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.
