In the spirit of @PortfolioPlus respectfully questioning what he sees as price exuberance in a popular stock and @Strawman‘s appeal for energetic push back (while playing the straw, not the man), here are some Risks for EOL that I see.

Please come back with any risks you think I may have missed. I’ve tried to call out what I see as risks here but likely have blind spots as It’s a large position for me that I want to see do well.

Growth, Margins and Valuation

EOL have seen falling margins in recent years as they invest for growth.

Margins have also been impacted in FY24 by adverse effects in the cyber attack which required remediation and investment to improve defences as well as a failed (and poorly handled) opportunistic takeover attempt, and interest rates raising their debt servicing requirements despite falling debt levels.

This saw Statutory NPAT fall 51% in FY24, after falling in both FY23 and FY22 by 18% and 3% respectively.

So despite growing Revenue at an average of 24% p.a. over the last 3 years, NPAT has fallen by 61% over that period.

During this time they raised debt and equity to fund M&A which has added scale but potential fragility to operations and financials.

Financial objectives of growing revenue AND margins could be ambitious as these are often competing objectives to be traded off against each other.

There is a risk that this is a perpetual ‘Jam tomorrow’ story, where the jam never arrives.

One reason for the current market pricing may be a tug of war between believers like myself who have faith in managements ability to realise the obvious potential and sceptics looking at a trailing PE multiple of 98x and wanting to see proof of NPAT margin growth, debt repayment and all the other good things management are projecting.

Funding – Debt & Equity

Multiple Equity Raises – some for M&A, some for Debt paydown – have diluted shareholders over time and the return on these investments is not transparent.

Debt is high for a company of this size – and the recent interest rate rises have increased the debt servicing burden by 25% having a relatively large impact on the bottom line.

This net debt of $14.2m is due to be paid in FY27 but the CFO plans to repay it by FY26 requiring a big uplift in FCF that does not look imminent based on recent financial trajectory.

M&A cuts both ways

Lots of acquisitions in the past – how well these have been bedded in remains unclear. If there’s a level of tech debt built up through this, it will hopefully be addressed by the new IT systems being implemented at present. However, these are also not without risk – as we’ve seen from outages by Optus and Microsoft / Crowdstrike.

The takeover attempt in 2023 at $5.85 seriously contemplated by the board, then scaled back to $5.15 and rejected by the board highlighted a few cracks which are now being remedied, predominantly with IT spend.

This included losing experienced, aligned (16% holding) board member Vaughan Busby in the process as he (rightly in my opinion) opposed the takeover from the start.

Key Person Risk

The long tenure of board and management with skin in the game can be a real asset while it lasts but can create a void when a key person leaves.

If CEO Sean Ankers were to leave or Chair Ian Ferrier were to leave or sell his holding, this would be a big red flag.

In smaller, fast growing businesses, management can have an outsized impact compared to larger, more established, stable businesses.

There has also been an Org Restructure that has resulted in senior country heads departing and effectively being replaced by new functional heads. This kind of restructure can lead to a loss of corporate memory that has been built up over many years.

It also places a lot more focus on the CEO to get the new hires up and running, aligned with culture, etc.

Regulated Industry

Energy Industries are heavily regulated to ensure adequate, affordable supply in the advanced markets that EOL operates in.

This means that solutions may need to accommodate different regulatory frameworks / industry dynamics across different markets.

Also, the reg requirements in any given market are prone to change with elections, lobbying, etc.

Populist backlash from right of centre parties in Europe playing on cost of living pressures and xenophobia have the potential to eliminate / soften climate forward policies which could slow the transition to renewables that EOL supports and benefits from. The CEO indirectly called this risk out in the FY24 earnings call with reference to the on again off again transition policies implemented / cancelled by Australian governments.

For example, Government funded, large scale nuclear would likely suppress renewable investment and thereby opportunity for EOL to service a large number of renewable start ups.

Barriers to entry

Adjacent technologies pointed at a large energy markets could make inroads.

I’m often cautious of small companies chasing big markets – as these large potential profit pools can attract well resourced players seeking growth from adjacent / core markets.

A big competitive barrier is the in-house systems used by large players. If these are expanded / made available to smaller players this could represent a threat – however, these systems are likely specific to a particular vertical / geography so may have limited scope.

I attended the EOL FY24 Call today. They said a recording will soon be up on their IR site. Here are my thoughts.

It’s not a wildly complex business but there are a lot of moving parts. Happily they are all pointing in the same direction - hoping to catch a huge tailwind and take a large share of a small but growing niche. That being as “A leading independent global supplier of energy trading and risk management (ETRM) software systems and services”.

They are well diversified across customer, geography and industry segment. So as long as energy generation remains a large (and hopefully evolving) industry they should not be overly subject to customer / industry issues like some other picks and shovels providers are.

EOL seems very deliberately well positioned to benefit from the drive to renewables – there's some reg / sovereign risk in all of this but they are yet to enter the US where this reg risk appears most acute.

Costs

The One-Off Costs impacting 1H 24 are really thought about as investments as are the increase in run rate costs (except for the increase in interest costs due to rates rising), mainly the uptick in employee expenses.

They are very much building for the future to capture the growth they see coming down the pipe.

The 28% increase in employee costs (vs 17% Revenue growth) in FY24 is seen as a one off and includes an Org Restructure. From here on in, employee costs should grow as a % of revenue growth as they continue to invest in people but with cost discipline to grow margins – so this should not be a drag on Op Leverage going forward. Something to watch…

On the interest costs / debt, they plan to repay the debt in full by FY26 meaning they will need to generate FCF to clear the (net) drawn $14.2m (of a $25m facility) in the next 2 years.

This is a big step up from the $1.9m FCF in FY24 ($1.2 in FY23, 2.0 in FY22).

Their financial focus is on growing both revenue and margins so if they are successful higher FCF should be a happy byproduct and reducing debt will cut out ~$2m of interest p.a. adding to the momentum.

Presentation

The 36 page Preso was detailed and they called out a number of items in it - https://www.marketindex.com.au/asx/eol/announcements/energy-one-fy-2024-investor-presentation-2A1542127.

Net Revenue Retention of 108% with Churn remaining low at 3.5% (up slightly from 2.6% in FY23). I take this to mean existing customers spent 12% more in FY24 (108/96.5). If I'm right about this, it should give a level of confidence in Revenue growth as long as churn remains low and as new products come to market to up / cross sell into existing client base.

Interesting to see LTV/CAC up to 41x (vs 38.1x in FY23, 29.4x in FY22, 28.9x in FY21). They are refocusing their efforts on marketing but it’s not clear to me if this is driving higher LTV or because of it.

Competition & Market Penetration

They seem to have a first mover advantage on offerings like "one stop shop" and ‘follow the sun’ support services. They also have greater coverage of European and Australian markets than competitors – who tend to be more single country focused.

Australia is a larger, “very profitable” and more mature market for them but Europe is where the growth runway is – I think of this as parlaying their stable Australian earnings into a bigger opportunity in Europe. Also using their Australian expertise (well developed energy market) and products to service European customers.

Slide 24 of the Preso gives a good breakdown of their Australian operations. Namely:

• 50%+ of installed energy in the National Energy Market (NEM) passes through their software
• They are effectively 4th largest generator in the NEM – although they are only a broker, so don’t take any energy price risk.
• ~13% of east coast gas market volume managed by EOL - excluding LNG.

Management

Management talk calmly but enthusiastically about the business - they seem to know it very well, and gave plenty of time for investor questions.

They also seem to understand the market and their customer needs very well. At the risk of stating the obvious, staying very close to this changing industry and their customers seems key as the shift to renewables gains pace – the electricity grids in developed economies need to triple in coming years to cope with the electrification required to hit climate targets!

However, their competitive position and value prop compared to peers is hard to validate from an outside view (for me at least). Mgmt tenure and skin in the game give some comfort in this regard.

Disc: Held – 7% position.

@Valueinvestor0909 gave a good, visual summary of the results that EOL dropped while everyone was at lunch today.

I'll attend the conf call 11am tomorrow and feed back if anything material arises there.

Here's my thoughts while they're fresh / unfiltered...

The good

89% Recurring Revenue, 93% Gross Margins - both stable over the last 3 years.

Revenue Growth 16.5% - all organic.

The not so good

NPAT halved as cost growth outpaced Revenue growth for the third year in a row (by my measure). I look at what I call "Net OpEx". This is effectively EBIT minus Gross Profit, to capture all operating expenses by removing COGS, Interest and Tax).

Tough year including failed (cynical) M&A Approach, Cyber attack, Org Restructure, expensive skilled recruitment.

The context

NPAT down 51% partly due to $1.8m one-off costs, would have been up 10% otherwise, and up 27% if interest rate rises did not increase finance costs by 25% / $0.5m (vs 17% Revenue Growth - there's the Op Leverage).

Built out corporate infrastructure, incl CRM, cyber defences, etc as well as follow the sun support capability to support future growth.

Essentially front loading costs to support bigger scale and generate growth in organic revenue – that may still be augmented by M&A.

As they already have debt (albeit recently restructured so that 85% of it is maturing in 2.5 years), they will probably need another Cap Raise if future M&A opportunities arise.

Having debt for a business of this size (and in tech) is not ideal, however with 90% recurring revenue and 2.2x Interest coverage (down from 3.9x in FY23) and Debt / Equity of 36% (down from 51% in FY23), I’d say it’s manageable but not expandable.

That said, they are likely now becoming a more attractive target for acquisition as they complete their cyber security ISO certification and corporate infrastructure build out – commensurate with their growing size / focus on organic growth / emerging maturity.

This little business is growing up

This is still a small business with a market cap of $135m (at a SP$ of $4.50), revenue of $52m, but has been profitable for a decade, has aligned management with 35% ownership and average Board tenure of 16 years.

Price/Sales of 2.6x is in the bottom quartile (18%) for it’s last 5 years but Statutory PE is 94x. Adjusted for One-Offs PE is 42x so still lots of expectation baked in for a business growing organically at 17%.

That said, it should have stable NPAT Margins of 10%+ over time (got to 13% in FY21 & 1% in FY22). If the perceived long runway for growth can support a PE of 25x (8 year average PE is 32x), a 10% RRR would only need a 5 year Revenue CAGR of 13% and it’s not been that low in the last 8 years at least, albeit aided by M&A in many of those years.

It’s been a wait for this business to show its potential and the wait goes on but it is looking better to my eyes.

There are growing pains for sure and the failed / bounced lowball M&A approach last year highlighted to management where they were lacking from a corporate structure POV which they are remedying. The Cyber attack was not as bad as could have been (dumb luck?) but showed where they need to tighten up.

They are doing the things you would hope in response to these issues and being as proactive as their size and growth profile permit.

Disc: Held – 7% position.

Some good industry analysis in the attached 30 min pod.

Should provide some strong tailwinds for EOL in particular.

https://player.fm/series/inside-the-rope-with-david-clark/ep-156-matt-rennie-the-energy-transition-its-challenges-opportunities

Disc: Held