There has been no shortage of criticism of the climate
change movement as being driven more by politics and government control than a desire
to reduce emissions. When a company like Zefiro Methane Corp. (ZEFI.NE) is
largely ignored, that type of criticism appears to have merit. According to the EPA, methane
accounts for 16% of global emissions, while the UNEP
claims it’s more than 25%. Methane is over 25 times more potent than carbon
dioxide at trapping heat in the atmosphere, and 84 times more harmful for
twenty years after it is released. Cutting methane emissions by 45% could lead
to meeting the Paris Agreement goal of limiting global warming to 1.5° Celsius.
Instead of endless debates about carbon taxes and subsidies
for renewables, it would be wise to focus efforts on reducing methane emissions.
This is where Zefiro comes in. Zefiro is an environmental services company that
specializes in the plugging of abandoned oil and gas wells that are currently
leaking methane. Prior to its IPO, it acquired Plants & Goodwin and
Appalachian Well Surveys. P&G offers vertically integrated services for
plug and abandonment operations, upstream workover, well completions, and
cementing services. The subsequent acquisition of AWS by P&G expanded
Zefiro’s wireline capacity, enabling it to become the energy sector’s first
comprehensive ‘end-of-life’ provider of well retirement services.
Owners of oil wells that have reached their end-of-life must
perform the necessary steps to ensure that the well is plugged and land
reclaimed. However, there are as many as five million orphaned wells across the
United States. These wells are currently leaking greenhouse gases, some of them
for decades. Many were drilled at a time when regulations and record keeping
was minimal, and the owner is unknown or long gone. These wells are now a
liability of the state. Fixing this
issue is gaining
some political attention, with rare bi-partisan agreement. $4.7 billion has
been set
aside for the plugging of these wells, with $560 million of it spent as of
2023. The rest of it to be released in the coming years. This leaves ZEFI in an
enviable position to procure lucrative government contracts over the next
several years. Particularly in the northeast portion of the United States where
it currently has its operations and has developed strong business
relationships. Zefiro claims an average of $180,000 in revenue per well cleanup.
The politics behind methane abatement is gaining traction,
but ZEFI’s unique position and opportunity is largely overlooked. Zefiro plans
to leverage the carbon markets to further accelerate high margin revenue opportunities.
CEO
Talal Debs was on the Smarter Markets podcast, run by Abaxx (ABXX.NE), a
past pick of mine. This gives me further confidence in the strength of the
business model as I recognize and respect ABXX as a thought leader in the burgeoning
carbon markets industry. This also demonstrates the upside potential of ZEFI. ABXX
is nearly 10 times the market cap of ZEFI, despite ABXX being a late-stage
startup while ZEFI has active operations. Some investors would rather dumpster
dive failing electric vehicle companies in a saturated market than pick up a
company that is knocking on the door of profitability in a climate
change-battling sector with an up to $600 billion total addressable market.
Analysis
of Q1 results shows that profitability is within reach
While junior companies in the clean energy sector have good
intentions, they tend to be science projects where investor money goes to die.
Unfortunately for early Zefiro investors, it has not
been immune to this trend. The stock has dropped by more than half since it started
trading in April 2024. However, where things differ for ZEFI is that it isn’t a
science project that burns through tens of millions of dollars a year. Its burn
rate is a little over a million dollars a quarter. With revenue having exceeded
$10 million last quarter, the breakeven point is within sight. The company
achieved positive EBITDA of nearly $0.5 million, more than doubling in
terms of year-over-year performance. This is a snapshot of its income statement
for its fiscal Q1 ended September 30, 2024:

Revenue increased over 25% from $8 million to $10 million
(all figures are in U.S Dollars). Gross margin increased over 45% from $2.2
million to $3.3 million. While the net loss appears to be going in the wrong
direction from $1.1 million to $1.7 million, that is largely driven by the
increased interest and income tax expense. The operating loss was $1.1 million
compared to just under $1 million for the previous year’s Q1. General and admin
and salaries and benefits skyrocketed compared to the previous year. These
costs can be explained by the acquisitions of P&G and AWS and increased
expenses related to being publicly listed. As revenue and gross margin
continues to grow while these two expense line items stabilize, profits look
within reach. The cash flow statement tells another positive story:

Operating cash flow was $140,000 for the quarter. Excluding
the changes in non-cash working capital, it was around breakeven. This is
driven by amortization, accrued interest expense and share-based compensation
being non-cash expenses. Junior companies are always looking to raise funds by
issuing equity, and Zefiro will be no different. However, any dilution it may
do in the future will likely be for more acquisitions or capital investment,
rather than to fund operating losses. Dilution is one of the biggest sources of
poor long term stock performance for small caps in the clean energy
sector. ZEFI’s numbers for Q1 gives
investors some assurance that if dilution does occur, it won’t be to toxic
levels that we see so often on other small cap listings. In addition to
dilution risk, investors should also be aware of any lock that may come off founder
shares. This could result in a supply overhang on the open market once they do.
However, I would rank this risk as fairly low given that early-stage investors
understand better than most that ZEFI is trading at a cheap valuation right
now. Some will want liquidity while most others will be patient until ZEFI is
no longer valued at such a discount.
This
unique environmental services stock is cheap compared to peers
One challenge when assessing a stock with a unique business
model such as ZEFI’s is finding appropriate peers to come up with industry
benchmark valuations. Using Q1 as a baseline, annualized revenue would be
approximately $40 million USD, or about $58 million CAD. Considering that the
market cap at $0.65 is $48 million, ZEFI’s revenue multiple is 0.8x. This
appears to be quite cheap as multiples below 1x revenue are usually reserved
for companies with flatlining revenue growth, low margins or those in mature
industries with minimal growth prospects. ZEFI clearly doesn’t fit that
profile.
Montauk
Renewables (MNTK) is “a renewable energy company specializing in the
management, recovery and conversion of biogas into RNG. The Company captures
methane, preventing it from being released into the atmosphere, and converts it
into either RNG or electrical power for the electrical grid”. While MNTK
isn’t a perfect fit with ZEFI’s business model, its methane capture focus makes
it enough to be a reasonable comparable. Its revenue multiple
ranges between 3-4x and has a trailing P/E of around 30x. While MNTK is
profitable, revenue has stagnated. It fell from $206 million in 2022 to $175
million in 2023 before recovering in the first nine months of 2024 with 16%
revenue growth. Assuming similar growth for Q4, this would track it to be about
flat from 2022 to 2024.
Given that ZEFI hasn’t achieved profitability yet but has
shown a superior revenue growth profile, I believe that these two impacts
should offset each other. I will use the lower end of MNTK’s revenue multiple
range of 3x as a fair valuation metric. That would lead to a target price of
$2.40, or 269% upside from its current stock price of $0.65. ZEFI’s Q2 ended
December 2024 should be out by the end of February. I look forward to providing
an updated assessment to its financial performance at that time. If ZEFI can
build on its strong Q1 result, that leaves the door open to an increased target
price, assuming a static 3x revenue multiple.
Insider
buying further suggests that ZEFI is trading at a discounted level
For those who still are on the fence about ZEFI even when
comparing it to ABXX or MNTK, perhaps the strong buying from insiders will be
the clincher. CEO Talal Debs has consistently bought shares
at various price levels and times, starting with open market buying at $1.70 in
early May up to the most recent buy in early December at $0.82. He purchased a
total of 789,000 on the open market. In addition to that, he purchased 420,200
shares in the company’s IPO at $1.50. Between his holding companies X Machina Sustainable
Technologies and the more active X Machina Capital Strategies Fund, he owns
over 20 million shares of the 73.2 million outstanding, or over 25%.
Considering the shares owned by other insiders, including
those bought on the open market, insider ownership is approximately 46%. In
addition to providing confidence to outside investors that management is
strongly aligned with the interests of shareholders, this also implies that the
float is much smaller than the outstanding shares of 73.2 million. Upon the
right news, improved financials or sector hype, ZEFI has the ingredients for a
run that goes beyond the $2.40 target needed to get aligned to MNTK’s
valuation.
Disclosure: I am long on ZEFI. I have been compensated to
write about ZEFI, but like all other articles where I mention getting paid, the
main purpose was to accumulate a position. The connection to ABXX is what
initially impressed me with this stock. With the decent financials, business
model primed for growth, insider buying and low valuation compared to its peers
being further bullish catalysts to my thesis.