Beacon Securities UpdateXebec Adsorption (XBC-V) A Raging Bull Put In The Penalty Box For a Bit March 12, 2021 Ahmad Shaath, CFA, MBA (416) 507-3964 ashaath@beaconsecurities.ca
Xebec provided an updated FY20E guidance that called for lower revenues (~24%) and potentially negative gross margins driven by lackluster performance in RNG. Overall the revisions for sure will put Xebec in the penalty box for sometime however we remain focused on the long-term prospects of the company that are driven mainly by Hydrogen, and we see the pull back in shares as a buying opportunity. We pushed the reset button on our FY21E outlook, revising RNG revenue by 40%, removing any acquisitions in the Service segment as well as reducing the organic growth rate, factoring in Inmatec at virtually zero growth and resetting our margin expectations as well. Based on this worst case view, our FY21E revenue and EBITDA are lower by 13% and 52%, respectively. Recognizing that investors will have trust issues and XBC shares will be in the penalty box, we revise our valuation multiple to 8.0x (vs. 11x previously). Our new target price of $7.50 represents a very conservative view on XBC’s outlook with significant room for upward revisions as we get more clarity with FY21E guidance.
Guidance Revision Driven by Cost Overruns and Money-Losing Contract Cancellations. Xebec announced that its revenue for FY20E will be ~$57 million (vs. previous guidance of $70-$80 million), gross margin will be -$1 to $1 million and its Q4/FY20E SG&A expense will be $15-$16 million. The revisions are mainly driven by cost overruns in the RNG business, which also resulted in XBC’s decision to exit two contracts as well (details in Exhibit 1). The extent of the impact on XBC’s current backlog is negative ~$8.0 million as of today. Management noted that the decision to cancel two contracts was driven by continued delays resulting in cost overruns and the contracts becoming negative from a gross margin perspective. Overall this revision is certainly operationally driven and puts Xebec in the penalty box, raising questions about its ability to deliver on its promises to clients in the RNG business and to do so at a profit. Severe lockdowns in Quebec certainly played a factor in this but we would have expected XBC to have adjusted to this new norm by now.
Switching RNG Focus on The Containerized Biostream System. Management indicated that going forward, the focus will be on the containerized system (Biostream) and will shift away from custom designs that require more engineering work. This is certainly a step in the right direction given XBC’s ongoing issues in adapting its model in the new environment. As of today, the company has one such Biostream in operation in California and another 6 being built and will be deployed across various projects. With such approach, it is vital to prove the product’s ability to work well with various feedstocks which is the aim of the 6 units. The company will also be looking to honour some of its existing contracts, namely the Sapio contract, by using the Biostream system in a modular approach. Overall, XBC’s growth in the RNG sector will be contingent on the success of Biostream in the marketplace. Consequently, and given the lack of clarity on the status of its current RNG backlog (we estimate it to be $40- $45 million), we revised our RNG revenue forecast for FY21E down by 40% to ~$24 million which is reflective of a slower delivery schedule and no meaningful wins.
But XBC is Way More Than Just RNG. Given the operational challenges, we have also taken a conservative view on all of XBC’s businesses. First, in the Service segment we have elected to remove the acquisitions we factored in for FY21E as we believe management’s sole focus right now should be on improving its existing operations. We have also revised our organic growth lower for the segment, mainly driven by the implied run-rate by the revised guidance of ~$8-$9 million (we were at ~$12 million for the segment). We kept our assumptions for HyGear unchanged and we layered in Inmatec at little to no growth. While we do appreciate the high growth nature of Inmatec, we would like to understand how much of that growth is sustainable post the pandemic. We have also reset our margin assumptions on RNG and Service segments in line with the lower revenue base and factored in the higher SG&A costs. As we have discussed before, XBC has grown beyond its RNG roots (our revised FY21E revenue only 17% comes from RNG) into a diversified renewable gas generation play with a service segment. Given the lack of visibility into FY21E numbers, we have no choice but to factor in the conservative assumptions to reflect a worst case scenario. In line with that, we revise our valuation multiple to 8.0x (from 11x) to our revised FY21E revenue. Our multiple reflects “penalty box” like valuation for all of XBC revenue lines (13x Hydrogen ,4.5x RNG, 4x Service). With 34% potential upside and XBC trading at just 5x FY21E sales, we maintain our BUY recommendation