the US. The reason behind this is that hydro projects are so long term and we know very well how to build them, how to operate them and how to forecast them, long term. Wind is great in the sense that you can grow fast with it, but it’s a little more challenging to establish a long term forecast and there’s a lot more maintenance to do. But when you have good management and you have been diligent about figuring out the cost of operations it can be a great business. The problem is that there are a lot of people coming into the business that are challenging the total return because they may be too optimistic in some aspects. Our competitiveness in wind could be challenged by the fact that we have been a developer and operator for long term, so we are accustomed to making sure that long term forecasts are done the right way with regard to things like the cap-ex and maintenance programs.
So I guess as the wind industry matures we see that the players are becoming more focused and conservative in their approach, hence we will have the chance to grow our wind business a bit more. In the most recent RFPs in Quebec we have not been very successful. A lot of players came in and I think the total expected return was a bit optimistic, to say the least. But I think the whole industry is coming back to reality a bit. As far as solar goes, I think solar has a nice window of opportunity in Ontario because the price was established about four years ago when the price of panels was pretty high and since then the price of the panels has dropped by at least 35-40%. So there’s a window of opportunity to develop the old contracts that were signed with the Ontario Government. Our first project in Ontario is Stardale and I would love to be able to do some more, we’re just waiting to see how the government there will establish prices going forward.
So going back to your question. What is the perfect mix for us? Well we would love to be 50% hydro in the long term and a split between wind and solar after that. I guess the minimum would be 40% hydro. Right now we are looking at 2017. With our existing run rate, we would be about 74% hydro. So there is room to grow the other sectors on a target basis.
Can you explain to us how the financing of a typical wind or hydro project happens? It seems it can be quite complex.
It can be complex but it depends. Some bigger companies are doing balance sheet financings, so its a more typical approach in the sense that more often they are rated by an agency and they have an overall corporate leverage that are driven by the standards and limits of the agency. Typically, it’s hard for a big corporation with say an A-minus rating to have more than 50% leverage, so if you use that type of approach and you want to be fair in your allocation of the cost of capital you end up having maybe 50% leverage on either a hydro or a wind facility. We haven’t really gone that route ourselves. But we do a a lot of project finance, and that probably answers your question more specifically.
Typically, it is roughly the same between hydro, wind and solar. The lenders figure out your debt coverage ratio, which is calculated using your EBITDA or operating profit divided by the total payment to service your debt including the capital and the interest. For hydro, that ratio could be around 1.25 for the first year, for wind you are looking at 1.40 to 1.50, and for solar 1.30-1.35. So basically, you are taking the long term forecasts of your operating profit and dividing it by this ratio and this provides you with the capacity of leverage that the project can sustain. This type of coverage brings a leverage in hydro of between 80-85%, wind can vary from 65-75% and solar between 70 and 80%. But this type of high leverage brings a high level of scrutiny on the part of the lenders. They want to make sure they have all the security, they want the major contract assigned to them, all the permits assigned to them and so forth. So it brings a form of diligence in the corporation, making sure that everything is in order before you get the financing. Hence the perception by the market that project finance is very complicated because the lenders rely only on the project to protect their mortgage or their money. They want to to make sure that if something goes wrong. they are able to get into the project and have control of the material contract and permits.
Have you had to weigh the merits of debt and equity financings? It seems to me that debt financings would be pretty appealing in today’s environment.
Well you’re always competing in trying to make sure that you have the lowest cost of capital. In hydro, if you have a long term Power Purchase Agreement of forty years, right now the Canadian bond, which is sometimes the benchmark that we are using to price the loan against these hydro facilities, is below 3%. I have been in the business since 1991 and at that time long term bonds were hovering around nine or ten per cent. Right now the thirty year bond is at 2.60%. So this is the benchmark, the risk-free rate. The lender would typically would add 2-3% over that. So you end up having a the cost of the debt for forty years fixed at roughly 6%. If your cost of capital is lower than that on the equity side you would tend to use equity, but typically equity would fetch a higher return than 6%. Your tendency to have a good mix of debt and equity ratio a ratio for hydro of between 70 and 80% is definitely creating value for your stockholders because your cost of capital is reduced by the amount of the loan.
I have noticed that in your press releases such as the ones regarding the Viger Denonville and Gros-Morne wind farms you point out the cost of the projects and the anticipated annual return. On Viger Denonville it was $75 million a year, with $10 in annual revenues expected. Is there a ratio you look for?
That always a moving target and obviously we want to be a little vague because we don’t want to give our exact internal rate of return target when we are bidding against other players. It’s obviously a big part of the pricing. In finance you always have a balance between risk and return, so we are trying to ensure that whenever we are doing something that we have the right fit. I’ll give you an example. The lowest risk project for us is in brand new hydro that has a fixed forty year project financing. That is lowest risk in our portfolio. If you have that type of project you may need a lower internal rate of return than say a wind project. Some developers say a project can return 20-25%. But that’s very rare. I’m not saying it couldn’t happen, but when you take into account the cost of the head office and the other sunk costs, this type of average return is very, very difficult to obtain. On a an average 12-14% is probably more realistic.
Switching gears, I wanted to ask you about the Cloudworks acquisition. Is that fully integrated into to your business yet?
Yes. There were some challenges, as expected when you merge two entities. The Cloudworks culture was very close to ours, but we had some difference in the way we approach construction and the number of people working in our office versus in Vancouver. I would say that things have worked very well considering the distance and considering the complexity of projects under development. We had a lot of projects under development and so did they. We had to make sure the team was focused on the most important things. I guess the biggest challenge was making sure each team understood the priority of the projects and were focused as a common group. We’re happy with the result.
We cover a lot cleantech stocks at Cantech Letter. Not too many went up in 2011, but yours did. We even saw insider buying on your stock. What do you hope to accomplish in 2012?
Well we have a lot on our plate. We will have our first solar project being put into commercial operation, that a very important milestone. We’re also going to have Phase Two of our Gros-Morne wind farm put into commercial operation at the end of the year so that’s two major projects that will begin production. We’re advancing into the construction of Northwest Stave River and Kwoiek Creek Projects in BC. 2012 will be a very busy year in building those two projects. We’re also hoping to have the conclusion on some of the environmental aspects of our projects in the Pemberton Valley and The Big Silver-Shovel Creek and Tretheway Creek projects near Vancouver should also be concluded. Its a big year for us in terms of commercial operation dates, for construction and for environmental development. On top of that, we’ll also be doing proposals to Hydro Quebec. There is an Request for Proposal (RFP) that has been announced but we don’t know the exact date yet for submissions. It’s an RFP in the range of 400 to 700 megawatts of hydro and wind in Quebec. We’re also looking at an RFP in Nova Scotia, and hopefully we’ll advance some of our projects in BC. They have the Standing Offer Program in BC, so we are prioritizing some of our projects, to submit them under the SOP. And, of course, the Liberal government was reelected in Ontario so it means the they’ll be reviewing the pricing of both wind and solar projects. We have quite a few feed-in tariff program applications in Ontario, about 60 megawatts of solar applications and more than 300 megawatts of wind applications, too. Ontario will be active for us. We’re also looking at the possibility of acquisitions; the M&A sector is still active. So I think we will be very busy, in a good way, in 2012. These projects are fun and challenging and we love what we do.