Leclanché — Brakes off

Utility-scale generation and microgrids

While the ramp-up in growth in large-scale energy storage systems was held back by working capital constraints during FY17, the successful sourcing of finance (see below) meant this was no longer an issue during H118. Segmental revenues totalled CHF19.0m compared with only CHF1.4m in H117, as the company delivered on several major projects. These included a 34.8MWh battery energy storage plant in Cremzow, Germany; a 15MWh project for SWB in Bremen, Germany and a 19.5MWh project in Marengo, US. Segmental EBITDA losses widened from CHF2.0m to CHF5.2m. Profitability was affected by the switch to the IAS 15 standard for recognising revenues, which led to the business incurring costs on some projects that are not matched against revenues as these will not be recognised until H218 (the standard has not been applied retrospectively). Additionally, there was a big increase in personnel costs as the business unit worked on multiple large projects in parallel.

Management notes that it is on track to deliver a cumulative total of 100MWh of operational projects by the year end, thus doubling the installed base in the space of a year. However, several major projects, including one in the Caribbean on which management had expected to be working during H218, have been delayed for an unspecified period because the third parties involved have not yet secured the project financing required. We therefore reduce our FY18 delivery estimate from 70MWh to 46MWh. Management does not expect the delay in this individual project to affect FY19 deliveries as there are so many utility-scale projects in the pipeline, reflecting the increasing popularity of battery energy storage systems to smooth out the fluctuating output from renewable energy sources. We therefore leave our delivery estimates for FY19 and FY20 unchanged at 100MWh and 150MWh respectively. (See Exhibit 3 for a summary of the changes to revenue estimates for each business unit.)

Segmental revenue rose from CHF0.1m in H117 to CHF0.6m as the company worked on the test phases of programmes for electric bus battery packs with Sun Mobility in India and Skoda Electric in Europe. Segmental EBITDA losses widened from CHF0.6m in H117 to CHF3.2m, partly as a result of IAS 15 adoption, partly as a result of increased staffing levels ahead of volume deliveries. These are for battery rack systems for 12 vessels and offshore rigs collectively totalling more than 50MWh for Kongsberg Maritime, as well as the Sun Mobility and Skoda Electric projects.

Noting the new order from Kongsberg and the progress on the programmes with Skoda Electric and Sun Mobility, we leave our segmental estimates unchanged. These assume volume deliveries on the Skoda Electric programme from FY19 onwards and on the Sun Mobility programme from FY20 onwards. Management anticipates that the Skoda Electric agreement will require deliveries of c 100MWh energy storage over a four-year period and the Sun Mobility programme annual volumes of 90-150MWh. The design for Skoda has been completed and Leclanché is constructing the battery packs required for independent certification. The first electric bus deploying the solution is scheduled to commence regular commercial service in December 2018. Leclanché has already delivered battery modules to Sun Mobility for certification including road trials. Management expects to announce the results of this phase by end FY18.

Segmental revenues halved to CHF1.6m while EBITDA losses widened from CHF0.6m to CHF2.2m. This reflects the cost of working on projects for the Swiss army, where revenues will not be recognised until H218, together with delays in fulfilling materials handling-related work. Since we do not expect the business unit to catch up on this lost revenue during the second half of the year, we reduce our FY18 segmental revenue estimates but leave our FY19 and FY20 segmental revenues unchanged.

Energy efficiency solutions

Segmental revenues declined from CHF1.2m to CHF0.9m, while EBITDA losses widened from CHF0.1m to CHF0.2m. Initiatives to expand both the portfolio of third-party batteries it distributes and the sales channels have not yet succeeded in delivering any segmental growth. We therefore reduce our segmental revenue estimates for FY18, FY19 and FY20.

Group revenues (including other income) more than doubled to CHF22.3m. Raw materials and consumables used remained close to revenue levels, as the breakthrough in energy efficiency that would materially change this metric is not expected to be implemented in commercial battery cells until FY19. Personnel costs grew by 12% year-on-year, reflecting the recruitment of more than 45 people (now c 155 staff) in production, R&D, project management, and energy storage system design. This investment is necessary to support increased cell and module output volumes for the large projects on which Leclanché is working and to carry out engineering, procurement and construction (EPC) activities for some of these projects. Other operating expenses almost doubled to CHF11.5m, distorted by CHF5.7m exceptional costs, which are primarily related to financing activities. Stripping out these exceptional costs, EBITDA losses widened by CHF7.5m to CHF17.1m.

Management continued with its financing programme (see Exhibit 2). Net debt increased from CHF19.5m (including CHF22.7m convertible loans) at end FY17 to CHF50.0m (including CHF46.6m convertible loans) at end H118. Key items include a CHF13.6m increase in working capital linked to revenue growth, the large (CHF25.2m) loss for the year and CHF2.2m capex. This was invested in the R&D facility, production capacity in Germany ahead of volume ramp-up in FY19 and completion of the module assembly line. Management notes that it has sufficient funding to fully finance the company through to FY20, when it expects to be EBITDA positive.

As a result of this financing activity, FEFAM has substantially increased its stake in the company. (FEFAM is AM INVESTMENT SCA, SICAV-SIF - Liquid Assets Sub-Fund, together with FINEXIS EQUITY FUND - Renewable Energy Sub-Fund, FINEXIS EQUITY FUND - Multi Asset Strategy Sub-Fund and FINEXIS EQUITY FUND - EMoney Strategies Sub-Fund (also called Energy Storage Invest).) At the end of H118, FEFAM held a 48% stake. It now holds all of the convertible loan notes, including CHF20.0m not on the balance sheet at the end of June 2018, (this is the additional funding that FEFAM agreed to provide in June). If this CHF66.6m of loan notes was all converted to equity, it would give FEFAM a 68% stake in the company. FEFAM has confirmed its plans to convert CHF54m of its debt to equity later this year (this is in addition to the CHF16.5m converted in February). A further takeover waiver is being sought to cover this transaction.

At the end of June 2018, management noted that the company was working on a confirmed order book of over 50MWh, which it expected would contribute CHF40-50m revenues in FY18. It did not provide explicit guidance at the time. Our estimates assumed that additional utility-scale orders would be received for delivery in H218, given the size and likely timescales of projects in the pipeline, raising revenues above the CHF40-50m level. However, several contracts relating to utility-scale projects have been delayed because the third parties involved are still in the process of securing project finance. As a result, Leclanché’s management noted at the interim stage that the company was on track to double revenues during FY18. If we treat ‘Other income’, which includes grants for developing an energy storage system for an e-ferry, as revenues, this is equivalent to guidance of at least CHF36m. We therefore revise our estimates to reflect:

Because Leclanché’s transition from traditional battery manufacturer to vertically integrated battery energy storage system provider has not yet generated operating profits, the use of peer-based multiples is limited as a valuation methodology. Moreover, while management has good visibility of projects totalling over 1GWh of capacity, there still remains significant uncertainty as to how quickly it will be able to deliver on the projects. Given this level of uncertainty, we present a scenario analysis with the base case adopting the rate of revenue growth and costs as shown in our estimates from 2018 to 2020. Using this as our basis, we model potential revenues rising with a CAGR of 37% between 2018 and 2027, assuming that a substantial proportion of battery cell manufacture from FY20 onwards will be carried out by local partners for projects in China or India, thus reducing capex. Applying a terminal growth rate of 3% and WACC of 10%, (both unchanged since our June note), our base case gives an indicative valuation of CHF2.33/share (previously CHF2.51/share).

Clearly, there is no certainty that the individual projects contributing towards the revenue growth adopted in our valuation will progress as expected. However, we note that the technology being deployed is proven and Leclanché has already demonstrated that it can deliver on large projects. While there remains a risk that individual projects may not come to fruition, there is rising demand for battery energy storage for both stationary grid-related and e-transport applications, with very few companies able to offer the battery modules, energy management software and engineering, procurement and construction services that Leclanché can. This puts it in a good place to win work on alternative projects.

The current share price suggests the market is assuming a slower growth rate than that adopted in our estimates. Our reverse DCF calculation generates an indicative value similar to the current share price when revenues are scaled back by 3% across the forecast period. This indicates the potential for modest share price appreciation as Leclanché demonstrates it is able to convert the existing pipeline and achieve the growth rate shown in our estimates. Giving some view of what might happen to valuation if revenue growth is faster than the rate assumed in our base case, our ‘high’ case shows that scaling up revenues by 10% gives an indicative value of CHF3.64/share.