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It has been a punishing year for junior renewable energy utility Polaris Infrastructure Inc. (TSX:PIF). While utility stocks overall have performed reasonably well to see the largest sector specific exchange traded fund, Utilities Select Sector SPDR ETF gain 6% for the year to date, Polaris was punished by the market, causing it to lose a whopping 36%.

That can be attributed to the market pricing in the additional geopolitical risk, which emerged in the jurisdiction in which Polaris operates, Nicaragua. Higher interest rates and fears of an emerging markets crisis have also weighed heavily on Polaris’ stock, but the latest news from the renewable energy utility indicates that much of that risk will diminish in coming months. 

Now what?

Polaris owns and operates the San Jacinto-Tizate Geothermal Project in Nicaragua, which has installed capacity of 77 megawatts (MW). It is this key dependency on its Nicaraguan operations that saw the market heavily mark down its stock. Earlier this year, Nicaragua erupted into political crisis because of controversial reforms made by the government of President Daniel Ortega to the Latin American nation’s welfare system.

Those cuts acted as a catalyst that triggered wider anti-government protests that saw over 300 deaths and caused damage of over US$1 billion to Nicaragua’s economy.

Analysts believe that this will push the country into recession and cause real gross domestic product (GDP) for 2018 to contract by almost 1% compared to an earlier growth forecast of 3.2%. That has the potential to cause the demand for electricity in Nicaragua to fall, impacting Polaris’ earnings.

Nonetheless, despite the political crisis, the renewable energy utility reported record electricity generation at its San Jacinto geothermal plant of 144,411 megawatt hours (MWh), which was 15% greater than the same period in 2017. This healthy increase in power output can be attributed to the new production wells at the facility, which were connected in early May 2018.

As a result of this solid operational performance, adjusted EBITDA shot up by an impressive 20% year over year to US$15.5 million, while net earnings grew more than fourfold to almost US$4 million. This robust financial accomplishment is the result of not only greater revenue because of greater electricity output, but also a notable reduction in costs.

For the third quarter, general expenses fell by 40% year over year, other operating costs were an impressive 44% lower, and finance costs dropped by 6%. That trend will continue because of management’s focus on reducing expenses and driving greater efficiencies.

While these latest results are impressive, it is Polaris’ planned acquisition of Union Energy Group Corp that bodes extremely well for the company’s outlook. The deal adds the operational Canchayllo 5MW Peru facility to Polaris’ portfolio as well as the late-stage Generacion Andina hydro projects with 28MW of generating capacity and the early stage Karpa 20MW hydro development. There is also an assortment of early stage projects with total forecast capacity of 189MW.

The two facilities making up the Generacion Andina development have power purchase agreements (PPAs) in place and are expected to come online in late 2019. The Karpa project has a PPA in place, but construction of the facility has yet to commence, and Polaris plans to assess the project in early 2019.

This deal delivers a range of benefits for the renewable energy utility. It reduces its dependence on Nicaragua by providing a solid operational footprint in Peru, which, with a forecast GDP growth rate in excess of 4% is one of the fastest growing economies in Latin America. There is a clear correlation between GDP growth and greater consumption of electricity.

Peru is also viewed as a more business friendly and stable jurisdiction in which to operate compared to Nicaragua. The successful completion of the deal and commencement of the Andina Generacion facilities will dial down the degree of geopolitical risk associated with Polaris’ business while also boosting earnings. 

So what?

Undoubtedly, there is considerable risk associated with investing in a microcap renewable energy utility like Polaris. However, the company is making all the right moves to reduce the degree of risk associated by its operations, the key being the completion the Union Energy deal.

That will give its earnings a further a boost, which will lift its market value. Meanwhile, investors will be rewarded by Polaris’ regular dividend yielding over 5%.

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Fool contributor Matt Smith has no position in any stocks mentioned.

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