Introduction

Spark Energy(SPKE) is an intermediary in the energy production and distribution chain. They compete and act as an alternative to your regulated local utility which probably has a monopoly on most aspects of your electricity/power.

Their business model essentially involves buying and selling electricity from a variety of sources and then using another utility’s distribution infrastructure to deliver that electricity to customers. The hope is that they have bought the electricity at a lower price than they sell it to the end customer, after covering the cost of transportation and delivery by another company.

Source: Co-investor presentation

Recent results

Spark’s recent results have been inconsistent. It had very good results in 2017 and 2016, but it has had difficulty making a profit in the last two years. Their revenues have fluctuated widely, which I think is a virtually useless measure because the absolute price of the energy they sell is not important, but rather the margins they can get on what they sell, and other customer loyalty measures are the main drivers of their business.

Source: Annual Report 2019

More recently, the company had a good first quarter, but anticipated the challenges of the upcoming pandemic. Surprisingly, Spark still relies heavily on old-fashioned marketing strategies such as telemarketing and door-to-door sales to convince owners to switch energy suppliers. These efforts are expected to diminish for security reasons.

They also mentioned that they monitor bad debt expenses. It is not clear whether Spark is subject to the rules and regulations proposed by many countries regarding the inability to refuse or stop service for non-payment during this period, but in any case, I think they will see an increase in the number of non-paying customers.

They have seen their net revenues rise sharply this quarter as the cost of energy has fallen much faster than they can charge customers.

Source: 1st Quarter 2020 Revenue Release

Reflections on the Business Model

After doing some research and thinking, I don’t think I like Spark’s business model. One of the problems is that they’re not even really useful in the sense that a normal person would think of them. They don’t have power plants, wind turbines, substations, power lines or anything like that.

If you look at their balance sheet, they have assets of $422 million as of December 31, 2019. Only $3.2 million of those assets are property, plant and equipment (PPE), and that’s where you traditionally find the items on the balance sheet.

Nearly a third of the assets are goodwill, which are merely accounting adjustments on acquisitions and are probably overpaid. While for some companies this “light” model may be an advantage, I do not think it is in this case.

Source: Annual Report 2019

It is interesting to note that customer acquisition costs and customer relationships are recorded as assets on their balance sheet. It seems to me that the Spark model is very similar to the subscription boxes that have become so popular in recent years.

The cost of customer acquisition and the retention of existing customers are key elements when it comes to performance with Spark. The company makes this clear in its annual report :

Source: Annual Report 2019

Taken in isolation, these costs appear reasonable. But when they are put in relation to the rest of the income statement, these costs represent 15 to 20% of the operating costs that are not depreciation and amortization or the actual cost of purchasing energy, which is essentially the cost of goods sold.

Of course, they can also acquire customers in a significant way through block acquisitions, the type of which would appear as investing activities in the cash flow statement.

The Company spent the majority of its 2018 and 2017 operating cash flow on these types of acquisitions.

Source: Annual Report 2019

At the end of the day, I think it’s clear that Spark and his business model is not for me. I think there’s nothing to defend here other than the fact that they already have customers and there’s a cost to someone else to take them away, but that cost doesn’t seem particularly insurmountable.

Furthermore, it seems that the business as a whole is just a commercial vehicle where they hope to buy low and sell high, take the margin and hope they do not lose their shirt on the various financial instruments and derivatives they use to do so.

Risks

I also believe that the company faces significant regulatory risk. While this is an ever-present dynamic and risk for virtually all businesses, Spark, in particular, operates in a subset of the utilities and electricity sector that is just beginning to come under closer scrutiny.

The sales proposal that the company is putting forward is a deregulation proposal that gives consumers the choice to have their electricity delivered only by their monopolized local utility, but to leave the generation of that electricity to anyone else.

However, New York, New Jersey and others have begun to put pressure on these types of companies and the rates they can charge and how they can pass on the costs to consumers. In addition, their marketing tactics are outdated and expose them to liability, but they also do not seem to be appropriate for the future.

Evaluation

It is difficult to assess the spark because it is difficult to say what they will earn in the future, regardless of the basis. It all depends on how many customers they leave, how many customers they acquire and at what cost, the price of energy, not to mention normal execution-type elements such as the quality of the work they do to capture the gap and with their financial coverage.

Extrapolating from the first quarter, one could earn $0.80 this year, which would give a p/e ratio of 8.75, which is rather low. But for a company that’s not high quality, the price has to be right.

ChartData by YCharts

In addition, corporate dividends totalled about $45 million last year on common shares and unitholders, with an even larger amount being paid to preferred shareholders. This amount is likely to exceed their net income for this year, so it may have to be reduced at some point, creating a negative headwind.

But at the end of the day, I don’t really want to own Spark, no matter what the price. With the pandemic likely to push us into situations where higher quality companies with long experience become more attractive, I think I’m going to save my cash for those opportunities instead.

 

Disclosure: I/we have no position on the shares mentioned and I/we do not plan to take any in the next 72 hours. I/we have written this article myself and it expresses my/our own opinions. I am not receiving any compensation for this (other than from Seeking Alpha). I have no business relationship with any company whose shares are mentioned in this article.

Link to source

2020-07-03