Yü is a business born out of the deregulated markets for gas, electricity and water. It provides these utilities to SME businesses and has no involvement in the overcrowded domestic market. Things are going so well for it at the moment that during the month it said it expects to be “materially ahead” for the third time since July. In light of that, broker Liberum has upgraded its eps forecast from 14.2p to 26.8p. Its forecasts for the following two years are 42p and 61.2p.
The company’s success is down to the fact that it is a virtual supplier and not encumbered by having to possess its own energy network infrastructure. It doesn’t aim to be the “cheapest” compared to the “Big Six” operators but its Digital by Default strategy means it is good at winning business and quickly onboarding customers. As I describe below, by using economies of scale and technology to create efficiencies (with unified billing so customers can access their single bill online and systems for risk management) it can deliver savings to its clients and a better service while making healthy profits for shareholders. If I am right in thinking that businesses are so disenchanted by incumbent suppliers then the opportunity facing Yü should be spectacular.
Materially ahead and possibly still conservative
When I spoke to chief executive Bobby Kalar, he talks in terms of energy sales becoming a multiple of current levels in future years. Of course, some of the growth in sales from £155m in FY21 to £260m expected for this year is down to the inflationary environment (Kalar is coy on giving the unit growth in the period) but the fact is that the market has become tight with only 15 rivals and this is allowing it to charge a higher margin than in the past; customers are less inclined to quibble because chances are they won’t get a better deal elsewhere. I also think this is a conservative estimate because bad debts are running below those forecasts by brokers.
Hedges its entire position
Anyone who looks at a small energy supplier might think this is a risky business. In the past 18 months there have been 30 energy company failures as surges in wholesale electricity and gas prices exposed the weak business models of many. The demise of Bulb Energy, for instance, the biggest supplier to have collapsed, is forecast to have cost taxpayers as much as £6.5bn after it was placed into special administration in November last year and funded with government loans. After a contested battle, Bulb is being taken over by Octopus Energy but in the past Yü too has been appointed by Ofgem as “Supplier of Last Resort” (SOLR) for five other small energy suppliers on the brink of administration and took on their electricity and gas customer books.
The reason all these companies failed is because they were buying their energy on the wholesale market and then selling it on a fixed price basis. In historical times, the price of energy was fairly stable and only moved by 5% between 2005-15, says Kalar, whereas in recent months it has moved as much as 20% in an hour and many suppliers found themselves in a position of selling energy for less than they bought it.
Fortunately, Yü hasn’t tried to live on its wits - if it did it could easily have got caught on the wrong side of things, which would have destroyed the company. Instead, its policy has been to be 100% hedged against moves in wholesale prices. Energy contracts are sold to customers at mostly fixed rates (about 25% of sales comes from variable rates), and as soon as is practically possible, forward contracts are taken out with the wholesale energy market to lock in a margin and reduce the risk of future wholesale price moves.
In the past, Yü also used to be constrained by its own balance sheet; for instance, if wholesale energy market prices moved, Yü used to have to provide more collateral against the hedges, which would leave it with less money to invest in its business. But in 2019, Kalar struck an exclusive trading agreement (running for five years) with SmartestEnergy, a wholesale energy market counterparty (a wholly owned subsidiary of Japanese corporation Marubeni). The agreement means that Yü exclusively buys its energy from Smartest at competitive and transparent prices. It also eliminates the need to put up any cash as collateral as it benefits from a credit-line provided by Smartest. The impact of this agreement has been to effectively reduce Yü’s cashflow volatility and it also means it can grow customer numbers faster and invest in other areas of the business. Net cash is currently £15.7m.
If you needed me to describe just how volatile energy prices have been in a different way, just assume each one of Yü’s SME customers decided they no longer wanted to buy any energy from Yü starting tomorrow, then because the prices have moved up so far, the hedging contracts would be worth an eye-watering £300m.
History
Yü was founded by Kalar in 2009 and began trading energy following its receipt of a gas licence from OFGEM in 2013 and an electricity licence in 2014. As a new entrant, Yü initially had to trade under the probationary Controlled Market Entry (CME) rules, which capped the number of meter points that could be added each month but by March 2015, the regulator decided that Kalar was a safe pair of hands and lifted the cap, giving the Group the opportunity to ramp up growth. In March 2016, the shares then joined AIM.
As Kalar explains, the SME commercial market landscape is vast. Back in 2015, 90% of SMEs were customers of the “Big Six” energy suppliers, and even now, seven years later, 84% of them still remain with the Big Six. But the shocking energy price rises we have seen recently have begun to encourage some to look elsewhere and Yü therefore has a commercial opportunity to take market share through the provision of better pricing and a higher level of customer service, which is an area where the Big Six have historically been lacking partly due to complex and outdated systems and practices.
Digital onboarding
You can wrap an old fish in a new piece of paper and call it change - but it’s still going to stink and many business energy users have had enough of the same old thing (I find the same is true with banks and this is why challenger banks are eating away at them - Editor). But Kalar, with a background in Electrical Engineering and an early career at Colt Telecoms, before a brief stint owning care homes and hotels, had clearly spent most of his early years nerding out with modern technology.
At Yü he has developed a sophisticated tech stack during the past two years, the latest generation of which went live in April this year and is intended to speed up the quoting and onboarding processes for new customers plus in the long run, reduce the cost required to serve its customer base. As he explains, the online platform is capable of all customer processes with zero human intervention. For instance, when a customer lands on the website, via Gorilla there is live and instant gas & electricity pricing allowing quotes to be priced in real-time. Prospective new customers enter their name, their meter point access number and usage data and receive a quote within 90 seconds for their utilities compared with the industry norm of several days for some complex quotes. An automated digital contract is generated and signature handled by DocuSign, with payments then set up to be collected by direct debit. Even before that there will have been a credit check process behind the scenes completed by Experian. The credit data gets updated monthly even for old customers so that if a customer looks like they may have problems paying in future, its contracts allow Yü to ask them to pay upfront or pay a deposit.
Yü has also built all the usual billing, customer care and easy online account management functions. Kalar’s hope is that its staff never need to speak to one of their customers - and consequently, staff numbers are small at 145. With such automation driving down the cost to serve, Kalar has a clear medium-term target of £500m in revenue and a 4% EBITDA margin. This compares to FY22 sales, which are expected to increase to £260m and EBITDA margin of 2.5%.
Focus on creditworthy customers
All this technology also means that Yü can now service micro SMEs just as efficiently as larger heavy users. The market is large at c. 3.4m meters. Yü currently has a customer base of c.26,000 meters and hence a tiny share. When I asked Kalar specifically about the target market, he said size doesn’t matter; his preference is to only contract with the most creditworthy customers, utilising the knowledge it gains from the credit checks it runs and to make informed decisions as to which smaller SMEs to contract with and which to avoid.
A second vexed question I had was about tolerance charges. For instance, Yü’s terms and conditions allow a customer to use 10% more or 10% less energy than the historical usage pattern they indicated when taking on the contract. Obviously if they are using less, Yü is in a superb position because most contracts are at lower values and it can easily sell the energy to someone else making for a windfall profit. If they use 10% more there is possibly some gnashing of teeth at Yü HQ.
In a similar vein, it hasn’t always been plain sailing for Kalar. Back in 2018, a new finance director found that the company had booked accrued income on estimated customer consumption of energy, which was later found not to be billable – and it had therefore over-stated profitability. This resulted in a write-off. In its defence, a high level of accrued income is required in the normal course of business, as customers are invoiced for energy consumed monthly in arrears, and if a meter hasn’t been read, you need to make an estimate. But the episode was painful for Yü and it ended up with a change of auditors and new policies being adopted. Nowadays, of course, increasingly Yü can accrue revenue with greater precision as it is based on smart meter readings and when a meter reading is not available (e.g. where there is a traditional meter and the customer has not provided its own read), then algorithms (which are used across the industry) are utilised to estimate customers’ energy usage, so there is less doubt over consumption.
Yü Smart set up in May
Smart meter uptake clearly gives Kalar better oversight of how much energy customers are using and so more accurate billing as the meters communicate directly with Yü remotely. This is why on 9 May 2022, Kalar created a metering services division following the integration of the management and support teams and intellectual property of Magnum Utilities. Yü Smart (the new name for the division) will undertake installation of SMET smart meters for business and residential customers (initially its own business customers but eventually to other energy firms also), he explains.
Yü Smart does not supply its own meters. These are generally bought from one of the big suppliers and once one has been installed, Yü Smart enters into a meter management contract with the energy supplier, which is typically for 15 years. So as well as eliminating the meter management element on the meter points, it will eliminate the rental paid on new ones it installs. Kalar says the activity will move into profits next year. Other benefits include being able to add energy efficiency reporting for customers whilst smart meters also give Yü an ability to remotely reconfigure meters (eg. move a customer onto Pay As You Go supply in the event that the customer is not paying).
All told, Yü has been finding that overdue customer receivables have been relatively stable in the last five years, which makes me think that even current forecasts could be beaten because the current broker forecasts factor in bad debt provisions increasing from 3.1% in FY 21 to 7.2% in FY 22. Kalar tells me this is unlikely. A 2023 NAP; I am a buyer.
