Whisper #349-January 11/23--COMPANY ANALYSIS UGE INTERNATIONAL

Nick Blitterswyk <nick.blitterswyk@ugei.com> To SM <saamfr77@gmail.com>

19 Jan, 2023, 21:52

Nick Blitterswyk
CEO

www.ugei.com | 417 5th Ave, Suite 803 | New York, NY 10016

Direct: +1 917 720 5683 | Mobile: + 1 626 589 1126

From: Investing Whisperer <customerservice@investingwhisperer.com>

Date: January 11, 2023 at 5:15:13 PM AST
To: Gordon Holmes <gordon@lookoutridge.com>
Subject: Whisper #349-January 11/23--COMPANY ANALYSIS UGE INTERNATIONAL
Reply-To: customerservice@investingwhisperer.com

Whisper #349 January 11 2023

COMPANY ANALYSIS
UGE INTERNATIONAL
(UGE – tsxv // UGEIF-PINK)

I am on the lookout for small cap solar—for a few reasons. On the surface,
economics for solar energy look to be improving:

1. Power prices are rising in many states/provinces in US/Canada

2. Solar power capex is declining/getting more efficient
3. Debt funding for capex is a mature market (and it’s non-recourse
debt; it stays with the project not the company)
4. Between debt and tax incentives, operators like UGE can pull out
enough money to stay liquid, and basically mortgage the rest of
the project
5. High multiples, resulting from long term cash flow (which should
 rise marginally over time are making take-out values in sector
very lucrative for small developers like UGE

HOWEVER, in my last writeup I outlined the issue:

A. Solar take a lot of money

B. That money is needed up front.

Together that adds up to a big roadblock for small cap stocks.

1. From my work, I have identified two ways that small solar players
have wedged themselves into the landscape.As an early-stage
developer selling the project before it gets to the big capital
expense phase
2. As a niche player in a less capital-intensive corner

My last writeup, Westbridge Renewable Energy Corp (WEB – TSXv), went

route #1.

My next pick, UGE International (UGE – TSXv), is going down #2.

UGE’s niche: Community solar.

This I think this is a good niche—but the real juice for shareholders is likely
back end loaded on a take-out by a larger company. The economics of
community solar look OK-to-solid.

(I want you to think that payback for UGE is basically INSTANT; they get
more money out of a project as the developer BEFORE they start producing
solar energy--than it costs them. The debt stays with the project. Great gig!)

The downside is: the projects are small. UGE will need a lot of projects to get
to scale. As you will read, they actually DO have a lot of projects—their
backlog is up to 260 MW.

And UGE is on the cusp of turning a big chunk of that backlog—about 115
MW, or half—into operating projects by the end of 2024. This creates a
HUGE value lift. (Normal delays could push this into Q1 or Q2 2025)

Once a solar developer gets a project to NTP stage—NOTICE TO

PROCEED—the Market gives that project a HUGE valuation. The Market is
basically saying—OK, this is a done deal, and developers can SELL a project
at that stage (which is what Westbridge does).

UGE already has enough projects at NTP stage that there’s a theoretical market valuation
here of over $4/share TODAY—with another low-risk $4+/share in value coming in the next
15 months as this backlog gets closer to production, and the stock is trading at $1.45.

Be aware the value I speak to is take-over pricing by a larger solar company;

it’s not cash flow. These solar assets don’t create a lot of revenue growth in
2023, but this is high-margin, long lasting revenue, which is why the Street
values these stocks at 17x EBITDA (that’s a lot sexier than 2.5x-4.5x in oil,
gas & services stocks).

CEO Blitterswyk suggests revenue will be at US$8 million annualized by Dec

2023, and US$22 million (again, annualized) by Dec 2024.

I think solar is one of The Big Memes of 2023. There’s huge gov’t money
behind this sector, AND solar debt is cheap and abundant—a strong sign the
Market views this as low risk.

Blitterswyk has multiple term sheets whenever he wants a few million in debt.
Solar will have the least impact of any form of energy if there is a recession
in the coming year; society wants it.

I’m long 50,000 shares at $1.48.

QUICK FACTS
Trading Symbols: UGE-TSXv / UGEIF-PINK
Share Price Today: $1.45

Shares Outstanding: 32.7 million basic/38.9 M FD

Market Capitalization: $47 million

Net Debt: $12 million
Enterprise Value: $59 million

POSITIVES

-UGE starting to hit its growth curve—big increase in operating MW coming

next 8 quarters

-Mgmt owns 11 M shares or 30% of company

-Debt is cheap and abundant for solar projects
-market gives high valuation—15-20x EV/EBITDA vs 4x for oil & gas

-lots of buyers (takeout offers) for solar producers

NEGATIVES

-in community solar, everything is small; a lot more work to scale up

-valuation blue-sky is based on theoretical takeout value, not cash flow (at
least for a couple years)

-thin trader (for the best reasons; ideological buyers have soaked up the
float)
-delays are common in getting solar projects operational

-US states change rules sometimes; mgmt has to stay nimble.

 WHAT IS COMMUNITY SOLAR?

Community solar allows energy users to subscribe to a shared system of

solar panels that is not on their own roof.

The panels are usually—but not always—built within the community. You can
buy solar power in the US that’s tens of miles away. It could be from a
school, a commercial building, an empty lot (though this is less common) or a
combination of the above.

Community members sign up to the project – agreeing to receive power and

get a credit on their electricity bills for the power produced from the solar
array.

These projects are bigger than a rooftop but far smaller than utility scale
solar farms.

A utility scale solar project ranges from 200 MW to 300 MW project. A

community solar project is less than 5 MW and often less <1 MW. But bigger
than a residential rooftop, which is typically <10 KW.

HOW THEY GOT IN THE BIZ

UGE began as an Engineering, Procurement and Construction company

(EPC) performing solar installations.

Most of their work was in Canada. But that work was sparse. Until just
recently Canada has had a bumpy go of it with solar.
I was surprised to learn that Canada didn’t even have an Investment Tax
Credit until one was announced this fall! Compare that to the United States
which has had one in place for nearly 20 years.

Being an EPC is a slog at the best of times. In a slow market it is just a bad
business. So in 2019, after several years, UGE pivoted.

They changed their strategy from EPC to a builder of their own projects.

Their focus shifted to the US, where the subsidies were best, and to
community solar projects, where a small firm could compete.

The last 3-years has turned that 180 into reality. It has been slow.

The stock hasn’t done much. The low valuation is because the Market is
waiting for the company to prove itself as an operator. I’m hoping that as
CEO Nick Blitterswyk gets the next couple of quarter’s installs done on time
and on budget, the Street could DOUBLE the valuation here and still be
below peer multiples.

But now we’re getting close. Projects should begin to come online next
year. UGE’s first tranche of projects are now starting to hit NTP—Notice To
Proceed. Hitting NTP is a BIG inflection point for valuation.

The hope here (mine included) is that will lead to an inflection in the stock, as
these projects have very good economics.

ECONOMICS OF COMMUNITY SOLAR

The business of community solar boils down to one big positive and one big
negative.
The positive? The economics – even the unlevered one – are really, really
good. Add leverage and it is a home run.

The negative? Scale. Scaling projects that are <5 MW means you need A
LOT of projects.

First the positive. UGE provides two examples in their corporate

presentation. One in Maine, one in New York.

These are not theoretical projects, actual installations. The New York one is
operational, the Maine one will be shortly.

The key chart here is what UGE calls Project Sources and Uses:
Source: UGE December Investor Presentation

This is for the Maine project, which is a 1.074 MW installation that is going to
cost about $2.8 million all in.

Take a close look at the sources and uses of cash. On the usage side,
CapEx is $1.8 million. When I talked with CEO Nick Blitterswyk he said
construction costs in general are $1.50 per watt. Another $200k goes to
interest and closing costs.

The rest? It goes back to UGE.

This is quite something. You can see on the “Sources” side that UGE is
putting in about $300k of equity. But as project EPC, they are taking out
$900k—more than what they contributed in equity.

In other words – the equity interest is FREE.

I know what you are saying. How can that be? No free lunch, something,
something.

That is usually correct – unless the government is involved. In this case, the
tax equity (a little under 30%) reduces the actual cost of the project enough
to more than cover the need for equity.

The result is that UGE can extract their equity back out of the project before
they even flip the switch on it.

That’s a pretty good deal, eh? With the new IRA—Inflation Reduction Ac—
they are probably going to be able to pull out even more.

The same applies for the New York project. UGE provides us with cash
sources and used for the 740 KW Peekskill project in NY.
Source: UGE December Investor Presentation

740 KW at $1 million CapEx – about $1.35 per watt. Because tax equity
covers $500k of the project cost and project debt of $1.2 million can be
raised, UGE can pull out $800k upfront, again covering most of their equity.

The consequence is that UGE is participating in these projects nearly

for free.

Neither of these projects are theoretical. Both are completed. They gave us a
picture of the New York rooftop project with their Q3 webinar:
Source: UGE Q3 2022 Financial Results Webinar

Now for the negative.

The downside – which you may have already noticed – is that these are not
big projects. 740 KW is pretty darn small.
Net cash flow generation to UGE is <$100k.

The Maine project will deliver about $226k of EBITDA per year—of course,
EBITDA is before things like INTEREST—and most of the cash flow from
these projects goes to service the project level debt that gets these things
built. Only $55k of cash distributions to the equity (ie. to UGE).

BUT…think that multiples on these projects are 15-20x. That means the
Maine project—which is 1 MW--is worth US$1 million to UGE
shareholders. UGE hopes to have over 100MW producing by YE 24, all with
these same economics—take up front equity out, let cash flow pay off the
debt interest (just keep rolling over the project level debt (if that game ends
this would NOT be good)) and take a 20-30 yr royalty basically.

Source: UGE December Investor Presentation

It is possible—unlikely but possible—that no equity needs to be raised

again. However, I think UGE will want to raise AT LEAST US$50 M if they
can get their stock to peer group valuation (that’s over $4).

The New York project is even smaller.

That means that UGE is going to need A LOT of these projects to turn this
into a growing business at size.
 BACKLOG AND ROLLOUT

UGE is all about getting on the construction flywheel and turning MW

installations into cash flow for the company.

That starts with backlog. The headline number is impressive. UGE has a backlog of 260
MW (as of Jan 9 23) and development pipeline is 393 MW.

Source: UGE December Investor Presentation

That backlog has been increasing steadily each quarter.

Source: UGE Q3 2022 Financial Results Webinar

Now, I want you to look at the legend on the right of that chart above, where it shows
“Stages 3.1-3.3”. There are several stages of development, and it makes sense that the
farther advanced a project is, the more that capacity is worth.

Here is one brokerage firm’s guess-timation of what it COULD be worth (and this chart is
only a month old; Nov 22). It shows where a lot of value is right now in the UGE backlog—
Stage 3.1, where over 200Kw has most of the heavy lifting done in getting a project to
commerciality. That’s what I circled in yellow. A couple pages down I do the math for you
to show what it will be worth in 15 months.

Appreciate that these brokers get paid to be a bit positive, but it gives you a
ballpark valuation metric (that is not based on cash flow):
If I use the Maine and New York projects as typical, you are looking at
$0.20/KW of EBITDA and $0.05/KW of distributable cash flow each year.

Plug those numbers into the backlog and 237 MW of installed capacity will
translate to nearly $50 million EBITDA and $12 million DCF. If that happens
UGE will have a much higher market cap than ~$50 million.

Of course, the big question is how fast these projects get built.

If they get built on the current timeline, we should start to see growth in late
2023.
Source: UGE December Investor Presentation

NTP stands for notice to proceed. COD is “commercial operation date”.

Commercial operation date is when revenue starts to flow.

There is anywhere from a 6-18 month lag on rooftop projects between NTP
and COD, and for ground-based projects that can be over 24 months.

In 2023 UGE is projecting 14 MW of generation going into operation.

Add that to the ~2MW currently operating and you’d be at a run rate of ~$3
million EBITDA by YE23.

Blitterswyk told me UGE is forecasting an exit rate of US$8 million in

annualized revenue; YE 2023.

SO HERE’S THE PRO-FORMA VALUE LIFT

The light green bars in the deployment backlog chart is the MW of solar
energy that get to the all-important NTP stage (which is Stage 4)—you can
see those bars, over the next 5 quarters, at 12 MW, 7 MW, 13 MW, 7 MW—
then Q1 2024 there is a HUGE jump to 104 MW.

Just that first 12 MW—which right now would be in Stage 3.2 and 3.3 (4 and
7.5 MW now =$15 M in value) going to NTP means a lift in value of $15
million to US$24 million (averaging US$2/w).

But look at the overall 143 MW that hits NTP by end of March 2024. If you
look at the Private Market Valuation chart above that, you see the lift in value
of those 143 MW going from Stage 3.1—roughly 75 cents per watt—to Stage
4—at $2/w—well, 143 x $1.25/w increase in value=US$178.75 million.

That’s CAD$232.375 million with the CAD/US at $1.30. With 38.9 M shares
out FD, that's an increase in (takeout) value of $5.97/UGE share—basically
$6/share increase in 15 months from NOW.

The Big Risk here—and history says it’s a certainty, not a risk—is that some
of these projects will get delayed. Maybe it’s a month, maybe it’s an entire
quarter.

So what I just showed you is a perfect world scenario. It won’t be perfect. But
these projects are in several different states, so there’s some geographical
diversification. It’s not based on one state having a great year.

UGE has a stated goal of 100 MW operating assets and 100 MW annual
capacity by the end of 2024.
Source: UGE December Investor Presentation

UGE is expecting a big ramp in project construction over the coming

months. They have raised debt to support the working capital needs.

They closed a $15 million revolving development capital facility during Q3.

Over the last few months, they have also closed ~$10 million of green bonds.

EXPECT DELAYS

UGE is transparent about their backlog – in fact WAY MORE transparent

than most companies.

This is the project-by-project backlog released with the Q3 results:

Source: UGE Support Materials for Q3 Earnings

I love the transparency. I appreciate being able to see the specific projects
tied to the backlog.

However, the backlog also does show us that project delays are common.
There are two Maryland projects at the top of the list, scheduled for August
and November 2023. Looking at a past press release from June 2021 these
projects were supposed to be in operation by year-end 2022.

Remember that 740 KW New York Peakskill project that I referenced

earlier? In the November 2021 MD&A it was forecast to be CDE in Q1 2022.

In mid-2021 UGE expected “an additional 7-10MW to reach ready to build or

construction phase (Stage 4 or higher)” by year-end 2021. They had
expected “deployments to have increased quite rapidly by the end of the
year, but especially through 2022”.

We’re now finished with 2022. Deployments won’t start to ramp until Q3
2023.

You get the picture. Projects are getting done, but the timelines are often
stretched.

HOWEVER—I think investors have a back-up here and that’s why I’m willing
to start a position in UGE now.

Yes, UGE is not a cash flow story for a couple more years—think YE
2024. But as their backlog grows and they get more projects to Stage 3.1
and NTP, they get scale.

Combine that with slightly higher power prices and increased ITC, and the
Market should then get more comfortable valuing the stock more in-line with
the sell-side valuation chart I showed you above.

UPSIDE ON POWER/ELECTRICITY RATES

Community solar is tied to retail prices. As retail prices go up, revenue goes
up.

With natural gas prices up so much this year, residential rates have followed.

On the last call UGE said that we have seen “historically high-rate increases
in Maine and NY in 2022”.

In Maine rates are published at this time in the year, for 2023 and the rate
increase is similiar to last year. If you take 2022 and 2023 rate increase,
looking at a doubling over last 2 years.
In New York, rates are up about 20%.

Source: EIA Electric Power Monthly—you can see all US state energy prices
YoY here—(data geeks only)

https://www.eia.gov/electricity/monthly/epm_table_grapher.php?t=epmt_5_6_a

This is not great for customers, but it is additional revenue for UGE.

These rate increases are not baked into the above numbers. If power prices
stay high, cash flows could be even better.

It was interesting to me that—on analyst’s valuation of UGE, post Q3—

increased power prices took up all the drag on the company’s NPV and
discounted cash flows from the delays on their projects.
 SOLAR AT THE STATE LEVEL

In 2021, 22 states passed legislation and enabling Community Solar. That

gives UGE lots of addressable market.

In their corporate presentation UGE outlines their own perspective on states

most open to community solar projects.

Source: UGE December Investor Presentation

I’ve already pointed out New York and Maine.

New York has 2 projects (800KW) in late stage and 3 early-stage projects
that will deliver a little under 12 MW by YE 2024 if they are completed on
schedule.

In Maine, UGE has six projects in later stage development (~13 MW) and two
earlier stage backlog projects scheduled for 2024 for a combined 5.2 MW.

The Maine market has been challenging for UGE. Changing rules has been
the culprit.

This is another risk. The solar market is new for a lot of states. Rules
change. Politicians change. You just never know.

In 2021 Maine changed the maximum size of community solar from 5 MW to

2 MW.

This impacted 2 of UGE’s projects, which no longer qualified.

Fortunately, another 6 were grandfathered in even though they exceeded the

2 MW limit.

More generally, UGE talked on their call about Maine “utilities adding steps”,
something that delayed 3 of their projects by 3-4 month. It didn’t sound like
the first time.

In California (biggest solar market in the US with half of residential solar – 13

GW) they have very high residential solar rates, but are now lowering
residential solar pricing. Blitterswyk says California is NOT lowering
community solar rates.

California is running into the obvious problem – that all solar produces at the
same time – and that does not always coincide with demand peaks.

California is being forced to change the rules. While they haven’t figured out
exactly how – their first stab at legislation in the fall of 2022 met with huge
opposition – it is inevitable that they will reduce prices for
new residential solar installs – likely to the going rate of $0.05 per kWh to
$0.08 per kWh—which is down from the $0.23 per kWh to $0.35 per kWh
right now!
UGE’s first California projects have NTPs 18 months from now. This is a big
part of UGE’s 2024-25 backlog. While Blitterswyk is still confident in
California, it’s unclear how the Street will value Stage 3.1 projects in
California then.

Massachusetts is going down the same road.

Massachusetts makes up a large part of the 2024-2025 backlog.

Like California, Massachusetts also already has lots of solar capacity.

They have layered a state tax credit, a solar rebate, and waived property tax
and sales tax on solar installs. Lots of incentive, lots of solar in
Massachusetts.

There’s also lots of opportunity in Massachusetts for energy storage.

UGE has a big backlog of projects in Massachusetts, around 100 MW, and
that is largely storage.

Storage seems to me an inevitable next step here as renewables take on

more grid capacity. I think this could be a bigger opportunity than solar itself,
especially since UGE is getting a head start. I’ll update the storage angle at a
later time, as it nears commerciality.

Overall, my point here is that the timelines of these projects can be “fluid” as
solar goes mainstream and many of these states are creating the rules as
they go.

CONCLUSION—
THE STOCK COULD LAG THE BUSINESS
There’s a lot here to like. Big social- and government-funded tailwinds. Low-
risk, high-margin growth just starting. Instant payback. Cheap market debt.
High valuations.

But the first BIG stage of growth doesn’t really get going until late 2023 and
all through 2024 – and that assumes that the projects hit their timeline. So
from a cash flow perspective, you could argue this stock isn’t going anywhere
for 2-3 quarters.

But as the UGE project backlog increases, and mgmt starts announcing more
NTPs in that backlog, the Market could de-risk the stock sooner than you
think.

And remember, there is not much liquidity here. Over the coming months,
there is a good chance the stock trades mostly at the bid. If/when this stock
goes, it will only trade at the offer.

I think for sure that by July 2022, if UGE has met its first two quarters of MW
implementation, the Market will start to price in that big 104 MW of Q1 23
hitting NTP. That gives the stock potential to be 200-300% increase in 2023.

The Big Risk—and I have painstakingly walked you through some of the
history here – is that (for a variety of reasons not under UGE’s control)t
timelines tend to not get hit.

Even that could change. The Inflation Reduction Act (IRA) and growing
climate change momentum could drive projects through the pipeline faster.

So until UGE hits critical mass the company will lose money and investors
will keep a skeptical eye.

But…maybe not all investors. Maybe things happen sooner.

But I would say--absent a takeover though, this is a long-term hold, not a

short-term trade. The company needs to build momentum, turn projects on,
show that they are generating revenue and cash.
If they do that – which really means EXECUTE – the stock price will go
up. Just don’t expect it overnight. I see the potential for a 3-bagger in 2023
and 5-7 bagger in 3-5 years.

I’m long 50,000 shares at $1.48.

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