From Coal To Green
In today’s edition I’ll do a brief company presentation, market observation and the reasons to why I’ve initiated a position in Grodno SA. This article may contain factual errors and this article is not investment advice of any kind.
Market cap: 240m pln (56m usd)
Grodno is a family owned leading distributor serving over +10 000 professional installers with over +40 000 SKUs in product categories ranging heating, building products, ventilation, lightning and electrical supplies. What sets Grodno apart from other peers is the early and aggressive tilt towards being a comprehensive supplier of RES (Renewable Energy Sources) solutions: Grodno is also a leading supplier of solar PV and heat pumps. Trading at basement bargain levels @ ~ ev/s 0.3x and p/e 6.5x I believe Grodno offers exceptional value and considerable upside.
The Great Smog of Lo…Warsaw
Data by the World Health Organization shows that 36 of Europe’s 50 most polluted cities are in Poland and, according to the European Environment Agency, the poor air quality cause premature death of as many as 44 000 people each year. Cities such as Warsaw and Krakow rank worse in air quality compared to Dhaka (Bangladesh) and Delhi (India) to this very day. As the old adage goes: a picture is worth a thousand words; looking at a recent heat map of Europe we get a sense of what 38 million Poles suffers on a daily basis.
Poland’s nationwide sheet of smog stems from its use of coal for home-heating and electricity. Approximately 80% of all low-rise buildings heated by burned coal in Europe are located in Poland and it is also the only country in Europe to use more coal-derived energy for residential heating today than it did in 1990. Further exacerbating the problem is that >60% of Poland’s building stock have low, or very low, standard of thermal insulation.
Poland’s main cause of contamination is the combustion of coal releasing sulphur oxides, nitrogen oxides, hydrocarbons, carbon oxides and solid particles such as ash and soot into at the atmosphere. Low-stack emissions, combustion of coal in households and heating plants below 40 meter, is particularly dangerous and unfortunately very common in Poland. Consequences of smog, perhaps self explanatory, is a severe degradation of way of life and outdoor activity, property damage and most importantly cause of permanent health issues. The Great Smog of London, depicted as a thrilling set piece in Netflix smash-hit series The Crown, was an actual series of events that is believed to have influenced national regulations throughout Europe to not adopt UKs dependency on coal for heating and electricity. Although there are several historical circumstances explaining reason to why Poland’s energy mix so vastly differs from its European neighbors, the colossal use of coal for electricity and heating in Poland is nonetheless unique in an international context.
Fortunately, change is happening. Poland’s new Energy Policy by 2040 (PEP2040) includes a significant decrease of the share of coal in the national power generation mix: from +70% currently to the low 20%’s in 2040, and a substantial increase of renewable generation in its place. Also, Poland aims to launch its first nuclear reactor in 2033 with another five reactors coming online every other year until 2043. In November, Poland made a commitment to stop issuing permits to build new coal plants and the very powerful coal unions signed an agreement to completely exit coal by late 2040s. Finally, the population is demanding a change and the EU is providing pressure (and financial carrots) to make it happen. I would argue the use of coal finally has reached an inflection point and I see a great upside in buying the players providing the picks and shovels for this (decade long?) inevitable energy transition in Poland.
The Way Forward
1) Given Poland’s current national energy mix, a house heated by a heat pump emits 40% less carbon dioxide than a house heated by coal. As there are +3 million buildings heated by coal furnaces in Poland (2019), equipping them all with heat pumps would substantially reduce CO2 emissions on a nationwide scale. Also, replacing coal boilers with heat pumps provides immediate benefits in terms of reducing dust, sulphur, and nitrogen oxide. The different types of heat pumps: Air Source, Water Source, Geothermal Source, Hybrids, etc., all have pros/cons, different efficiency and are suitable for different conditions. The main takeaway, however, is that all are preferred to a coal furnace.
2) While heating is a low-hanging fruit to combat low-stack emissions, the national power system itself if still heavily dependent on burning solid fossil fuels to create electricity. The general industry derives majority of its electricity needs from burning coal and approximately 80% of district heating grids are still hard-coal fired. Consequently, if a coal furnace at an end-user is exchanged for an electric boiler the CO2 output is still somewhat equal that of the energy mix. Simplified, replacing the coal furnaces is a great first action to take but to create the largest impact coal needs to be replaced for power generation as well.
The EU’s 2021-2027 budget - EUR 1,2 trillion - coupled with the NextGenerationEU stimulus package from the coronavirus aftermath - EUR 806 billion - will be the largest stimulus package ever financed in Europe, surpassing that of the Marshall Plan post WWII in inflation adjusted terms. A part of this spending bonanza is the European Green Deal with the goal to cut CO2 emission by -55% (1990 base) by 2030 and reaching net-zero by 2050. Both targets completely unattainable if Poland, with the land mass of Germany, remain the 9th largest coal burning consumer in the world. EU acknowledges that incentives, or financial carrots, must be put in place for Poland to even consider to agreeing upon a green pact - not to mention doing it in an immediate time span. The Just Transition Mechanism, or the financial carrots, expects to distribute the burden of transitioning to a greener economy more fairly and just: those with higher greenhouse emissions will receive more financial aid. The first pillar of the JTM has been awarded and Poland scooped up 20% of the total allocation (Sweden: 0,8%). One fifth.
Italy’s budget deficit reached EUR -127,4 billion last year, not a far cry from the negative -158,4 billion print in 2020. Intuitively it might be hard to fathom that a country that has been unable to produce not a single budget surplus the latest 30 years offers a 110% subsidy to homeowners for heat pump installations and other thermal renovations. The reason to why compassionate Italian lawmakers added an extra 10% on top of that for-free heat pump is to compensate for the time value of the tax deduction.
Italy is forecasted to print another -€100 billion deficit for 2022 but that doesn’t preclude launching a subsidy of €6,000 if you buy a new electric vehicle (+€2,000 trade in) and several tax cuts for individuals and corporations. Why enormous deficits and generous subsidies fly together is because these projects are not only implicitly funded via the EU’s 2021-2027 recovery package, where Italy is to receive €68,9 billion in grants and €122,6 billion in close to zero interest loans, but it’s also endorsed.
Let me share you an anecdote of why this is relevant to the stock market in general, and for Grodno in particular. As previously mentioned, to combat the Coronavirus aftermath and kickstart the economy Italy launched 50%-110% subsidies for thermal modernization (insulation, windows, heating, ventilation and so on). On this news Sciuker Frames $SCK.IM had its sales estimates revised upwards 3x over night from sell-side analysts (pic 1). The stock went on to 5x the coming year. The stimulus was initially temporary and with a set deadline but Italy apparently had the financial standing to extend it to 2025. Today, sales related to the 110% stimulus is so substantial that it’s reported as a separate KPI on their roadshows (pic 2).
The EU is creating and distributing a lot of billions today and for the coming 6 years. Since government agencies aren’t producing heat pumps, insulation materials or solar PVs - private companies will inevitable be the beneficiaries.
Heat Pumps en masse
Domestically, to accelerate the energy and heating transition the Polish government launched several subsidy programs such as “Clean Air”, “My Heat”, “My Electricity” and more.
Clean Air was introduced to replace coal furnaces used for heating with an alternative such as a heat pump (or a gas-boiler etc). Two months ago, subsidies were raised and the application process simplified in an effort to increase uptake. The subsidy is stackable with another subsidy called Stop Smog making the installation of a heat pump up to 90% deductible for the lowest income earners and estimated 60% deductible for regular incomes. Affordable and government backed co-financing has been introduced in the latest iteration tackling the need of upfront savings. Lastly, municipalities heavily impacted by smog are running their own subsidy schemes on-top of Clean Air, making them in practice stackable for end users as well.
To give a sense of how vast the program is: if you replace a coal furnace in your home with a subsidized heat pump installation you’re then also eligible for subsidized Solar PV/Thermal installations and/or hot water modernization.
Running concurrently next to Clean Air is My Heat, My Electricity, Energy Plus and Energy Agro. Rumored upcoming, albeit unconfirmed, subsidies for energy storage and EV chargers are in the makings. Needless to say, Poland is hellbent on modernizing the outdated and energy inefficient residential building stock. The programs have different end-dates of which Clean Air is set to run until 2029. Over PLN 100 billion (EUR 22,5 billion) of funding has been allocated in total, compared to less than PLN 7 billion in payouts to date (2022-02-24).
Early days, still.
Not surprisingly, heat pumps are flying of the shelves and Port PC (Poland’s Heat Pump Association) forecast a +50% market growth for heat pumps in 2022.
Before gas- & electricity prices quadrupled this winter, Port PC did a Normal- & Optimistic Scenario forecast for heat pump sales in Poland. With exploding utility bills, it is not impossible to make the case that consumers are evermore leaning towards energy and economically superior heating alternatives such as heat pump, instead of a gas-boiler or coal furnace.
According to EHPA (European Heat Pump Association), the European heat pump market is set to accelerate its growth 2021-2027 compared to that of 2015-2020. They argue the key drivers are “…to front-load Green Deal targets” and that efficiency and technology strides in product development is driving higher value for the end user. Poland’s penetration of heat pumps was 11% compared to 90% that of the Nordic countries in 2020, creating the possible setup of a decade long growth runway.
To the Mo..Sun
Three days ago, March 16, Poland produced 493 GWh of energy of which 399 GWh - or 81% - came from coal (hard coal + lignite a.k.a. brown coal). In 2020, greenhouse gas emissions were +400 million tons of carbon dioxide equivalents. The high and constantly growing prices of CO2 emission rights make coal power plants less and less profitable in operation. These super-polluting smog stations are not only terrible for the environment but also makes less economic sense by the day.
Solar is an inexhaustible energy source, which can be gathered easily and converted into electric power only with the help of a photovoltaic module. In the current context of transition from fossil fuels to cleaner energy sources, Poland is demonstrating a strong commitment to solar via the generous My Electricity subsidy program. This program, containing not only a cash-component but also electricity price rebates while connected and supplying the grid, enabled Poland to 10x its solar PVs installations in only a handful of years. The third (3.0) iteration of My Electricity is set to end next month making it the main bear case against investing in Grodno.
75% of countrywide installations up until now have been micro-installations (<50kW), the majority of which 3-10kW as the subsidy was capped at 10kW installations. The opportunity ahead, and what management also emphasized in a call to me, is the medium-sized (<500kW) to large-sized (>500kW) solar PV installations that are still in its early innings. Medium-sized PV installations are usually rooftop installations for offices, warehouses and other buildings: private and state owned. Large-sized PV installations are usually solar farms for factories, standalone investments or for power generating utilities themselves.
Grodno is a comprehensive distributor of panels, accessories and technology know-how to all three markets.
One week ago, March 8, the CEO re-emphasized the market opportunity in Mid/Large, and downplayed the fallout in Micro.
Excerpts from Pap.pl interview:
"According to the Energy Market Agency, in 2022, the increase in capacity from large installations in Poland will be 50 percent higher than in 2021, so we are not worried about the fact that our revenues from micro-installations will drop - we will make up for it to a large extent"
The end of subsidy program My Electricity 3.0 is the main bear case for Grodno. What is indicated by several sources quoting government officials, however, is that the next iteration, My Electricity 4.0, will commence probably already next month (sources: 1 2 3 4 5). What the articles states so far:
- Power generation to the grid will change from a rebate to a net-billing system (- neg)
+ Cash subsidy in 4.0 same as in 3.0
+ Electric Vehicle Chargers
+ Energy Storage / Battery Storage
+ Systems for managing electricity in the home (“smart homes”)
+ Heat & Cold Storage
+ Subsidies run until 2023
+ Budget allocation is increased from 3.0 to 4.0
The interesting takeaway here is Energy Storage. Well-researched challenges for solar is its variability in electricity output and mismatch with electricity demand. Without energy storage, on a net-billing system, assuming you’re a surplus producer, you’d be “forced” to export excess electricity when you and your community is at peak production i.e. at low prices. With an energy storage system, instead of exporting any excess solar production to the grid, you can first use that electricity to charge your energy storage system. Then, when you’re using electricity after the sun’s gone down, you can draw from your solar battery instead of from the electric grid. Battery storage, often considered the final piece of the puzzle to make solar PV a viable standalone energy system, is expected to grow multi-fold the coming decade.
Grodno, a leading electrotechnical distributor in Poland, should be a huge beneficiary in this next iteration of My Electricity 4.0.
Russia’s invasion of Ukraine have forced European leaders to re-think its energy policy and, among other initiatives, double down on renewables with utmost urgency. Last week, in a response to the invasion, the EU launched REPowerEU which is the foundations for a new energy plan: more solar investments, higher heat pump penetration and overall increased energy efficiency investment of existing building stock. With the risk of sounding cynical to some readers of this blog, but - in essence - a decree most likely having the outcome of fortifying, expanding and increasing the already very generous subsidies that are in place.
Excerpts from the statement by the EU:
“The Communication encourages an accelerated roll-out of solar, wind and heat pumps. This could bring important energy savings and reduce significantly the use of fossil gas for power and in buildings. On solar energy, the Commission estimates that by accelerating the roll out of rooftop solar PV systems by up to 15TWh this year the EU could save an additional 2.5 bcm of gas. We will present a dedicated communication on solar energy in June to unlock solar energy's potential. The Communication also proposes to roll out 10 million heat pumps in the next five years to help European families reduce their dependency on gas and lower their energy bills.” - European Commission
Post-invasion, the IEA (International Energy Agency) issued a 10-point plan to reduce EU’s reliance on Russia. Point (4) is about “faster and more deployment of solar PV” and (7) “scaling up of heat pump installations via targeted support” and (8) “accelerate energy efficiency improvements in buildings and industry” - and so on.
Market cap: 240m pln (56m usd)
Grodno is a family-owned owner-operator with the CEO, the CFO and the Vice-President owning 63% of shares outstanding. Grodno is a market leading distributor serving over +10 000 professional installers with over +40 000 SKUs in product categories ranging heating, building products, ventilation, lightning and electrical supplies. What sets Grodno apart from other peers is the early and aggressive tilt towards being a comprehensive supplier of RES (Renewable Energy Sources) solutions: Grodno is also a leading supplier of solar PV and heat pumps.
Grodno’s offering is toward professional clients only and it’s available via
e-Commerce, click & collect, unattended POS Kiosks or via service staff at 97 locations. The e-commerce is served by two warehouses, wholly owned, of which the second is newbuilt and coming online this very quarter. The CEO states that the 97 store locations is one of the main competitive advantages as it solves a huge problem for the professional installers: logistics and warehousing. The complexity of a geothermal installation, replacing the drain and/or electricity in a house always entails new problems mid-work hence the need for a location nearby where they can pick up installation materials. Speaking to industry professionals on both sides of this dynamic, I’ve repeatedly been ensured that omnichannel is the most favorable setup.
With +40 000 SKUs, +3 200 manufacturers, e-Commerce and 97 physical locations you become a comprehensive, reliable and convenient partner to installation firms of all sizes. Likewise, there’s no economy for all the thousands manufacturers to have single, low volume, accounts with thousands of installers. What makes distributors such as Ferguson, AOJ, Ahlsell, Beacon Roofing, Reece Group contain market leadership for decades is scale. In Trian Partners pitch of Ferguson they called it “A Virtuous Cycle” and Ahlsell, before being acquired by PE, called it “A Fortress Position” to be a market leader.
Sales has been rampart throughout the year and this 240m market cap company just passed +1 billion in sales LTM. As Grodno disclose monthly sales numbers we’re able to peek into next Q results, and there’s no signs of slowing down: January’s and February’s sales are up +82% and 67% YoY respectively (not in the graph below).
Why I spent significant time on heat pump roll-out and energy efficiency subsidies in my earlier paragraphs was to show that Grodno has been a direct beneficiary of such. The niche and inventory of Grodno is almost comically aligned with ditto.
Grodno seems confident for future growth as a they just finished building a completely new warehouse, set to start operations this current quarter.
While the exceptionally strong numbers of 2021 could be explained by buzzwords such as pull forward demand, it’s important to take note that Grodno have constantly been taking market share and outperforming peers the six years running up to 2021.
“We always want to be one step ahead of the competition. …we entered the heat pump market in 2015. …we were polishing our offer and just waited for it to surprise. We knew what we were doing, because all market data and signals from clients indicated the enormous potential of RES. While the broad market remained skeptical, time has shown that it was an excellent move. Today, all our areas complement each other smoothly, we generate strong synergy effects, which translates into an above-average pace of development.” - Andrzej Jurczak, CEO.
Q3 results (Grodno’s ‘broken’ financial year spans April 1 - March 31) was released three weeks ago: 9M and Q3 sales were up +67% and +76% respectively, far outpacing the overall market.
Looking at profits, scale has clearly kicked in and in turn it awards us with a triple digit print on the bottom line.
This 240m mcap company achieved +32m in net profit in only nine months coupled with accelerating sales and net profit growth in the most recent quarter. In mid February, before the Russian invasion of Ukraine, as well last week, post-invasion, the CEO confirmed that the growth is continuing. Actually, his wording is explicitly optimistic.
Comments from CEO from the Q3 last month:
“The prospects for the Group's further growth are extremely favorable. Due to the ongoing energy transformation, the demand for energy-saving building solutions and renewable energy installations remains very high. There are also no signs that this situation should be reversed, on the contrary - these trends will increase. We are calm in terms of both the short-term and long-term development of the Group.”
Comments from the CEO in Pap.pl last week:
"In the coming years, we expect to maintain a double-digit growth rate - maybe not as dynamic as 60 percent in the previous periods, but it will be a very good time for Grodno related to renewable energy sources, energy transformation in the country, independence from gas or investments in development of power grids and support programs”
The company holds ~ 1.5h webinars for retail investors after each quarterly results, which is a great level of standard even compared to US/Nordic IR.
Taking management for a 5 day long climb of the highest mountain in Africa, Mount Kilimanjaro, just to announce they’re about to pass 1 billion in sales - smells like tiger blood to me, and not a stagnate value trap.
“As for the coming quarters and years, I am confident about further increases and maintaining the positive development trend. Demand for renewable energy sources, but also for all modern electrical engineering, energy and specialized engineering services will remain huge.” - Andrzej Jurczak, February 15th.
As Grodno disclose monthly sales numbers we know 2/3’s of the revenue of the coming quarter: January’s and February’s sales are up +82% and 67% YoY respectively. I’m not going to overcomplicate the reason why I’m long this case: Trading @ 6.5x current year net earnings (+ dividend) while flexing explosive sales growth selling heat pumps, solar PV, electric vehicle chargers and other ESG-products - is simply too low. Even if we do a s simple back-of-the-envelope assuming Grodno slows down to 10% growth, this owner-operator should earn its entire market cap in accumulated net profit in less than 6 years. One could also make the case that this $56m market cap leading distributor with 2 warehouses, 97 physical locations and established e-commerce business is a possible take-over target for PE or EU/US/Nordic peers looking to enter a 38 million population market with the landmass similar to Germany. Judging by the quality of the existing building stock and the subsidies in place, one could make the case there’s work to be done here the coming decade.
Grodno have a decade long history of execution and profitability, stressing my opinion that we’re not looking at a couple of accidental good quarters.
Thank you for reading today’s company presentation.
- This is not investment advice
- This blog may contain factual errors which you can not base your investment decisions upon. Do proper due diligence and fact checking of all statements herein.
- Please advice your bank and/or financial advisor before making any investment of any kind
- I’m obviously biased and this article is most certainly biased
- I will not update if I sell or buy shares