Eco Investor October 2015

Core Securities

Can Energy Action Regain its Earnings Growth Profile?

By Simon Turner
Principal
Rising Star Research

Energy Action is a provider of business energy procurement and consultancy services. The company launched in 2000 and listed in 2011. It appeared to be a true growth stock for the first two years on the ASX but more recently Energy Action has been an under-performer as the market has questioned the company's long term earnings growth prospects. We investigate the company's earnings growth prospects at this time of uncertainty.

During the 2014/15 financial year Energy Action reported an impressive 25 per cent increase in revenues but a net profit decreased of 41 per cent. The impressive revenue growth was largely driven by the acquisition of Energy Advice which contributed for 10 months of the financial year. And the dramatic margin drop reflected lower Activ8 revenue (online energy usage data platform), the Projects & Advisory Services (efficiency & sustainability consultancy) product mix and bad debt write-offs. However, the biggest factor was a significant increase in the cost of goods sold due to lower high margin Monitoring revenues and higher low margin Projects & Advisory Services revenues.

Arguably the key question looking forward is will the recent shift towards lower margin revenue sources continue or are there credible reasons to expect a reversal of this trend?

One of the great aspects of Energy Action's business model is the high portion of recurring revenues based upon long term contracts, which provides excellent visibility looking forward at least a year. If we look at the company's future contracted revenues for the next couple of years, the first point to highlight is that despite the recent loss of clients, future contracted revenues are pretty stable but are not growing at the same rate as in recent years. It is also noteworthy that the contribution of Projects & Advisory Services is running at 14 per cent of the 2015/16 future contracted revenue base versus 7 per cent for the reported 2014/15 financial year.

Given the shift towards Projects & Advisory revenues was a key driver behind the company's margin contraction last year, it seems likely that the same margin challenges will be a factor again in 2015/16. It seems fair to say that Energy Action's management have a solid track record of managing the contract management business but are finding it challenging to manage the very different consultancy business. This is not surprising given how different these two models are and we see minimal synergies between these two sides of the business.

Company management are obviously aware of the margin challenges and are looking to drive earnings growth longer term through a number of recently announced actions. Management are aiming to expand the customer reach with the release of a new platinum version of Activ8 as well as a number of other service level improvements. In addition, they are aiming for operational improvements driven by some further internal restructuring, better utilisation in Projects and Advisory and more automation across the business. It is positive that management are both aware of the challenges, particularly the utilisation rate within Projects & Advisory, and are taking action which should help margins over the longer term. The strategies mentioned all make good sense.

Time will tell whether management can turn around the recent margin decline. Micro Equities clearly believe they will be successful since they recently bought a position in the company. It seems fair to say that whilst there may be further margin pressure in the short term, the longer term picture is clearly improving due to recent management action. Investors will be wishing management good luck with the turnaround.

 

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