Two Canadian cleantech stock buys from Paradigm Capital

Paradigm Capital analyst Adam Gill is doubling down on Canadian cleantech with two coverage initiations on Tuesday, both in the renewable natural gas (RNG) industry. Gill started out Greenlane Renewables (Greenlane Renewables Stock Quote, Charts, News, Analysts, Financials TSX:GRN) with a “Buy” rating and Xebec Adsorption (Xebec Adsorption Stock Quote, Charts, News, Analysts, Financials TSX:XBC) with a “Hold” rating, saying both names should benefit from the swell of momentum in the RNG space.

Dealing with the impact of climate change, countries worldwide as well as energy companies themselves are turning more to renewable natural gas as one part of a larger energy use framework. In his report, Gill pointed out that coming from sources like landfill, dairy farms and sewage waste, RNG is seen as a less greenhouse gas-intensive fuel source compared to fossil fuel-derived natural gas. 

On the one hand, RNG processes divert off-gassing methane from directly entering the atmosphere where methane has about a ten times greater greenhouse effect compared to CO2. On the other hand, emissions from burning RNG are also lower at an average intensity of about 44g of CO2 per Megajoule (MJ) compared to about 83g of CO2 per MJ for fossil natural gas. 

That makes for a growing market for companies involved in taking raw, mixed gas  (called biogas) from landfills, etc., and filtering out impurities to produce usable methane stream, according to Gill.

“There is significant momentum building in the RNG space, with utilities activity sourcing new supplies to decarbonize the gas grid and large integrated energy companies making direct investments to provide lower emission sources of fuel,” Gill wrote.

“We believe we are in the early stages of a substantial investment cycle in the sector, which will be beneficial to the two equipment providers we are initiating coverage on,” he said. “The increase in natural gas prices around the globe (notably Europe and Asia) also supports the economics of RNG development, which has typically been a higher-cost source of methane. Lastly, valuations in the CleanTech sector have seen a material climb down after a massive hype ramp-up in early 2021, making the space more attractive today than it was last year when valuations were elevated.”

Gill pointed to increased adoption of RNG with Europe leading the way with 992 RNG facilities currently in operation and sporting a CAGR of about 15 per cent between 2017 and 2021. Meanwhile, the US has seen a 34 per cent CAGR in RNG facilities since 2017. Worldwide, Gill said RNG demand is forecasted to grow by a CAGR of 33 per cent to 2025 and then by 25 per cent to 2030 from 2018 levels, while a ramp-up in government policies could result in further increases. 

“Overall, we see strong growth in development over the coming years, providing opportunities for growth investors and energy investors looking for more growth exposure as E&Ps continue to shift focus on cash returns to shareholders,” Gill wrote.

Starting with Greenlane, it’s an RNG equipment provider with a number of purification and RNG upgrading solutions for projects of various sizes. Gill said Greenlane is the only company offering water wash, pressure swing adsorption (PSA) and membrane separations systems the three main techniques used to purify sourced biogas, giving Greenlane a market advantage as it allows the company to bid on a broader number of projects. 

Gill said Greenlane is the leading RNG upgrading equipment provider with installed capacity now in 19 countries and so far has been the first RNG project equipment provider in 12 countries with some of the largest jobs worldwide under its belt.

“Greenlane Renewables is a pure-play renewable natural gas (RNG) upgrading equipment provider with a fast-growing revenue stream and positive EBITDA reached in Q4/20. The company runs an asset-light model, holding key IP for its biogas upgrading designs while outsourcing fabrication. Financially, the company is very well positioned with $35.6 million ($40.1 million net working capital) of cash on hand and no debt outstanding,” Gill wrote.

Greenlane hit positive EBITDA in its fourth quarter of 2020, with Gill now expecting EBITDA margins to ramp up significantly in coming years as equipment demand expands. As for catalysts, the analyst said he’s watching for growth in the company’s order backlog which he sees picking up after a lull during COVID, meanwhile funds from its latest equity raise will be deployed into RNG infrastructure ownership and potential new business lines, both of which could drive “a meaningful shift in growth projections and upside potential,” Gill said.

“We believe given the growth potential in the RNG space and Greenlane showing profitability, the near-term valuation will remain elevated as the market will price in future growth. Continued near-term growth will confirm views around long-term potential, and we believe there are meaningful catalysts ahead for the company with the deployment of funds for new ventures and/or RNG project ownership,” he said.

By the numbers, Gill is expecting Greenlane to generate full 2021 revenue and EBITDA of $52.6 million and $1.4 million, respectively, which should then run to 2022 top and bottom numbers of $72.4 million and $5.6 million, respectively, and 2023 numbers of $90.0 million and $10.2 million, respectively. EV/Sales for GRN is expected to go from 2.3x in 2021 to 1.7x in 2022 and then 1.3x in 2023, while EV/EBITDA is expected to go from 84.8x in 2021 to 22.3x in 2022 to 11.4x in 2023.

With his “Buy” rating Gill is pairing a 12-month price target of $1.60, which would translate into a return at the time of publication of 48.1 per cent.

“We see [GRN’s] valuation normalizing over time to ~8–9x, in line with the small-cap industrial average. Currently, we see Greenlane trading at a 7.3x EV/EBITDA in 2024, so, at this point, we believe the market is fairly valuing growth over the next three years on our forecast,” Gill wrote. 

“Looking at our $1.60 target implies the valuation shifts forward one year with some slight improvement given confirmation of very strong near-term EBITDA growth (185 per cent from Q4/21 to Q4/22), to ~9.0x in 2025. We believe if Greenlane can show the growth expected by the market and the outlook remains robust, a fair valuing of four- year growth potential will remain in the stock, justifying our target price valuation,” he said.

On Xebec Adsorption, the company is a multi-line gas equipment and services provider with PSA solutions in the RNG sector, hydrogen solutions through its European-based subsidiary HyGear and other industrial gas generation through its Inmatec subsidiary.

Gill said Xebec’s wide and decentralized product offering in the growing RNG field along with its solid recurring support and service revenue stream are positive markers, where 43 per cent of revenue over the last four quarters came from its Support segment. Over the near term, Gill said the most important driver for the company is the order for 18 BGX Biostream units from San Francisco-based waste solutions company Brightmark LLC. 

Going forward, Gill said continued profitability and momentum in Xebec’s order backlog will be key catalysts for the company and stock. 

“Xebec’s profitability challenges have been partially attributed to delivering non- standardized RNG equipment with cost overruns impacting returns. With the [Brightmark] order, the company is focusing on a standardized design, which is expected to drive better margins. In total, Xebec is building 30 of these units over the next year,” Gill said.

Gill’s estimates has Xebec hitting 2021 revenue and EBITDA of $120.5 million and negative $6.1 million, respectively. For 2022, those numbers go to $173.1 million and $13.4 million, respectively, and for 2023 they go to $212.6 million and $24.7 million, respectively.

With his “Hold” rating on XBC, Gill has a target price of $2.35 for a projected one-year return of 21.8 per cent at the time of publication.

“The market growth potential in RNG and hydrogen is substantial as the world moves toward stronger emissions goals, which will help support a higher valuation in the near term. Xebec’s decentralized offerings for hydrogen, industrial and medical gases also help with logistical issues and associated costs. The key bridge for the company to cross is to continue growing EBITDA,” he said.

“With Q3 results the company was able to return to positive adjusted EBITDA (after the prior five quarters of negative EBITDA), and we believe showing EBITDA growth with year-end 2021 results and into H1/22 will be a positive catalyst for the stock. That said, we believe investors should take a wait-and-see approach to ensure that margins remain on a constructive trajectory,” Gill wrote.