Regular readers will know that I've long followed the fortunes of an energy broker and energy efficiency company called Energy Action Limited (ASX: EAX). It has, in the past, attracted smart-money hoping to profit from the ongoing electricity price inflation.
The attractions are obvious: the company's reverse auction platform called the Australian Energy Exchange (AEX) allows clients to procure gas and electricity at the lowest possible prices. The company's high margin monitoring business helps those customers ensure that they abide by their low-cost energy contract, and keeps tabs on the energy retailers. Finally, when a customer was motivated to reduce energy bills further, Energy Action could provide energy efficiency solutions for them.
The first line of business, the AEX, is fairly low margin, but it provides a clear selling point because it immediately saves customers money. It also gives the company an in, and makes it easier to sell the high margin monitoring services, which cost little extra to replicate. Indeed, both these lines of business require relatively little capital expenditure. Best of all, they provide sticky recurring revenue.
The third line of business – energy efficiency solutions – is a different beast. Because improving energy efficiency usually requires actual hardware, as well as case-by-case analysis, it's relatively capital intensive. There are no real barriers to entry, and competition is fierce. For example, another ASX-listed company called Ecosave Holdings Ltd (ASX: ECV) also offers somewhat similar services. That company recently informed the market of adverse changes to Victorian government energy efficiency programs. Unlike Energy Action, Ecosave earns revenue from the USA as well as Australia.
The contract-based nature of energy efficiency businesses mean that margins can quickly come under pressure when demand falls. Worse still, a lot of demand has been spurred by government measures, which are being aggressively wound back since falling electricity demand is hurting the interest of powerful players like Origin Energy Limited (ASX: ORG), who are seeing energy retailing profits fall away.
In December 2013 and then again in May 2014, Energy Action forecast that operating NPAT would be approximately in line with FY 2013 operating NPAT of $4.9 million. As it turns out, operating NPAT was down 8% to $4.5 million, and statutory NPAT was down 20% to $3.5 million. The dividend was cut 15%.
The company managed to grow revenue in its low margin "projects & advisory services" energy efficiency business, thanks in part to the acquisition of Energex. In fact, further expansion by acquisition into the low margin project business is on the cards, as the company announced it would take on debt to fund the acquisition of EnergyAdvice for the bargain price of 9x the average EBIT of FY2012 – FY2014. No word on what EBIT was for FY 2014.
This move makes a lot of sense for CEO Scott Wooldridge, because 75% of his performance bonus is awarded if the actual operating earnings per share are higher than the budgeted operating earnings per share, whatever that is.
As speculators who lost all their money invested in Forge Group will know, it's pretty easy for a CEO to grow earnings per share, especially if they inherit a strong balance sheet. Simply by spending that cash and taking on a little debt, earnings will be boosted. The sad irony is that this performance hurdle will be achieved even if it is contrary to the long-term interest of shareholders and substantially weakens the company.
I sold my last few Energy Action shares on August 19 as soon as the market opened, having disposed of most of my holding last year. Unfortunately, I wasn't as clever as the various members of the board who have sold almost 5 million shares between them over the last two years. On the other hand, long-term focussed fund managers IOOF Holdings Limited (ASX: IFL) are still buying shares.
Energy Action does have the right ingredients to be a really great investment, but I question whether it has the right leadership. Despite the fact that the company is paying more and more to its executive level managers as well as lining the pockets of various consultants, results are getting worse.
Now that the share price has dropped below $2.80, it's arguable that the company deserves a spot on your watchlist. In fact, one analyst I admire thinks this may be the low-ebb for the company.
For now, I'm going to follow Warren Buffett's advice to only invest in shareholder-friendly management of the highest quality. However, Energy Action will remain on my watchlist. After all, I might be underestimating the acquisition strategy.
