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Alkane Energy is a fast-growing independent power producer and looks well positioned to profit from the looming energy crunch
July 31, 2014

If you followed our advice this time last year to buy shares in independent power producer Alkane Energy (ALK) and sold six months later - when we said take profits - after shale gas speculation disproportionately boosted the share price, you would have banked a quick 29 per cent profit before dealing charges.

IC TIP: Buy at 36p
Tip style
Growth
Risk rating
Medium
Timescale
Long Term
Bull points
  • Transformational acquisitions
  • Structural growth in 'power-response' generation
  • Shares lowly rated
  • Free upside on shale gas
Bear points
  • Weak power prices
  • Bedding in period could dent profits

We've been waiting for another buying opportunity and it has arrived. Alkane's shares have drifted below the level where we last tipped them and again offer excellent value, rated at just nine times next year's forecast earnings compared with 19 times at their peak. Technical analysis suggests they are oversold, too - the 14-day relative strength indicator has plunged to a three-year low. This technical set-up often produces a sharp bounce from a support level.

More importantly, the fundamentals of Alkane's power-generating business remain strong. The company continues to enjoy steady annual growth at its base load operations, where power is generated 24/7 by extracting methane gas from abandoned coal mines and converting it into electricity using onsite generators. It sells the electricity to National Grid (NG.) at a healthy mark-up. Alkane had 18 coal-mine methane (CMM) sites operating in the UK at the start of 2014, with an installed capacity totalling 45 megawatts (MW). It plans to bring two more sites on-line this year.

However, Alkane's relatively new power-response operation is the fastest growing part of the group. Here, Alkane buys gas wholesale and turns it into electricity during times of peak demand when prices are highest. Installed capacity was 36MW in December 2013, but this has risen to 92MW following two attractively-priced acquisitions this year, including the £12m purchase in July of three power-response companies with a combined generating capacity of 49MW.

ALKANE ENERGY (ALK)

ORD PRICE:36pMARKET VALUE:£53m
TOUCH:35.5-36p12-MONTH HIGH:52pLOW: 36p
FWD DIVIDEND YIELD:0.8%FWD PE RATIO:9
NET ASSET VALUE:27pNET DEBT:38%

Year to 31 DecTurnover (£m)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
20119.52.02.3nil
201214.72.93.00.10
201320.63.43.00.20
2014*22.04.22.90.25
2015*25.25.94.00.30
% change+15+40+38+20

Normal market size: 7,500

Market makers: 6

Beta: 0.4

*Arden Partners adjusted forecasts

The shift into power response makes sense because the UK's energy mix is becoming more varied and complex, with increasing dependence on energy from intermittent renewable sources such as wind farms. The ability of power response to fire up quickly during peak evening and winter demand means that it is becoming increasingly important to the UK grid. Moreover, the UK's power regulator, Ofgem, predicts spare generating capacity could fall as low as 2 per cent by 2016 as old power plants are shut down. Ofgem has repeatedly warned of a looming energy crunch and a heightened risk of power shortages or cuts over the coming years.

Granted, power prices have actually been weak this year following the warm winter and the plummeting price of coal. But Alkane has already contracted to sell 74 per cent of its 2014 base load output and 50 per cent of the 2015 load at the same price as last year or slightly higher. The new acquisitions will also take several months to bed in, denting profitability. Combine that with the dilutive effects of an £8m share placing, and EPS are forecast to fall slightly this year before soaring nearly 40 per cent in 2015 (see table).