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Does Energy Action’s recent share-price rally have further legs? Earnings growth should resume in FY15 and Energy Action has some strong traits.

The energy procurement and management companies deserves a spot on portfolio watchlists. After falling from $4.35 in November to $3.18, Energy Action has rallied to $3.55. Investors should watch and wait for better value.

Energy Action has three divisions: the electricity gas/monitoring and contract-management reporting service, activ8; Australian Energy Exchange (AEX), an online platform that connects energy-seeking companies with energy providers; and Sustainability Solutions, which incorporated the consultancy activ8+, and last year’s acquisition, Ward Consulting. Activ8 contributes more than half of revenue.

Energy Action is growing organically and through acquisitions, most recently buying the energy efficiency consultancy, Exergy, for $4 million. The deal is earnings-per-share accretive, will be funded out of surplus cash on the balance sheet, and is an excellent fit with Energy action’s broader business.

It is always good sign when fast-growing small-cap companies use surplus cash flow to acquire private assets, rather than loading on debt or issue equity in dilutive capital raisings.

Energy Action has done well since listing in 2011 through a $3.8 million float at $1 a share. It rallied as the market recognised the strength of its business model, industry position, management and balance sheet – and the value of its energy exchange.

Its activ8 reporting system is a highly scalable, technology-based service that can expand at little additional marginal cost. Customer-retention rates are high because companies find it hard to leave once they get used to the reporting system.

The Australian Energy Exchange platform acts like a reverse auction where energy suppliers bid against each other to supply energy to a new customer, with prices falling until bidding is exhausted. Energy Action said it its half-year result in February that about $6 billion worth of contracts have been settled via AEX since 2005.

The higher-margin sustainability and energy efficiency consulting was an obvious product extension. Get companies using activ8 to better understand energy usage; sign them up to AEX to help lower electricity bills; and offer a consulting/reporting service to help them become more energy efficient and compliant.

Companies are eager to reduce energy bills and energy suppliers are eager to win their business. Energy Action, through AEX, rapidly became an important interface between electricity retailers and commercial and industrial companies.

Investors liked Energy Action because it had reasonably visible forward earnings. Recurring sales, strong cash flow, a higher return on equity, and no debt were other attractions.

However, Energy Action surprised the market in February with a trading update and revised earnings guidance. It said FY14 after-tax net profit would be in line with FY13 NPAT of $5 million; the previous expectation was 10-15 per cent growth. The stock shed 70 cents – or almost 20 per cent of its market valuation – on the news.

Lower-than-expected earnings from activ8 (now called the Sustainability Solutions division) and higher costs from restructuring the sales division led to the revised. Action Energy CEO Scott Wooldridge replaced long-term CEO Valerie Duncan in September.  

A headwind had been carbon-tax uncertainty. It led to companies signing shorter energy contracts, and AEX’s average contract length falling. Energy-monitoring business Activ8 also suffered from lower contract duration and more companies switching to its cheaper service offerings.

The good news is Energy Action reaffirmed its revised guidance in February: there was not enough deterioration in the interim result to lower the full-year forecast.

There is a lot to like about Energy Action – at the right price. More companies are outsourcing non-core services such as energy management, and the broker market for energy procurement is highly fragmented. Energy Action’s share of the broker market is 22 per cent.

It has the balance sheet to seize this opportunity: no debt is always a good sign, and $6.4 million in cash at December 2013, less after the Energex deal, gives scope for modest acquisitions.

If its strategy succeeds, Energy Action will be worth a lot more in the next five years than today. As it increases market share, it should be able to cross-sell more products and services, boost revenue and make relationships “stickier” through more customer “touch points”.

Also, it is hard to see the trend of rising energy prices reversing anytime soon, heavy energy users showing less urgency in finding energy savings, or less interest in reporting energy usage and sustainability.

Energy Action is worth watching if the price tests support at $3.30, then $3, for investors who are comfortable with small-cap stocks and higher risk tolerance.

Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply stock recommendations. It does not take into account your individual circumstances or provide formal advice. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at April 30, 2014.

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