Clear guidance on government policy is a prerequisite for businesses. That’s because it impacts investment decisions and the purchasing activity of customers. Any policy change should therefore be enacted in a way that minimises disruption. This is not always the case.
The UK government has unexpectedly announced its intention to change the legislation that governs development in nitrate-sensitive areas with no prior consultation and without releasing details of how the new scheme will work. Since 2017, developers have been required to ensure new developments do not cause increased nitrate emissions into the local environment. Many have done so by installing control flow technology in homes, which reduces nitrate emissions by cutting the amount of water used.
However, through the levelling-up and regeneration bill, the UK government plans to remove this obligation on developers and replace it with an enlarged mitigation programme through The Department for Environment, Food and Rural Affairs’ natural England nutrient mitigation scheme. It is based on the generation of nutrient neutrality credits that are created by projects and then purchased by developers to offset the emissions from the new construction.
Ultimately, this could be good news for companies such as Eneraqua Technologies (ETP:73p). If the approach of generating and supplying credits is maintained, there may be enhanced opportunities for its Control Flow HL2024 technologies, which are the lowest-cost offset solution on the market. However, the group has no clarity at this point and will now engage with the government to understand the exact nature of the new scheme.
Bottom-fishing buying opportunity
Eneraqua’s directors had budgeted that work relating to the prevailing net nutrient neutrality rules would generate up to £2mn of cash profit in the financial year to 31 January 2024. It now expects clients to delay all, or a large majority, of this work until there is clarity on the details and mechanics of the UK government's proposals.
Analysts at Singer Markets reduced their cash profit estimates by £2mn in both the 2024 and 2025 financial years to £7.3mn and £9.6mn, respectively, on revenue of £90mn and £104.5mn. The downgrade led to 28 per cent and 23 per cent cuts in their pre-tax profit forecasts to £5mn (2024) and £7mn (2025). On this basis, expect earnings per share (EPS) of 11.3p (2024) and 15.6p (2025), implying that the shares are rated on price/earnings (PE) ratios of 6.5 and 4.7.
Moreover, having returned to a £0.5mn net cash position at the 31 July 2023 half-year-end, Singer is pencilling in year-end net cash of £2.6mn (7.8p) for the £24.2mn market capitalisation company and a 14 per cent higher annual dividend of 1.4p per share, implying a prospective dividend yield of almost 2 per cent.
Heat pump business powering on
It’s important to note that the group’s major income-generating activities, the provision of heating and hot water heat pump systems, are not impacted by the uncertainty.
Indeed, notable major contract wins that will commence in the second half of the 2023-24 financial year include the group’s first NHS Trust award, an £11.3mn contract involving the replacement of an end-of-life combined heat and power (CHP) and steam boiler with a low-carbon heat pump solution; a £12.7mn contract for the replacement of an end-of-life gas-fired heating system with a low-carbon heat-pump-based system in west London; and a £7.2mn contract for the replacement of an old gas-fired system with a new low-carbon heat pump solution for a museum, art gallery and leisure centre complex.
These contracts have helped boost Eneraqua’s order book by 14 per cent since early May 2023 to a record £146mn, of which £70mn will be recognised in the second half of the current financial year and the balance in the next financial year. Please note that revenue is historically weighted to the second half given that public sector clients tend to award contracts ahead of the year-end since grant awards are made in the autumn. Although the second-half weighting will be more pronounced in the current financial year due to the impact last year of inflation on clients’ capital budgets, the order book still provides strong visibility. Reassuringly, the directors point out that the inflation impact from last year is unwinding, a positive for further growth in the order book to de-risk earnings forecasts for the 2024-25 financial year.
Share price falls to record low
So, although Eneraqua's share price fell to a record low of 73p following the profit warning and has been under pressure since I rated the shares a hold at the annual results in late May, I feel bottom-fishers should be rewarded. Singer’s target price of 190p (from 249p) and Liberum's 235p target (from 335p) are not only materially above the current share price, but are well supported by projected earnings and delivery of a bumper and growing order book. Recovery buy.
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