Energy Solutions Devastated By Government Decision (ES)
October 17, 2008 | By Eric FoxEnergy Solutions' (NYSE:ES) dependence on sovereign governments for a large part of its revenue should have been a red flag to investors before the company lost half its market value after reducing guidance due to an adverse decision by a U.S. government agency. (Speaking of guidance, check out Can Earnings Guidance Accurately Predict The Future?)
The Nuclear Regulatory Commission (NRC) said that it would not change a rule to allow the use of decommissioning trust funds to clean up "major radioactive components that have been removed from operating nuclear reactors".
The Issue
The issue involves a closed nuclear plant in Zion, Ill., owned by Exelon Generation Co. Energy Solutions has an agreement to perform decommissioning work but needs the release of trust funds held to remove “major components” from the site. A major or large component is defined by the company as parts of a nuclear facility that require special handling with a weight of more than 20,000 pounds.
Energy Solutions provides nuclear services to governments, utilities and other entities that own nuclear power and research facilities in the United States. Services include cleaning up radioactive waste and contaminated locations, demolition and decommissioning of sites, and project planning of new facilities.
New Guidance
Guidance is now 50-60 cents per share, or 70-80 cents before the amortization of intangibles for 2008. The company said that earnings in 2009 would be flat with 2008. Analysts were expecting 69 cents, which was at the low end of the previous company range of 69-74 cents. The stock lost half its market value after the guidance cut. Energy Solutions went public in November 2007 at $23 and is down around 80%.
Customer Concentration
Energy Solutions is heavily dependent on revenues from sovereign governments. The U.K. Nuclear Decommissioning Authority represents almost all revenues in the company’s international segment and comprised 69.3% of revenues for the six months ending June 30. The U.S. Department of Energy provided 9% of revenues in the same period.
Energy Solutions was more optimistic during the Q2 conference call in August. When asked about its level of conviction that the NRC would approve the use of the funds, management said it was "comfortable that it's going to get done" since the idea had "a lot of support out there all the way through."
Dependence On Government In Other Industries
Other industries have a dependence on governments and have a volatile revenue stream as a result. The hospital industry is heavily dependent on government programs like Medicare and Medicaid to reimburse for services to patients. (Interested in learning more about Medicare? Check out What Does Medicare Cover?)
Health Management Associates (NYSE:HMA) received 53% of its gross patient service charges from Medicare and Medicaid in 2007. Universal Health Services (NYSE:UHS) received 37% of its net patient revenues from the two government programs in 2007.
Dependence on a large customer is not restricted to governments. Many smaller companies sell a large portion of goods to Wal-Mart (NYSE:WMT). Zvue Corp. (OTC:ZVUE) had 63% of its business with the giant retailer. Cott Corp. (NYSE:COT), a beverage supplier, was dependent on Wal-Mart for 39% of its sales in 2007.
Bottom Line
Investors should be wary about investing in a company that is too dependent on one or several customers for a large portion of its revenues, as this can increase volatility.
By Eric Fox
Eric J. Fox, is the founder of Brittain Capital Management, LLC., which is the manager of the Alesia Fund, LP., a Value oriented long/short investment partnership. You can read more of his views on investments at the Stock Market Prognosticator and Under the Buttonwood Tree. At the time of writing Eric Fox did not own shares in any of the companies mentioned in this article.
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