Pacific Energy (PEA) RECOMMENDATIONS INITIATION of COVERAGE Rating BUY ▲ Risk High Powering up Price Target $0.73 Share Price $0.64

BAILLIEU HOLST RESEARCH 11 August 2016 INTERNAL ONLY

Pacific Energy (PEA) RECOMMENDATIONS INITIATION OF COVERAGE Rating BUY ▲ Risk High Powering up Price Target $0.73 Share Price $0.64 . We initiate coverage of PEA with a BUY rating: Pacific Energy (PEA) has a significant presence in the remote power generation market in SNAPSHOT Australia and a good track record of delivering steady earnings growth. Monthly Turnover $2.1mn Management is looking to leverage its decades of experience in the sector Market Cap $235mn by pursuing growth offshore and in the broader energy infrastructure Shares Issued 370.2mn market. If it succeeds, we believe that there is strong potential upside to 52-Week High $0.65 our current 12-month target price of $0.73. 52-Week Low $0.36 . Delivering solid long-term growth: PEA has been a leading player in the Sector Utilities market since 1981, being involved in the construction and operation of 40 power stations. Revenue is generated under long-term contracts of 5-15 years, delivering good earnings visibility and steady growth, with bonuses BUSINESS DESCRIPTION for outperformance. Since 2009, PEA has grown its generation capacity Pacific Energy builds, owns, operates and from 100MW to 239MW, with EBITDA growing from $17m to $35m. maintains remote power stations and generation-related infrastructure, primarily . Pursuing multi-faceted expansion strategy: PEA is seeking to leverage serving the mining sector. The vast majority its strong operating base into adjacent areas in search of additional of its assets are gas, diesel and dual fuel growth. Its strategy includes: 1) expanding offshore into African projects generators, with hydro facilities making up the remainder. The company is now looking to with ASX-listed owners; 2) increasing its presence in renewable energy, by expand its activities into Africa and the partnering with suitable companies; and 3) reviewing opportunities for renewable energy space. investment or acquisition in the broader energy infrastructure market.

Remote, renewable power expanding rapidly: Industry research . 12-MONTH PRICE & VOLUME suggests that the remote power market will double by 2024, implying a 10% CAGR. Most of the growth will be in Asia-Pacific and Africa/Middle East and PEA is moving to capitalise on this. Similarly, renewable energy investment in the mining sector is forecast to grow by a 20% CAGR in Asia-Pacific to 2022. PEA recently signed an alliance with a German wind and solar power specialist to participate in this expansion. . Good 1H16 result; 2H16 to be better: PEA reported 1H16 revenue up 6% to $24.4m, Adjusted EBITDA up 17% to $17.6m and Adjusted NPAT up 24% to $8.7m. The result was driven primarily by cost reductions, but PEA is expecting a stronger 2H16 due to a number of additional projects coming online and we are forecasting it to beat guidance of $35m.

. Investment view: Our 12-month price target is in line with our valuation of $0.73. This is based on the average of valuations calculated using a DCF RESEARCH ANALYST analysis ($0.71) and a P/E multiple ($0.75). We believe PEA is a solid Luke Macnab, CFA growth stock with a decent yield of 4.8% (fully franked) and significant + 612 9250 8930 upside potential if its growth strategy is successful. [email protected]

Nicolas Burgess, CFA INVESTMENT SUMMARY + 613 9602 9379 Year End: 30 June 2014A 2015A 2016E 2017E2018E [email protected] Revenue $mn 47.9 45.8 50.6 55.6 58.9 EBITDA $mn 34.4 30.8 36.0 40.0 42.6 Josh Kannourakis EBIT $mn 23.4 19.4 23.6 26.6 28.1 + 613 9602 9265 Reported Profit $mn 14.7 12.0 14.8 17.5 19.4 [email protected] Adjusted Profit $mn 16.4 13.5 16.5 19.2 21.1

EPS (Reported) ¢ 4.0 3.3 4.0 4.6 5.0

Disclosure EPS (Adjusted) ¢ 4.5 3.7 4.4 5.0 5.5 The author owns no shares in PEA. EPS Growth % 0.7 -17.9 19.6 13.9 9.4 PER (Reported) x 15.8 19.5 16.1 13.9 12.6

PER (Adjusted) x 14.1 17.2 14.4 12.7 11.6

Dividend ¢ 2.5 2.5 2.5 3.0 3.3 Yield % 3.9 3.9 3.9 4.8 5.2 Franking % 100 100 100 100 100

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BAILLIEU HOLST RESEARCH Pacific Energy Limited (PEA)

Financial summary PACIFIC ENERGY Code: PEA Rating: BUY Analyst: Luke Macnab Price Target: $0.73 Date: 11 August, 2016 Upside/downside: 15% Share Price: $0.64 Valuation: $0.73 Market Capitalisation: $237m Valuation method: DCF/Multiple Financial Year End: June Risk: High

PROFIT & LOSS (A$m) FY14A FY15A FY16E FY17E FY18E EARNINGS FY14A FY15A FY16E FY17E FY18E Operating revenue 47.9 45.8 50.6 55.6 58.9 EPS - Underlying (cps) 4.5 3.7 4.4 5.0 5.5 COGS -2.6 -3.4 -3.7 -3.9 -4.1 EPS Growth - Underlying 11% -19% 21% 16% 10% Gross profit 45.3 42.4 46.9 51.7 54.8 EPS - Reported (cps) 4.0 3.3 4.0 4.6 5.0 Expenses -10.9 -11.6 -10.9 -11.7 -12.2 Diluted shares (m) 365.0 367.5 375.4 382.5 385.1 EBITDA 34.4 30.8 36.0 40.0 42.6 DPS (cps) 2.5 2.5 2.5 3.0 3.3 Depreciation -8.5 -9.2 -9.9 -10.9 -12.0 Dividend Yield 3.9% 3.9% 3.9% 4.8% 5.2% EBITA 25.8 21.6 26.1 29.0 30.6 Payout Ratio 62% 77% 50% 50% 50% Amortisation -2.4 -2.3 -2.4 -2.4 -2.4 Franking 100% 100% 100% 100% 100% EBIT 23.4 19.4 23.6 26.6 28.1 Net Interest expense -2.2 -2.2 -2.4 -2.5 -2.1 VALUATION FY14A FY15A FY16E FY17E FY18E Minorities 0.0 0.0 0.0 0.0 0.0 P/E - Underlying (x) 14.1 17.2 14.4 12.7 11.6 Underlying PBT 21.2 17.2 21.3 24.1 26.1 EV/EBIT (x) 11.3 13.3 11.5 10.0 9.3 Tax -6.5 -5.2 -6.5 -6.6 -6.6 EV/EBITA (x) 10.2 11.9 10.5 9.2 8.5 Underlying NPAT 14.7 12.0 14.8 17.5 19.4 EV/EBITDA (x) 7.7 8.3 7.6 6.7 6.1 Underlying NPATA 16.4 13.5 16.5 19.2 21.1 Price/Book (x) 1.8 1.8 1.8 1.7 1.7 Price/NTA (x) 2.4 2.3 2.2 2.1 1.9 Significant items (net of tax) 0.0 0.0 0.0 0.0 0.0 Price/FCF 22.5 15.1 -38.2 15.0 13.1 Reported profit 14.7 12.0 14.8 17.5 19.4 GROWTH FY14A FY15A FY16E FY17E FY18E BALANCE SHEET (A$m) FY14A FY15A FY16E FY17E FY18E Revenue growth 10% -4% 10% 10% 6% Assets COGS growth 0% 29% 8% 6% 6% Cash 15.6 16.3 5.8 5.5 5.9 Expenses growth -16% 6% -6% 7% 4% Receivables 6.6 5.5 7.3 8.1 8.5 EBITDA growth 23% -10% 17% 11% 7% PPE 128.8 129.2 155.8 158.8 161.5 PBT growth 45% -19% 24% 13% 8% Goodwill & Intangibles 29.4 27.2 25.0 22.5 20.1 Underlying NPAT growth 12% -19% 24% 18% 11% Investments 0.0 0.0 0.0 0.0 0.0 Reported NPAT growth 12% -19% 24% 18% 11% Other assets 1.1 1.0 1.4 1.4 1.4 Total Assets 181.4 179.2 195.3 196.3 197.4 MARGINS & RETURNS FY14A FY15A FY16E FY17E FY18E Liabilities EBITDA Margin 71.7% 67.3% 71.2% 71.9% 72.3% Payables 1.8 2.0 1.9 2.0 2.1 EBITA Margin 53.9% 47.3% 51.6% 52.3% 51.9% Debt 42.9 36.6 42.0 36.1 30.1 NPBT Margin 44.2% 37.5% 42.1% 43.4% 44.2% Provisions 1.9 1.9 1.9 1.9 1.9 ROIC 11.7% 9.9% 11.3% 11.9% 12.5% Tax payable 2.2 1.0 1.7 1.9 2.1 ROE 23.4% 9.3% 11.2% 12.8% 13.5% Deferred Revenue 1.0 1.0 0.8 0.8 0.8 ROA 28.5% 12.0% 13.9% 14.8% 15.5% Other liabilities 5.7 6.5 7.4 7.4 7.4 Effective Tax Rate 30.0% 30.0% 30.0% 30.0% 30.0% Total Liabilities 55.6 49.0 55.8 50.2 44.6 Equity GEARING FY14A FY15A FY16E FY17E FY18E Share capital 108.4 110.1 110.3 110.3 110.3 Net Debt 27.3 20.3 36.2 30.6 24.3 Retained earnings 18.1 20.9 23.6 29.7 36.6 Enterprise value 263.9 256.9 272.7 267.1 260.8 Other equity -0.7 -0.9 0.1 0.1 0.1 Net Debt/EV (%) 10.4% 7.9% 13.3% 11.4% 9.3% Total shareholders equity 125.8 130.1 133.9 140.1 147.0 Net Debt/EBITDA (x) 0.8 0.7 1.0 0.8 0.6 EBITDA/Net Interest (x) 15.5 14.1 15.3 16.1 20.6 BV per share (cps) 34.5 35.4 35.7 36.6 38.2 NTA per share (cps) 26.4 28.0 29.0 30.7 33.0 SEGMENT REVENUES (A$m) FY14A FY15A FY16E FY17E FY18E Kalgoorlie Power Systems 47.0 44.8 49.5 54.4 57.7 CASH FLOW (A$m) FY14A FY15A FY16E FY17E FY18E Other - 1.0 1.1 1.2 1.2 Cash at Start 12.0 15.6 16.3 5.7 5.5 Cash from operations 24.8 25.2 26.4 30.1 33.4 Capex -14.5 -9.7 -32.6 -13.9 -14.7 Free cash flow 10.3 15.5 -6.2 16.2 18.7 Cash flow from investing 0.0 -0.1 -0.5 -0.5 -0.5 Cash flow from financing -6.7 -14.8 -3.8 -15.9 -17.8 Cash at end 15.6 16.2 5.7 5.5 5.9

Free cash flow per share (cps) 2.8 4.2 -1.7 4.2 4.9 GOCF / EBITDA 114% 106% 101% 108% 108% FCF / Underlying cash NPAT 70% 129% -42% 93% 96%

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BAILLIEU HOLST RESEARCH Pacific Energy Limited (PEA)

Investment view . We initiate coverage of PEA with a BUY rating: Pacific Energy (PEA) has a significant We initiate coverage with a presence in the remote power generation market in Australia and a good track record of BUY rating and 12-month delivering steady earnings growth since the acquisition of Kalgoorlie Power Systems (KPS) price target of $0.73 in 2009. Management is now looking to leverage its decades of experience in the sector by pursuing additional growth offshore and in the broader energy infrastructure market. . Long term contracts deliver steady growth: PEA has been a leading player in the Steady growth since 2009, market since 1981, being involved in the construction and operation of 40 power stations. with minor impact from Revenue is generated under contracts of 5-15 years in length, delivering good earnings mining slowdown in 2014 visibility and steady growth, with bonuses for outperformance. Since 2009, it has grown its generation capacity from 100MW to 239MW, with EBITDA growing from $17m to $35m. . Expansion strategy looking to adjacent markets: PEA is seeking to leverage its strong Leveraging its experience operating base and management experience into adjacent areas in search of additional into new growth areas – growth. Its strategy includes: 1) expanding offshore into African projects, which often have offshore and renewables common owners and similar climatic conditions to Australian mines; 2) increasing its presence in the renewable energy sector, by partnering with suitable companies such as Juwi; and (3) reviewing opportunities for investment or acquisition in the broader energy infrastructure market. . Remote and renewable power expanding rapidly: Industry research suggests that the Remote power market remote power market will double by 2024, implying a 10% CAGR. Most of this growth will forecast 10% CAGR. occur in the Asia-Pacific and African/Middle Eastern regions and PEA is moving to Renewable investment in capitalise on this. Similarly, renewable energy investment in the mining sector is forecast to mining forecast 20% CAGR grow by a 20% CAGR in Asia-Pacific to 2022. PEA recently signed an alliance with a German wind and solar power specialist to participate in this expansion. . Valuation and target price: Our 12-month price target is in line with our valuation of $0.73. Significant upside to our This is based on the average of valuations calculated using a DCF analysis ($0.71) and a valuation of $0.73 if growth P/E multiple ($0.75). Our DCF analysis uses a beta of 1.1, averaging the observed betas of initiatives are successful engineering/construction (1.3) and power generation (0.8). Other variables include risk free rate of 5.0%, market risk premium of 6.0%, terminal growth rate of 3.0%, debt cost of 6.5% and debt/equity ratio of 30/70. These give a WACC of 9.5%. The P/E multiple valuation is based on a FY17 multiple of 16.0x, in line with the average small cap multiple. . Investment view: We believe PEA is a steady growth stock with defensive characteristics, having a decent yield of 4.8% (fully franked) and high earnings visibility. The startup of new projects in 2H16 should lead to good earnings growth in FY17 and if PEA’s growth strategy bears fruit, there should be significant upside to our current forecasts. We initiate coverage with a BUY rating and a 12-month price target of $0.73.

FIG.1: PEA REMOTE POWER STATION FIG.2: PEA DIESEL GENERATORS

Source: PEA Source: PEA

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BAILLIEU HOLST RESEARCH Pacific Energy Limited (PEA)

Company overview . Pacific Energy (PEA) builds, owns, operates and maintains power stations and generation- Main business is to build, related infrastructure. The majority of PEA’s customers are mining companies in remote, own and operate remote off-grid locations, which require a reliable and cost-effective power supply to maximise mine site power stations production. PEA also has a small hydro-electric power business in Victoria, which sells under long term contracts electricity into the national power market. . PEA’s head office is located in Perth and it currently operates 22 power stations, with a total generation capacity of 239MW. PEA’s 20 off-grid facilities use gas, diesel or dual fuel generators and provide 233MW of this capacity; the hydro facilities make up the remainder. Power supply agreements are usually long-term, between five and 15 years in length. . PEA’s listed life began as a nickel exploration company (Arboyne NL), which had its IPO in 1987. It subsequently changed its name to Pacific Nickel in 1997 to reflect the acquisition of some offshore exploration assets. The Company then acquired the Blue Rock Dam and Cardinia Reservoir hydro-electric power plants from the Kvaerner Group and changed its name to Pacific Energy in 1998.

FIG.3: LOCATION OF PEA ASSETS FIG.4: PEA GAS GENERATOR

Source: PEA Source: PEA

. After failed merger attempts with Energy Equity Corporation and Energy World Corporation (EWC), in 2002 PEA made the decision to focus on its energy assets. Consequently, shareholders received an in-specie distribution of EWC shares and SMC (an exploration company) shares. Remaining non-core assets, including resource exploration projects and offshore infrastructure assets were divested over time. . In 2009, the current PEA began to take shape with the purchase of Kalgoorlie Power Acquisition of Perth-based Systems (KPS). KPS was established in 1981 by Ken Hall and had a strong historical KPS was transformative. presence in the WA Goldfields. At the time of acquisition, the company had around 100MW Clients are medium-large of generation capacity, consisting of 11 natural gas, diesel and dual fuelled power stations listed mining companies at mine sites across Western Australia (WA) and the Northern Territory (NT).

Kalgoorlie Power Stations . The KPS Head Office, storage facilities and main workshop are located at Kalgoorlie in WA. KPS currently operates generators in three Australian states, having developed a project in South Australia (SA) since acquisition. These generators are typically located near and provide energy to mine sites, usually with a capacity of 2MW to 45MW. . KPS clients are generally medium to large public companies and include Newmont, Iluka Resources, AngloGold Ashanti, Sandfire Resources and Regis Resources. The weighted average remaining contract duration is around four years, giving good earnings visibility in

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BAILLIEU HOLST RESEARCH Pacific Energy Limited (PEA)

the medium term. KPS’s customers are mostly engaged in gold production (around 75-80% of revenue), with the remainder in other precious metals and mineral sands. . The KPS model provides 100% of the funding for the power station’s construction, which KPS model and in-house frees up mine owner capital to fund other mine-related investment. KPS then charges a expertise is a strong fixed monthly tariff under a long term contract, commencing after mine commissioning. competitive advantage . Once in operation, the mining company supplies the fuel and KPS generates and distributes electricity to the mine site. There are also incentives in the contract whereby KPS participates in any efficiency gains but is also penalised for not meeting performance hurdles for efficiency or uptime. . A key selling point for KPS in the market is that it provides a single point of connection between the mine owner and the power supplier throughout the entire life of mine. This can significantly reduce the risk, cost and time involved when compared to dealing with multiple parties being responsible for the power supply. . KPS has a significant amount of in-house expertise in power station construction and project management. A key differentiator for KPS is that it modifies and ruggedises equipment purchased from the original manufacturer, customising the build for harsh Australian outback conditions. There are also a number of established sub-contractor partners which contribute to the activities of the company.

FIG.5: PEA REVENUE SPLIT BY COMMODITY FIG.6: EXISTING PEA CONTRACTS Contract Client2016 2017 2018 2019 Mine life

11% Tropicana AngloGold to 2028 Garden Well Regis to 2020 4% Moolart Well Regis to 2020 7% Gold DBS* Newmont to 2022 Copper Thunderbox Saracen to 2020 Mineral sands Jacinth Iluka to 2019

Other DeGrussa Sandfire to 2022

Carosue Saracen to 2020

78% Gwalia St Barbara to 2024

Other Other to 2022

Long term contracts Mine life Source: PEA * Assumes current contract extended Source: PEA

. This expertise has been tapped to develop and commercialise a new waste heat recovery technology for its diesel and dual fuel power stations, under an exclusive arrangement with Bowman Energy Recovery. This process recycles the heat energy available from exhaust gases to achieve a fuel consumption reduction of around 8% relative to standard equipment performance, and 6-7% relative to KPS solutions. . As part of its offering, KPS itself provides a guaranteed level of fuel efficiency (diesel or KPS offers guaranteed fuel gas), rather than simply passing on the guarantee of the original equipment manufacturer. performance levels and KPS manages and mitigates its fuel efficiency risk with the following processes: participates in the upside from efficiency gains - Selecting equipment based on demonstrated “in field” efficiency performance in similar ambient temperate conditions and geographical location; - Securing expert personnel to manage and develop performance enhancement innovations; and - Continuous evaluation of new technology opportunities including: low temperature waste heat recovery and intake cooling; and development of “low cost” dual fuel conversion technology on standard diesel solutions. . KPS’s uptime benchmarks of 99.9% are achieved by: - Installing minimum redundancy capability at each power station; - Developing equipment and technology to extend component life and reduce maintenance costs; and

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BAILLIEU HOLST RESEARCH Pacific Energy Limited (PEA)

- Managing oil and maintenance monitoring programs to ensure preventative action is undertaken prior to breakdown/outage. . Having secured the initial contract to build and operate a remote power station for a certain Incumbency is a key number of years (typically 5-15), it is obvious that the incumbent supplier has a significant advantage when contracts advantage when it comes to renewing that contract. This is because any new supplier are up for renewal would have to build its own, new power plant and KPS could be in a position to offer a lower price going forward, having presumably recouped its capital cost and an appropriate return on the initial contract.

Victorian Hydro . Victorian Hydro operates two power stations in Victoria, with a combined capacity of 6MW, Victorian Hydro plants located in South East Victoria at Cardinia Reservoir and Blue Rock Dam. These facilities contribute 6MW of capacity have been in operation since 1992 and the electricity generated is purchased by Energy Australia. . Blue Rock is a 22kV 2.6MW facility, located approximately 130km east of Melbourne in the Latrobe Valley. Cardinia is a 22kV 3.5MW facility, located 40km east of Melbourne. Both were developed, designed and are operated by PEA personnel, with the turbines and generators supplied by Kvaerner. . Cardinia and Blue Rock both have long term power purchase agreements, though Blue Rock’s is able to be terminated by either party with six months' notice. As a contingency plan, Blue Rock is also a registered Small Aggregated Generator under the NEM rules and will be able to sell renewable electricity at NEM spot prices if the contract is terminated.

Other growth initiatives . The KPS Africa division was established in June 2016 and seeks to replicate the success of KPS Africa looking to the Australian remote mine-site generation business offshore. PEA will look to leverage its replicate Australian existing relationships with Australian miners into its African projects – there are 190 ASX- success overseas in listed companies with almost 600 mining projects in 38 African countries. This is even similar conditions before taking into account other non-Australian owned projects.

FIG.7: ASX-LISTED MINING PROJECTS IN AFRICA – LOCATIONS FIG.8: ASX-LISTED EXPLORATION IN AFRICA BY RESOURCE

Source: Australia-Africa Minerals & Energy Group Source: Australia-Africa Minerals & Energy Group

. PEA also recently announced an alliance with Juwi, a specialist in wind and solar energy Alliance with Juwi looking projects, headquartered in Germany. Together, they will focus on projects seeking to to expand PEA’s presence integrate solar and battery energy with traditional diesel or gas fuelled power stations in in the fast-growing remote areas. renewables space . Previously, they collaborated on Sandfire’s successful DeGrussa hybrid power station, where the existing KPS 20MW power station was integrated with a 20 hectare 11MW solar and 6MW battery system. This project is the largest integrated off-grid solar and battery storage facility in Australia and reportedly, one of the largest in the world.

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BAILLIEU HOLST RESEARCH Pacific Energy Limited (PEA)

Industry Background . The remote power market services a need for the provision of reliable, cost-effective power Remote power station to off-grid locations. As an example, mining operations often run around the clock to market forecast to grow by maximise capital efficiency and energy providers have to meet these demands. 10% CAGR globally . Industry researcher Navigant estimates that the overall value of the market for remote power systems is around US$13bn this year and is forecast to double by 2024. Renewable energy will have an increasing role in this market, but existing thermal technology will still have a large part to play.

FIG.9: ANNUAL REMOTE MARKET CAPACITY1 AND REVENUE2 FIG.10: SUBSTITUTION VS LOAD TRADEOFF FOR DUAL FUEL

1 Bars, LHS. 2 Line, RHS. Source: Navigant Research Source: Drilling Contractor Magazine

. Diesel-fuelled power generation dominates the remote mine power market in Australia. This is mainly due to the absence of gas and electricity transmission infrastructure in mine locations. The use of natural gas has increased in recent years, with lower fuel costs and a reduced carbon footprint driving this increase, in markets where the gas supply is suitable. . Dual-fuel power stations are able to substitute up to 80% of the diesel fuel with cheaper Fuel is 80% of total power gas, offering additional flexibility for customers to manage their fuel input costs. Many cost – need for efficiency factors (including engine speed and load) affect the substitution, but rates of 50% to 70% is paramount. Dual fuel are typical. Having this flexibility has increased in importance in markets where fuel can also reduce costs suppliers have a dominant position and the potential for gas interruption risk exists. . Electricity generation typically accounts for 15-25% of total operating costs for remote mining projects. The cost of electricity generation is comprised of fuel (80-85%) and power station costs (15-20%). As such, fuel efficiency and availability of generation capacity is paramount in minimising the overall cost of power supplies.

FIG.11: DEGRUSSA COPPER MINE AND HYBRID POWER PLANT FIG.12: RENEWABLE INVESTMENT IN THE MINING INDUSTRY1

1,400 2013 2018E 2022E 1,200

1,000

800

600

400

200

0 Europe North Middle Latin Asia- America East/Africa America Pacific

Source: Juwi 1 Base case in US$m Source: Navigant Research

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BAILLIEU HOLST RESEARCH Pacific Energy Limited (PEA)

. In the past few years, off-grid industries suffered as the cost of diesel fuel increased Renewables is a key significantly. Whilst it has reduced recently, volatility remains high and forecasting fuel costs growth area for the remote is difficult. Diesel plants are also costly to maintain, are heavy polluters and miners have to market, providing low manage the transport of fuel over extreme distances to feed on-site generators. emissions and flexibility . For the above reasons, many mining companies are moving to hybrid power generation, which incorporates a component of renewable energy to reduce the reliance on diesel. As a consequence, remote thermal generators (like KPS) are increasingly partnering with experts in renewable generation (like Juwi) on new projects, such as the DeGrussa project. This type of integration requires development of sophisticated control systems in order to manage load swings and ensure uninterrupted power supply. . We expect this to be a strong growth driver for the remote power industry. It is expected that the value of renewable energy consumed by the mining industry will more than double by 2022. Wind power hybrids have become commonplace in areas where they can be supported (eg South America), although solar power is expected to eventually command a greater market share as solar cell and battery technology improves.

FIG.13: PEA ASSET LOCATIONS FIG.14: PEA CUSTOMER REVENUE SPLIT AND MILESTONES

8% AngloGold 3% 18% Newmont 5% Regis 6% Saracen Sandfire St Barbara 8% 18% Metals X Millennium 9% Iluka Other 10% 15%

Recent customer milestones

Thunderbox New 14MW gas-fuelled power station Tropicana Conversion of existing 44MW diesel- fuelled power station to gas-fuelled Deflector New 7MW power station Carosue Dam Conversion and expansion of existing 10MW diesel-fuelled power station to 11MW dual-fuelled Moolart Well Rollout of waste heat recovery units Bluebird Restart of 8MW power station

Source: PEA Source: PEA

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BAILLIEU HOLST RESEARCH Pacific Energy Limited (PEA)

Financial position and outlook . PEA reported a solid 1H16 result, with revenue up 6% to $24.4m and Adjusted EBITDA up Earnings growth in 1H16 17% to $17.6m. This was driven primarily by a reduction in corporate costs and general result underpinned by cost overheads. Adjusted NPAT was up 24% to $8.7m. During the period, an additional 18.6MW reduction program of new contracts and expansions to existing contracts were secured, representing an 8% increase on the previous installed capacity.

FIG.15: PEA REVENUE ($M) FIG.16: PEA EBITDA ($M) 60 50

50 40 40 30 30 20 20

10 10

0 0 FY14A FY15A FY16E FY17E FY18E FY14A FY15A FY16E FY17E FY18E Source: PEA, Baillieu Holst forecasts Source: PEA, Baillieu Holst forecasts

. Although the slowdown in the resource sector has had an impact on earnings (notably in FY15), it has been relatively small. PEA had no exposure to iron ore miners, who have been hit hard (commodity price down by c.50% from its 2012 peak in AUD terms) and significant exposure to gold miners, who have held up well (commodity price up slightly from its 2012 peak in AUD terms). . PEA is expecting a strong 2H16 due to a number of additional projects coming online Earnings expected to be during the period and we are forecasting it to beat guidance of $35m. Gearing was elevated stronger in 2H16 and FY17 at the end of 1H16 due to increased investment in equipment during the period and is as new projects start up expected to reduce in 2H16 as capex slows. The Net Debt/Adjusted EBITDA ratio stood at 1.1x as at 30 June 2016, compared with historical levels of 0.7-0.8x.

FIG.17: PEA CONTRACTED CAPACITY (MW) FIG.18: SPOT GOLD PRICE (IN AUD) 300 1,900 1,800 250 1,700 200 1,600 150 1,500 1,400 100 1,300 50 1,200 0 Apr 12 Apr 13 Apr 14 Apr 15 Apr 16 Dec 11 Dec Dec 12 Dec Dec 13 Dec Dec 14 Dec FY11A FY12A FY13A FY14A FY15A Current 15 Dec Aug 11 Aug 12 Aug 13 Aug 14 Aug 15 Aug 16 Source: PEA Source: IRESS

Outlook . We are forecasting PEA to achieve solid organic growth from expanding its business with Solid underlying business existing customers and winning new domestic business. The continuing focus on costs by with significant upside if the mining sector is a positive for PEA as the company is very focused on maximising the growth strategy bears fruit efficiency of their power generators and minimising costs. PEA is working on a number of new tenders, primarily in the gold, lithium and nickel sectors. . On top of this, management has outlined an aggressive expansion strategy which includes the KPS Africa initiative, the partnership with Juwi and reviewing opportunities for acquisition in the wider energy infrastructure market in general. If these initiatives are successful, there is significant upside to our current forecasts.

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BAILLIEU HOLST RESEARCH Pacific Energy Limited (PEA)

Additional information Key management personnel . James Cullen (CEO & Managing Director) – Appointed June 2015, was previously CEO Very experienced of Resource Equipment Ltd (2008-2014), which grew from $5m to $115m market cap management team before being acquired. Prior to that, was CEO of PCH Group (1994-2008), which grew from $1m to $260m market cap before being acquired. Other director roles include A1 Consolidated Gold (2015-) and Chesapeake Capital (2015-). Has extensive experience in the mining and engineering sectors. . Kenneth Hall (Executive Director) – Appointed May 2009, he is an electrician by trade and founded Kalgoorlie Power Systems in 1981. He has been involved in the mining industry for 50 years and the contract power generation business for 30 years. Mr Hall owns 49.9% of PEA. . Cliff Lawrenson (Independent Non-Executive Chairman) – Appointed August 2010, he is also currently CEO and MD of Avenira (ticker: AEV), a phosphate mining company. Prior to this, he was CEO of FerrAus until 2011 and CEO of mining engineering and development company GRD (from 2006-2009), where he was also Finance Director from 2004. Also worked at CMS Energy in the US and has led the development and financing of numerous major power and infrastructure projects. . Louis Rozman (Non-Executive Director) – Appointed May 2009, he is a founding partner of Pacific Road Capital, a private equity mining investment fund. He has over 30 years' experience in mining operations, joint ventures and corporate management internationally. Prior roles include CEO of CH4 Gas and COO of Delta Gold and Aurion Gold. Other director roles include Kula Gold (2007-), Carbon Energy (2010-), Mawson West (2009-) and Timmins Gold (2008-2010). Pacific Road owns 22.9% of PEA. . David Manning (General Manager of KPS) – Appointed in 2014, he has 25 years of experience in the mining and power generation industry. His previous role was GM of Powerwest (2009-2014), which designs, constructs and operates remote power stations. Prior to that, he spent time as Regional Manager at KONE elevators (2006-2009) and Operations Manager for Westral Group in Atlanta (1993-2006), where the business grew substantially during his tenure.

Key risks . Customer risk – A number of PEA’s customers operate projects that may be shut down Key risks are around temporarily or permanently due to falls in commodity prices or other factors. This could customers, key personnel result in early termination of long term agreements or payments that are lower than and industry developments expected. Risk mitigation is achieved by active monitoring of both commodity prices and customers’ financial health, and having a wide spread of customers. . Re-contracting risk – The majority of PEA’s revenues are under long-term contracts. As these approach expiry, PEA will be required to renegotiate the contracts with its counterparties. In the event that PEA is unable to secure the renewal of these contracts, or can only secure renewal on terms which are less attractive than the previous terms, PEA’s financial performance may be adversely affected. The advantage of incumbency is a big mitigating factor against this risk. . Key personnel risk – A number of staff in PEA’s management team and in key positions in operational divisions have significant industry experience and expertise. If one or more of these key personnel were to depart, it may be difficult to replace them adequately, in which case there could be an adverse effect on PEA’s ability to execute its strategic plans. . Industry risk – The power generation industry is developing rapidly, with renewable and battery technology improving and regulation around carbon emissions remaining uncertain. PEA’s success will depend on its ability to anticipate and adapt to these developments and the potentially changing requirements of customers. A strong management team and customer focus will mitigate this risk. . Competition risk – The remote energy supply market is subject to strong competition and competitors may have greater financial, technical and marketing resources than PEA. This is mitigated somewhat by PEA’s size (it is significantly larger than many of the companies in the domestic market) and management experience (key personnel have been in the sector for over 30 years).

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BAILLIEU HOLST RESEARCH Pacific Energy Limited (PEA)

Appendix FIG.1: LONG TERM MOMENTUM INDICATORS

Source: Iress

FIG.2: SHORT TERM MOMENTUM INDICATORS

Source: Iress

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BAILLIEU HOLST RESEARCH

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