Low crude oil prices have driven the cost of heating oil in the U.S. below the cost of wood pellets for the equivalent energy in most locations. The impact on the heating pellet sector is very challenging in the Northeast, which is disproportionally reliant on heating oil compared to the rest of the U.S. At current prices, heating oil is about $200 cheaper per year.

The gap has come down in recent months as pellet prices have dropped. But low heating oil prices combined with a relatively warm 2015-'16 winter have significantly dampened demand for premium wood pellets. Inventory levels remain high. Until crude oil prices go above about $65 per barrel, it is likely that the premium wood pellet market demand will continue to have dampened demand, and downward pressure on the retail prices for pellets.  

It is quite possible that some of the existing pellet mills will be unable to generate breakeven cash flows under these conditions. Smaller, independent family-owned mills may not have the resources to weather these challenges. If a pellet mill is for sale, how can the buyer or seller determine its market value?

There are three basic valuation methods for determining the value of an existing pellet plant.  All three require that the participants have a broad perspective of the value of plant’s assets, its productive capability, and the current and future markets for wood fiber and for pellets. The three methods are based on: 1) the cost of a new facility of the same size; 2) the historic and expected future cash flows; 3) the net asset value of the plant.

Method 1: The value of an existing plant, in most cases, is less than the cost of building a new facility. The cost of a new, same-sized facility in the same market should set an upper bound on the value.  In very general terms, as a typical benchmark, the expected cost for a new plant with a nameplate of 90,000 tons per year (TPY) that is expected to run for 85 percent of the hours in a year (7,446 hours) and thus actually producing 76,500 TPY, costs roughly $23.8 million, keeping in mind that every plant is different and may have different cost structures.

Method 2: The next step in a valuation exercise requires a cash flow analysis. The level of free cash flow is often measured by EBITDA (earnings before interest, taxes, depreciation and amortization). Existing operations may have historical information that provides the financial data needed for a cash flow analysis. Some plants that have experienced recent equipment upgrades and operations optimization, or have been running below their normal operating levels due to the recent market challenges, may not have trailing financial data that is fully relevant to a valuation cash flow analysis.

Keeping in mind that every project is different, for the hypothetical 90,000 TPY plant, expected EBITDA using a typical cash flow analysis is $1.69 million in 2017. A typical negotiated valuation will be a multiple of that value. Multiples of 4.5 times to 6.5 times are typical. The riskier or more uncertain the future cash flows are, the lower the multiple.  If the hypothetical project above were valued at six times the expected EBITDA of 2017, then the selling price would be $9.6 million.

For forward-looking valuations, the terms of the deal may include an earnout.  An earnout is a contractual provision stating that the seller of a business will receive additional compensation in the future, if the business achieves certain financial goals. For the example above, the closing price may be $7 million with an earnout of $2.6 million at the end of 2017, if EBITDA exceeds an agreed- upon hurdle. 

Method 3: The buyer may also want to perform a balance sheet or net asset value (NAV) assessment of the project. The balance sheet or book value of the assets are the original cost of the assets minus the accumulated depreciation. Accumulated depreciation is an accounting metric that often has little to do with the actual market value of an asset.  A well-maintained asset will hold its market value, and is often worth more than book value. The NAV is the book value of the assets minus the balance sheet liabilities.

While a balance sheet valuation can provide some perspective, it will typically yield valuations that are lower than the market value of the project. In most cases, the cash flow analysis should provide the central point for the negotiation, the greenfield valuation should provide an upper bound, and the balance sheet analysis a lower bound.


Author: William Strauss
President, FutureMetrics Inc. 
Williamstrauss@futuremetrics.com
 207 824-6702