Ellomay Capital — Reinvestment in asset growth

Ellomay is an owner, operator and developer of renewable power generation assets. It is active in Israel and developed European markets such as Italy, Spain and the Netherlands. Management is currently focusing on reinvesting the cash generated by its solar plants in Italy and Spain to grow assets and maintain the yields.

We use a sum-of-the-parts method to derive a fair value for Ellomay of $11.3/share, after applying a valuation discount of 20% to reflect its 31.7% free float and limited trading volumes. We use DCF models to value its 30.5MW operating solar power plants in Italy and Spain, 9.375% stake in the Dorad Power Plant, the recently acquired 9MW Talmei Yosef solar project in Israel and the waste-to-energy (WtE) project in Goor and Oude-Tonge scheduled to be operational in Q417 and Q218, respectively. We use book value for its early-stage pipeline. We forecast Ellomay’s net debt to increase from $55m in H117 to $89m in FY18, mainly to reflect the $23m net debt of the Talmei Yosef project once consolidated into Ellomay. Its current market cap of $83m is only $3m higher than the adjusted book value of its projects (acquisition value of existing operating assets of $135m less net debt of $55m in H117). Our SOTP valuation suggests the market does not fully factor in the upside from the announced acquisition of a 9MW solar plant in Talmei Yosef, Israel (deal closed in October 2017) or the scheduled completion of the two WtE plants in the Netherlands. The Talmei Yosef plant is expected to bring in revenues of $4.5m and the WtE plants revenues of €6.9m pa.

Assuming no further regulatory interventions from the Italian or Spanish governments on solar subsidies of operating projects, Ellomay should be able to continue to enjoy stable cash flows (at $10m pa) and profits from its solar plants (an EBITDA margin of 79-84% in 2013-16). At this juncture, management is focusing on asset acquisitions and project developments to create new sources of revenues/profits. Leverage has gone up as a result (net debt to equity ratio up from 41% in H216 to 61% in H117). Net loss was c $5.2m in H117, more than 3x the H116 level, primarily due to higher finance expenses of $5.5m (up 117% y-o-y), which included $1.7m of hedging and $2.3m of forex losses. We have increased our revenue estimates for FY18 to take into account new revenue streams; however, higher debt and the financing expenses associated with hedging and forex losses in H117 have brought our normalised EPS estimates from $0.26 to $-0.13 for 2017e.

Investors in Ellomay should take heed of the following risk factors:

Ellomay owns solar photovoltaic (PV) power plants in Spain and Italy and is developing new projects with similar characteristics – regulated, capital-intense, long-term projects – in Europe and Israel. Currently, its operating assets comprise photovoltaic plants: c 22.6MW in Italy and 7.9MW in Spain. Meanwhile, the company has a 9.375% indirect interest in the Dorad Power Plant, a bi-fuel combined cycle power plant that supplies 6% of electricity consumption in Israel. Management is currently focusing on reinvesting the $10 of operating cash flows generated pa (at a 10% cash yield) from its solar plants in Italy and Spain to grow assets and maintain the yields.

New projects include the acquisition of an operating 9MW solar power plant in Talmei Yosef, Israel, in October 2017, and the completion of two WtE projects in the Netherlands: the Goor plant in Q417 and the Oude-Tonge plant in Q218. The early-stage project pipeline includes a 340MW pumped storage hydro plant in Manara, Israel, and a 300MW photovoltaic project in Talaván, near Cáceres, in the southern region of Extremadura, Spain.

Assuming no further regulatory interventions from the Italian or Spanish governments on solar subsidies of operating projects, Ellomay should be able to continue to enjoy stable cash flows (approx. $10m per year) and an EBITDA margin of 79-84% (in 2013-16) from its 22.6MW photovoltaic plants in Italy and 7.9MW in Spain. The 10% cash yield from these plants is the source of internal funding for asset acquisitions and project developments.

Currently, the operating photovoltaic plants in Italy and Spain account for almost 100% of Ellomay’s revenue and substantial operating cash inflows. Typically, the 22.6MW solar power plant in Italy generates €10m and the 7.9MW plant in Spain has €2m in annual revenues. We estimate that 86% of Ellomay’s revenues in Italy and 77% of its revenues in Spain are regulated. In each country, the company has minimal exposure to spot prices.

These solar power plants account for approximately 55% of Ellomay’s project asset value on its balance sheet. Out of its H117 net debt of approximately $55m, $17.5m is the outstanding debt for these plants (including the combined 5.6MW in Spain acquired in 2014, shown in the table below). We estimate maintenance capex for Ellomay’s operating solar in Italy and Spain to be minimal.

For 2018, management is aiming to create new revenue streams with the completed acquisition of a 9MW solar plant in Talmei Yosef, Israel, in October 2017 and the completion of two WtE plants in the Netherlands. The Goor project is scheduled to come online in Q417 and the Oude-Tonge project possibly in Q218. The early-stage project pipeline includes a 340MW pumped storage hydro plant in Manara, Israel, and a 300MW photovoltaic project in Talaván, near Cáceres, in the southern region of Extremadura, Spain.

In June 2017 Ellomay announced its intended acquisition of 100% equity in a 9MW photovoltaic plant in Talmei Yosef, Israel, from Solegreen (TASE: SLGN) for a purchase price of NIS39m (approximately $11m). Management expects that the consolidation of this solar plant will increase net debt by approximately NIS80m (or $23m) in the consolidated balance sheet. In other words, the enterprise value of this plant is approximately $3.8/watt when both the equity value of $11m and net debt of $23m assumed by Ellomay are both taken into account.

The Talmei Yosef plant is currently under a 20-year power purchase agreement (which commenced in November 2013) with the Israeli Electric Company (the grid operator and the major electricity producer in Israel). The tariff currently applicable to the Talmei Yosef plant is NIS0.9857 (c $0.278) per kWh and the tariff is adjusted each year based on changes to the Israeli Consumer Price Index. The plant was constructed by Belectric with thin-film modules from First Solar, and these modules have a better performance at high temperatures compared with mainstream crystalline modules. Ellomay forecasts this plant to generate annual revenue of c NIS16m ($4.5m) and a net income of NIS4.5m ($1.3m).

The accounting treatment of this plant is based on IFRIC 12 (Service Concession Arrangements). On acquisition, this project will be included in the consolidated financial statement as a financial asset based on the present value of expected revenues under the service concession agreement. The financial asset classified as a receivable that will be gradually reduced over the contract period as revenues are received

In July 2016, Ellomay entered into a strategic alliance with Ludan Engineering Group (a publicly listed company in Israel) for the development of WtE projects in the Netherlands. Since 2011, the Ludan Group has constructed more than a dozen biogas power plants, mainly in Spain and the Netherlands. The expected overall cost of the pipeline projects under this co-operation framework, if all are realised, is €200m (including project financing).

According to the agreement, Ellomay will take up at least 51% in each project company and Ludan will hold the remaining stake. Ludan will also act as the engineering, procurement and construction (EPC) and operation and management (O&M) contractor of the projects (except for the first gasification project). Each project is expected to have an operational period of approximately 12 years under a 12-year SDE subsidy structure with the Dutch government. (SDE stands for Stimulering Duurzame Energieproductie in Dutch, meaning Encouraging Sustainable Energy Production.) Currently, two project companies have been set up: Groen Gas Goor B.V. and Groen Gas Oude-Tonge B.V., for the development of anaerobic digestion plants with a green gas production capacity of approximately 375Nm3/h in Goor and 475Nm3/h in Oude-Tonge, respectively.

The Goor project is targeting construction to be completed in Q417 and the Oude-Tonge project is scheduled to come online in Q218. Ellomay expects the Goor project to generate c €3.5m and the Oude-Tonge project to generate approximately €3.4m in annual revenues respectively, mainly from the subsidies granted for the sale of biogas to the grid, and the net income is likely to be in the range of €0.8-1.0m per annum for each project. The capex for the Goor project is approximately €10m, funded in part with a €5.6m loan facility by Rabobank. The expected overall capex of the Oude-Tonge project, approximately €8.5m, has been funded in part with c €5m loan facilities provided also by Rabobank. Ellomay management aims to achieve 7% unlevered IRR and 13% levered IRR during the 12-year contract period with the government for this plant.

The Manara Project is a pumped storage hydroelectric generation project in Israel, with an intended capacity of 340MW and the construction period likely to span over a time horizon of six years. Ellomay has a 75% interest in the project; the remaining 25% is owned by Sheva Mizrakot, a private company in Israel. The project company Ellomay Pumped Storage (2014) received a conditional licence in August 2016, valid for 72 months, from the Israeli minister of national infrastructures, energy and water resources. Management indicates that this project is still in an early stage and hence the revenue potential and required capex are not factored into our forecasts.

Hydro pumped storage enables the integration of new renewable and intermittent energies to the grid. In Israel, where solar energy is booming, hydro pumped storage plants are critical to securing the stability of the grid. The current quota determined by the Israeli Electricity Authority for pumped storage projects in Israel is 800MW. In the event these or other projects hit the milestones before Ellomay, it may have adverse effects on the intended capacity or realisation of the Manara project. Although there were discussions concerning the increase of the quota to above 1,000MW, there can be no assurance as to whether and when the increase will be authorised.

In January 2017, the Israeli High Court of Justice dismissed a petition filed by Ellomay against the minister, the Israeli Electricity Authority and the Kochav Hayarden pumped storage project in Gilboa. The petition was filed in connection with the decision of the Israeli Electricity Authority to extend the financial closing milestone deadline of the Kochav Hayarden project, which received a conditional licence for a pumped storage plant with a capacity of 340MW in 2014. In March 2017, a new petition was filed by Ellomay. In August 2017, GE Renewable Energy was awarded the contract to construct the 344 MW Kochav Hayarden project in Israel. The project is expected to take 4.5 years, involves the construction of two reservoirs, and is expected to be commissioned in 2021. If the Israeli government does not extend additional quotas for pumped storage and other projects get completed before Ellomay, the Manara Project may not materialise.

In April 2017, Ellomay Capital purchased the entire share capital of a Spanish company, Talasol Solar S.L., for €10m, for the development of 300MW of solar pipelines in Talaván, near Cáceres, in the southern region of Extremadura, Spain. The project capex (including development costs and interests) is expected to be €225-255m. The business case assumes annual revenue of €25m and operating expenses of €6m. Management indicates that this project is still in an early stage and hence the revenue potential and required capex are not factored into our forecasts.

Ellomay indirectly owns a 9.375% stake in Dorad Power Plant, a combined cycle power plant based on natural gas with a production capacity of ~850MW, located south of Ashkelon, Israel. Dorad Power Plant supplies 6% of Israel's total electricity demand, primarily to commercial customers. The Dorad Power Plant commenced commercial operations in May 2014. It is located on the premises of an affiliate of Eilat-Ashkelon Infrastructure Service (which owns 37.5% of Dorad).

Ellomay’s 9.375% stake generated profits of $2.4m and $1.5m in 2015 and 2016, respectively. However, the typically low season in Q217 combined with higher financing expenses (up 31% y-o-y) have contributed to Dorad’s net losses of NIS36m during Q2. Ellomay’s share of net loss from Dorad Power Plant was $0.1m in H117 (vs a profit of $0.3m in H116).

Ellomay’s 9.375% stake in the Dorad plant is via its 50% ownership of Dori Energy, which holds 18.75% of the Dorad plant. Dori Energy is jointly controlled by Ellomay and Luzon Group (a publicly listed company in Israel). Dori Energy’s representative on Dorad’s board of directors is currently Mr Hemi Raphael, who also sits on Ellomay’s board. The operating data for Dorad at plant level and specific details on cash paid to Ellomay via Dori Energy are limited. The contribution from Dorad to Ellomay’s P&L from Dori Energy consists of two components: (1) the share of Dori Energy’s net income; and (2) the interests of the loans Ellomay extends to Dori Energy, which in turns extends loans to Dorad. (It is worth noting that Dorad borrows from other shareholders as well.) Ellomay’s 50% stake in Dori Energy accounts for 100% of Ellomay’s total profits from equity method investments.

Since April 2015, Dori Energy (as 18.75% shareholder of Dorad Power Plant) has been engaging in litigations against Dorad’s other shareholders, Edelcom, Eilat-Ashkelon Infrastructure Service, and Zorlu Enerji Elektrik Uretim regarding the EPC and O&M contracts. Dorad previously entered into an O&M agreement with a wholly-owned subsidiary of Eilat Ashkelon Infrastructure Services (which holds 37.5% of Dorad). Some obligations under the O&M agreement were assigned to Zorlu Enerji Elektrik Uretim AS (which holds 25% of Dorad). In 2013, the Dorad O&M contractor entered into an agreement with Ezom (25% owned by Zorlu and 75% owned by Edelcom, which holds 18.75% of Dorad).

Chairman Shlomo Nehama and the Kanir Partnership (controlled by Director/CEO Ran Fridrich and Director Hemi Raphael) hold an aggregate of 68.3% of Ellomay. Senior management comes from a background in banking and asset management. Ellomay directly employs 10 employees, all except one being domiciled in Israel.

Investors in Ellomay should take heed of the risk factors typically seen among project owners and developers:

We use a sum-of-the-parts method to derive a fair value of Ellomay of $11.3/share (from $10.9/share before), after applying a discount of 20% to reflect its 31.7% free float and limited trading volumes. We use a DCF model to value its 30.6MW operating solar farms in Italy and Spain, its 9.375% stake in Dorad Power Plant, recently acquired 9MW solar in Israel and the two WtE project in the Netherlands scheduled to come online in Q417 and Q218, respectively. We use book value for its early stage pipelines (ie 340MW pumped storage hydro plant in Manara, Israel, and a 300MW photovoltaic project in Talaván, Extremadura, Spain). We forecast Ellomay’s net debt to increase from $55m in H117 to $89m in H218, taking into account $23m net debt from the solar project in Talmei Yosef, Israel and assuming management will continue to invest in new projects.

In the absence of the asset value for Ellomay’s different segments, our previous valuation was based on a blend of DCF, EV/EBITDA multiple and per KW installed capacity. Given that the company has disclosed the book value of different operating assets in different geographies, and the addition of non-solar assets, we derive our fair value by constructing DCF models for different types of assets (solar and waste-to-energy). We think that a comparison of our DCF valuations and the asset value can best crystallise the upside to Ellomay’s share price.

Ellomay’s current market capitalisation of $83m is only $3m higher than the adjusted combined book value (acquisition value of its project assets at $135m less net debt of $55m). Our SOTP valuation suggests the market does not seem to fully factor in the upside from the completed acquisition of a 9MW solar plant in Talmei Yosef, Israel, or the scheduled completion of the two WtE plants in the Netherlands. The Talmei Yosef plant is expected to bring in annual revenues of $4.5m and two WtE plants to generate revenues of €6.9m per annum.

There are a number of renewable project developers and owners listed in Tel Aviv: Sunflower Sustainable Investments, Enlight Renewable Energy and Energix Renewable Energies. There is no consensus data available for these names, but a look at their valuations based on historical financials may yield some insight.

Among the three Tel Aviv listed companies, we think Energix Renewable Energies is probably the best comparable to Ellomay. It also has a limited free float but management has been able to consistently grow assets in Israel and overseas. Energix Renewable Energies is 70% owned by Alony-Hetz Properties and Investments, a major real-estate investments group in Israel. It is worth noting that the high leverage of Enlight Renewable Energy contributes to its high EV related multiples.

We note that the majority of comparators listed in Europe and the US in Exhibit 12 are of a larger size and have more mature businesses.

Assuming no further regulatory interventions from the Italian or Spanish governments on solar subsidies of operating projects, Ellomay should be able to continue to enjoy stable cash flows (at $10m pa) and profits from its operating solar plants (at EBITDA margin of 79-84% in 2013-16).

We have increased our revenue estimates for FY18 to take into account new revenue streams; however, higher debts and the resulting increased financing expenses associated with hedging and forex losses in H117 have brought our normalised EPS estimates from $0.26 to $-0.13 for 2017e.

For FY17, we increase our revenue forecast by 7.4% to reflect higher spot electricity prices and better solar radiations in Italy and Spain and the contribution from the recently acquired a 9MW solar power plant in Israel. For FY18, we factor in the new revenue streams: $4.5m from the Talmei Yosef plant in Israel for the whole year; €3.5m from the WtE plant in Goor in the Netherlands (scheduled for completion in Q417) and €3.4m from the WtE plant in Oude-Tonge, the Netherlands, scheduled to come online in Q218.

Our updated normalised EPS estimates take into account financing income and expenses in relation to hedging contracts. Previously, the hedging related activities were not included in the normalised number.

H117 revenues were approximately $7.3m, up 13% y-o-y, as a result of higher spot electricity rates and higher radiations in Italy and Spain. Gross margin improved by 1,100bps y-o-y due to lower opex and depreciation. However, Ellomay incurred higher development costs (up 122% y-o-y) and higher financing expenses (up 117% y-o-y) due to higher leverage, $1.7m hedging losses and $2.3m forex losses. To fund project development and asset acquisitions, the company’s net debt increased by 61% from $34m in H216 to $55m in H117, following the issue of $33m of debentures in March 2017.

Ellomay’s 9.375% stake in the Dorad plant generated $2.4m and $1.5m profits in 2015 and 2016, respectively. However, the typically low season in Q217 combined with higher financing expenses (up 31% y-o-y) contributed to net losses of NIS36m during the quarter. Ellomay’s share of net loss from Dorad Power Plant was $0.1m (vs a profit of $0.3m in H116).

Ellomay has increased its net debt by 61% from $34m in H216 to $55m in H117 by issuing debentures in March 2017 with a nominal value of NIS123m (approximately $33m) at a fixed annual interest rate of 3.44%. It has gross cash of $43.5m, sufficient to pay for the consideration of 100% equity of the Talmei Yosef plant at $11m. The capex for the Goor project is approximately €10m, funded in part with a €5.6m loan facility by Rabobank. The €8.5m capex requirement for the Oude-Tonge project (scheduled to be completed in Q218) has been partly funded with c €5m loan facilities provided by Rabobank. The capex for these two WtE projects have been reflected on Ellomay’s balance sheet. Out of its current net debt of approximately $55m, $17.5m is the outstanding net debt for its operating solar plants in Italy and Spain.