Usually, scarcity means value in the equity markets. Unfortunately, anything relating to the nuclear power sector in the U.S. is colored with risk and uncertainty, and small engineering services firm EnergySolutions (NYSE:ES) has had trouble leveraging its expertise and assets in nuclear decommissioning. Although budgets and schedules are likely to remain uncertain for the foreseeable future, it would seem that the valuation on this stock has factored in quite a lot of bad news already.
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Ahead of Schedule and Under Budget
The biggest project at present for EnergySolutions is the decommissioning of Exelon's (NYSE:EXC) Zion plant. Although there were fears that the early margins on this project would be weak, overall results have not been bad at all so far. More to the point, as of early 2012, it looks like this project is on target or better, and the company is working to renegotiate a cumbersome letter of credit. (For related reading, see Analyzing Operating Margins.)
Given that there are roughly a dozen shut-down reactors awaiting decommissioning, this is no minor detail. Although EnergySolutions has repositioned itself as more of a sub-contractor to larger firms like Fluor (NYSE:FLR) and Shaw (Nasdaq:SHAW), it is still critically important for the company to demonstrate its operating capabilities and its value as a decommissioning partner.
Partnering at Home and Abroad
EnergySolutions has not been shy about trying to form partnerships to expand its revenue opportunities. The company works with General Electric (NYSE:GE) at various sites in North America and has a partnership with Toshiba targeting clean up and decommissioning work in Japan.
Thus far, though, the overseas business has been a mixed blessing. Although there is substantial opportunity in markets like the U.K., China and Japan, the problems abroad are the same as the local issues - EnergySolutions is not a large engineering company and nuclear services just aren't a budget priority in tougher times. Nevertheless, considering China's future energy needs and its relative willingness to accept nuclear power as an option, it's hard to believe there isn't a solid long-term opportunity here, so long as the Chinese government is willing to deal with non-Chinese firms on an ongoing basis.
Can EnergySolutions Leverage Its Assets?
One of the cornerstones to many bull stories on EnergySolutions has been its company-owned low-level radioactive waste disposal facility in Clive, Utah. As readers may imagine, getting permitting for a radioactive waste disposal site is not at all easy, so there is significant implied value to this asset. What's more, the U.S. government recently decided that the company can dispose of radioactive resins at this facility (and U.S. reactors generate about 100,000 cubic feet of this waste).
Still, EnergySolutions has had this facility for some time now and while it is valuable, it is neither unique nor a guarantee of performance. EnergySolutions still needs to win commercial sector bids and get assignments from government-funded projects to leverage the asset. Additionally, investors should remember that Waste Control Specialists now has a facility of its own in Texas.
The Bottom Line
Buying EnergySolutions today is a bet on the success of the company's ability to become an invaluable Tier-2 specialist in nuclear waste management and decommissioning. Thus far, the transition has not been smooth and the company does not have ample scale or balance sheet to fall back on in tough times.
All of that said, I do believe there is more intrinsic value here than the Street currently projects. At a minimum, I would think that if EnergySolutions cannot get its revenue and profitability in shape within the next couple of years, a large energy engineering services firm like Fluor or Shaw would consider a bid just to own the disposal facility. Moreover, expectations are so low here now that if the company can post almost any long-term growth at all in free cash flow, the stock should outperform. (For more on free cash flow, see Free Cash Flow: Free, But Not Always Easy.)
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.