Advanced Emissions Solutions ($ADES) — Initiation (1/9/21)

This is a quick idea since there are a slew of unanswered questions about the business… I have a small position. It was larger at one time but has shrunk as the original thesis played out and they made a bone-headed acquisition…

Here’s the quick take with the open questions…

This is going to be the skinny version since the situation is changing pretty quickly.

ADES has 2 segments:

  • Refined Coal (RC) — Is a glorified tax vehicle. Obama era tax incentives to subsidize production of chemically treated (refined) coal was designed to reduce emissions. There are a limited number of facilities doing this and ADES controls several of them. Through a JV with Goldman Sachs they generate contractual cash flows in exchange for these tax subsidies. Oddly enough, insurance broker AJ Gallagher is the largest player in this niche space. This tax program expires at the end of 2021, thus killing off this segment — wind-down costs still an unknown.
  • Power Generation and Industrials (PGI) — Produces “activated carbon” used mainly in coal-fired power generation. They operate a lignite coal mine and This segment was acquired in late 2018 for ~$75m. But the company is hoping to break into water filtration and some other non-coal markets.

The RC segment had these contractual cash flows for years and ADES has used most of that cash for buybacks and a hefty dividend (total of $3/sh since 2H17). Then in late 2018 they made a $75m acquisition (PGI segment) and have since been focused on repaying that debt.

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Here’s the visual layout of cash generation since mid-2016 when the RC segment started kicking in…

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Free cash flow totaled $174m (don’t forget some of the equity earnings flowing through investing cash flows) — spent almost evenly between dividends ($59m), buybacks ($50m), and M&A ($64m).

The RC segment still has another $95-115m in cash flow left to generate until end of 2021.

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After that, we’re left with the activated carbon business…

A word on activated carbon…

In November 2018, when ADES acquired the activated carbon business, they thought they’d be getting ~$18m in annual EBITDA. That hasn’t happened as the business has been generating losses ever since. With the decline in coal generation, it’s unlikely this business will ever get back to what it once was…

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It’s not necessarily a bad business though. Competitor Calgon Carbon was acquired in 2018 for >20x EBITDA. Although Calgon had a much larger share in water and industrial markets with near-zero exposure to coal. ADES is in the opposite camp with 90% exposure to coal-fired power gen in their activated carbon business. The Cabot deal is a step in the right direction, giving them exposure to better end-markets and a good customer.

Activated carbon market overview

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So here’s the scoop…

  • At ~$5.50 this stock is a $100m market cap and $115m enterprise value
  • Refined coal should generate another $95-115m in cash over the next 5 quarters (before corporate costs)
  • PGI segment signed a new contract with chemical co Cabot that should generate $10-15m in EBITDA once fully ramped in 18-24 months
  • My ballpark corporate costs are $3-4m per quarter right now = ~$15-20m total cost by end of 2021 — management is targeting $5m in annual savings here
  • By yearend 2021, this business presumably has a large net cash position with a profitable long-term contract and prospects for additional customers

If you’ve done the math, that’s roughly a $15-40m enterprise value by yearend 2021 with a nice little long-term contract with a great company (Cabot) and a possibility to add more like it.

Still plenty of unknowns but if they can keep a lid on corporate costs and achieve the $10-15m targeted EBITDA level from the Cabot contract (admittedly a huge if), then this is a sub-$6 stock with $3-4 per share in net cash and a path to positive earnings…

For now, this is a tiny position as a lot could go wrong in taking on a new material contract. The balance sheet is fine and they’ll still generate plenty of cash all year but a good portion of that might already be spoken for… If the Cabot deal starts picking up sooner or if they land another non-coal customer, then this could get interesting pretty quickly. A Calgon Carbon multiple is possible if they can get some traction…

Questions still on the table…

  • Will it cost a lot of money to wind down the refined coal segment after 2021?
  • What do corporate costs look like after any cost savings?
  • What is total cost exposure to the Cabot ramp-up / reclamation?
  • After debt is repaid, what are plans for using cash?