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DCF Analysis: Market Maker Rates Nevada Geothermal (NGP) A “Buy”

Posted by on June 20, 2011 in Green Energy

Nevada Geothermal Power Inc. (OTCBB: NGLPF, TSX-V:NGP), a provider of renewable clean geothermal energy in the Western U.S., similar to companies like NV Energy Inc. (NYSE: NVE) and Ormat Technologies, Inc. (NYSE: ORA), was recently rated a Buy by Canaccord Genuity in its report “Opportunities in the ‘Overlooked’ Renewable Power Sector”.

Nevada Geothermal Power Inc. (OTCBB: NGLPF; TSX.V: NGP) got a recent boost from major market maker Canaccord Genuity in its report “Opportunities in the ‘Overlooked’ Renewable Power Sector” (by Alexander, Plessis, Lakhani). NGP holds four geothermal properties in Nevada (Blue Mountain, Pumpernickel, North Valley, and Edna Mountain), and a fifth at Crump Geyser in Oregon.  The properties are all hotspots with excellent electricity production potential with the 50-mw power plant at Blue Mountain (‘Faulkner 1′) up and running, selling power to utility company NV Energy under a 20-year contract.  Additionally, NGP recently has bought all of Iceland America Energy’s geothermal assets, further bulking-up the Company’s already formidable portfolio of assets.

Remarkable Facts In A Buried Report

Three things are remarkable about the Canaccord Genuity report. First, one must consider the source. Canaccord is a major market maker, recorded as of June 3 making markets in no fewer than 4,242 publicly traded company stocks. Among their recent transactions (May 2011) are counted more than $1.3 billion, related to Dexcom (NASDAQ:DXCM), Manabi Holding, SA, and Green Mountain Coffee Roasters (Nasdaq: GMCR), variously as private placement, follow-ons, and lead.

The second intriguing aspect of the report is that there is only one other major geothermal being rated ‘buy’ in its pages. The third point of interest is the exhaustive and scholarly nature of the report, as well as its discounted cash flow (DCF) methodology for arriving at a ‘buy’ recommendation- and it‘s this latter point, DCF, which seems of greatest import. DCF, especially in novel or complex sectors, is perhaps the most difficult assessment an analyst can make.

But first, the highlights. The May 11, 2011 updated report sets price targets for NGP at C$0.55; U.S. Geothermal, Inc. (AMEX: HTM; TSX: GTH) at C$1.65; and for Alterra Power Corp. (TSX.V: AXY)

at C$1.55. NGP is currently trading in the area of 20 cents on Tuesday, 6/14/11, far undervalued from the stated $0.55 target. The current CAD/USD rate is about 1 CAD = 1.03 USD (6/14/11, prox. 5 a.m., ET).

So What’s Discounted Cash Flow Analysis? (DCF)

So NGP is clearly in good company, and has been anointed for long-term success by a major market maker who- presumably- has a lot of reputation and money to lose by being wrong. But what exactly is a DCF-driven assessment?

Most any investor or trader has come across a DCF analysis at some time, probably traded on it, and didn’t realize their trade was DCF-based. When honestly made, nearly all analyst recommendations to buy or sell are based on discounted cash flow analysis. The basic question asked and answered by DCF is, “How much future free cash flow will there be for this company?” It then discounts that figure by a certain amount to account for known, unknown, and unknowable risks (by 16%, in the case of NGP in the Canaccord Genuity report) and basically divides the resulting amount by the anticipated number of outstanding shares for a given period to arrive at a target price.

Harsh Standards, Good Outcome Anyway

Canaccord’s apparent diligence in dinging NGP for various risk factors only lends credence to their recommendation, even going so far as to note how proximity of two particular wells reduces production efficiency, and the fine-print terms of a $98.5-million John Hancock (NYSE: JHF) and EPA loan agreement requiring NGP to constrain one facility’s power production to 35 MW, causing it to barely meet its power purchase agreement obligation (PPA) to NV Energy.

The DCF analysis goes on to say that it did not take into account company plans to add a wind farm at Blue Mountain, or to expand capacity at its geothermal facilities, adding, “…we believe it is premature to value the additional capacity at this point in time.” Nevertheless, it arrived at the $0.55 price target.  Moreover, as the acquisition of Iceland America was not a portion of the calculations, a fact that certainly would pad the future potential of NGP’s Discounted Cash Flow analysis as well.

The Canaccord report is well worth a read- particularly the section on NGP. It’s proof that complexity- like DCF analysis- can also yield clarity.

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