July 10, 2017

REX American: Culturally Frugal

by Debra Fiakas CFA

Among the surviving public ethanol producers in the U.S. is REX American Resources (REX:  NYSE).  Based in Ohio, REX American is an ethanol fuel producer with owned nameplate capacity near 215 million gallons per year.  Additionally, the company distributes by-products of the ethanol production process, including distiller grains and non-food grade corn oil.  REX has full or partial ownership in six ethanol production plants located in the Ohio, South Dakota, Illinois and Minnesota.

The company relies on corn feed stock for its dry milling ethanol production process.  Like any other ethanol producer, that puts REX American in a vulnerable position if corn prices rise faster or to an egregious high level relative to fossil fuels, which help determine ethanol selling prices.  This is called the ‘crush spread’.  REX uses forward commodity agreements to lock in raw materials prices as well as ethanol selling prices.  However, these fixed price contracts typically do not last more than three or four months.

REX management has done a fairly good job of handling the ‘crush spread’.  In the twelve months ending April 2017, the company recorded $466.7 million in total sales, providing $34.0 million in net income or $5.16 per share.  Importantly, the company turned 17.9% of each revenue dollar into operating cash flow.  The strong cash conversion rate has helped build cash balance at the end of April 2017 to $181.9 million.  With no debt, REX American has one of the strongest balance sheets among companies in the ethanol sector.

REX American stands out among small-cap companies  -  habitually profitable, naturally cash generative and capital conservative.  However, we do have some concerns about management’s ability to act decisively or to take bold or aggressive action in their market.  The balance sheet is fully capable of supporting debt to finance acquisitions or new build ethanol production.  However, there are no concrete plans for such expansion.

Cash assets are now greater than the book value of the Company’s property plant and equipment.  Management’s investment plans are increasingly under scrutiny.  While management describes plans to expand capacity, these are very small investments relative to the total cash resources.

Although the management team might not be as culturally agile as most small, innovative companies, the REX American group can be admired for its conservative nature.  Conservatism has helped build a frugal operating structure that generates strong operating cash flows.  In the end it is shareholders who benefit from management’s penchant for staying the course with proven strategies rather than taking bold actions.
At a price-earnings ratio of 21.3 times the current fiscal year consensus estimate, the stock appears priced well above its peers in the ethanol industry.  This should give investors pause.  The ethanol industry is subject to considerable uncertainty, which is not supportive of premium valuations.  For example, in November 2016, the U.S. Department of Environmental Protection announced the 2017 requirement of 15.0 billion gallons for conventional renewable fuels.  This equals the statutory requirement.   Despite this action well before the end of the calendar year, the ethanol market did not benefit from the expected certainly but was instead roiled by a temporary moratorium imposed by the Trump administration.

REX shares are rated at Trim by Crystal Equity Research given that fundamental valuation is at an egregious premium that may not be sustained.    The stock has shown considerable strength in trading in recent weeks.  Should the stock go through another retreat, tradings might be tempted to add to overall positions.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. As of the date of this article, Crystal Equity Research has a Trim rating on REX shares.

July 07, 2017

Recycler Priced for Recovery

by Debra Fiakas CFA

Shares of Appliance Recycling Centers of American (ARCI:  Nasdaq) has trended downward over the last year, despite some strong fundamental progress in the company’s position the recycling sector.  The corporate name tells at least part of the company’s story.  Besides recycling appliances such as washers, dryers and refridgerators, ARC also sells new and like-new appliances right out of the box.  The company has eighteen stores branded ApplianceSmart across the country.  Services to electric utilities and other energy companies related to energy efficiency programs provide yet another revenue source.

In the twelve months ending March 2017, ARC reported $101.5 million in total sales, providing $1.2 million in net income or $0.19 per share.  Importantly, operations generated $2.0 million in cash flow during this same period. The profits are a welcome improvement over losses reported in fiscal years 2016 and 2015.  Sales had been declining and did not fully cover operating expenses in 2015 and 2016.

Besides having a spotty track record in producing profits, ARC also has debt on its balance sheet.  At the end of March 2017, the company had $6.2 million in total debt on its balance sheet.  This represented a debt-to-equity ratio of 47.52.  Debt at any level might give some investors pause, especially if there is no consistent profitability.

Still there are some elements in the ARC story that should interest investors.  In April 2017, the company opened a new recycling center in the Milwaukee area.  The company has teamed up with a state program to recycle old kitchen appliances, cleaning up the environment and removing unsafe, uneconomical appliances from neighborhoods.  The company also launched new contact center services to consumers called Customer Connexx.  The service supports scheduling of services of local utility programs related to appliance safety and energy efficiency.

Shares of Appliance Recycling Centers are trading below a dollar a share, which might be off-putting for some investors.  For those who are not shy of penny stocks, ARCI could be your stock.  The shares are now priced at 4.2 times trailing earnings.  There is no forward price-earnings ratio given that the company has a limited following among sell-side analysts.  With recent demonstration of recovery (no pun intended!), the stock appears to be priced at a bargain.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

July 06, 2017

Oh, No! Renewable Energy Group CEO Departs

Oh, No! Renewable Energy Group CEO Departs

Intirim CEO plans no strategy change

Jim Lane

In Iowa, Renewable Energy Group (REGI) announced that Dan Oh has resigned as President and Chief Executive Officer and as a member of the Company’s Board of Directors. The resignation was effective July 3, 2017. The Board of Directors appointed long-time director Randolph (Randy) L. Howard as Interim President and Chief Executive Officer.

Howard is a 33-year veteran of Unocal, has been on the REG board since 2007 — so, a familiar face — at 67, may not be in the job for the long-haul, but a strong interim pick.

Oh departs as the company’s stock hit a 3-year high of $13.39 in Monday trading, and has surged 46.2% in the past 12 months, topping the notable surge in biofuels equities which has seen the Zack’s biofuels sector average jump 30.6% year-on-year.

REG stock traded down a whopping 5.74% on the news, closing at $12.40.

Staying the course

“The strategy is in place and there’s no change,” CEO Randy Howard told The Digest. “That is our #1 message. We placed markers on the table and we intend to execute, and today we are seeing part of that execution as we bring in leaders who can take us to that next level.”

Howard is the iCEO for now, but there’s no sense of a caretaker — the company will continue to drive while the search takes place. “We’ve grown dramatically, and we’ve presented to our investor community a growth perspective for our biodiesel projects, and for hydrocarbon projects like Geismar, and new products. We’ll need leadership that can manage can build big projects like that, and manage companies of that scope and scale. I obviously hope to accelerate that growth, there’s no time limit on the search [for a new CEO], and I am all in until we get it right, with the long-term leadership that can take us to the next level.”

Projects there are, but also the ongoing project known as public policy. The EPA proposed a 2019 “no growth” RVO. But Howard was not dismayed.

“We see in the next several months,” Howard predicted “public policy coming together to give the biodiesel a secure future for an extended time. Not this year to year of tax credits, RVOs and import penalties. All of it we think is coming together, so that we will have a public policy in place that permits the industry to manufacture to its capacity.”

Meanwhile, Howard pointed to the short-term organic growth opportunities. “We have opportunities such as our Ralston plant where we were birthed, to increase capacity — and projects like these can fundamentally can help us grow in the mid to long term. I think that’s why investors have become excited in recent months. They see benefits in the financial short term but also a vision for long-term growth. Not just running a set of assets.”

Bullish outlook, yes. But there’s some ‘whoa Nelly’ in terms of expectations on timing. Think ‘expansion to 112 million gallons at Geismar’ as an all-but-certain reality. Think the same way about optimization of existing assets. Think “not ready to make that decision, but soon” on further doubling Geismar’s capacity as much as 234 million gallons — specific volumes to be better studied before decision time. As far as greenfield hydrocarbon projects, Howard noted, “the other facilities we are looking at, that’s not this year for sure. That’s all in process, but there are a lot of issues to work through when it comes building greenfield projects.”

A three-year stock high

Late last month at the company’s Investor Day in New York City, the company pointed analysts confidently towards $150 million or higher annual earnings, saying that they saw $100 million or more coming from the company’s biodiesel operations and as much as $50 million in annual earnings from its renewable hydrocarbon business based in Geismar Louisiana.

Oh said that the company would be “expanding, adding geographies, products and markets and capturing more downstream margin, citing the development of speciality products. Though Argentine imports have surged into the US in response to favorable prices for advanced biofuels, Oh predicted that “trade sanction activity is underway, and it looks like going to happen.” He saw the import and export trade “moving back to balance”. And he said that a reinstatement of the $1.01 per gallon biomass-based diesel tax incentive “seems likely”.

Oh pointed to the “growing global distillate market,” and said that, in contrast to the travails of ethanol producers, “we don’t have tension with petroleum,” because of the global call for more heavy-duty, distillate fuel. The world needs more of what we do.” Oh noted at the time that just a 3 percent increase in global demand would increase the market for diesel by 12 billion gallons, and noted that LMC and EIA projections saw the distillate market growing from 480 billion gallons per year to more than 700 billion by 2030.

REG’s Competitive Advantage

We’ve noted it before, REG has been building a mini-trading behemoth, accessing a wide range of lower cost, lower carbon intensity (CI) raw materials that gives the company “pricing flexibility”, and “reliability as an off-take customer for key suppliers of contract-manufactured fuel”. The company also notes that it is “a preferred supplier to key customers and trading partners” known for an “ability to meet stringent customer specifications” with its REG-9000 biodiesel product. For carbon value, the company ability to deliver a massively advantaged molecule with 50% lower CO2 emissions has given it access to $1.00+ per gallon RIN credits that have been giving biodiesel the cost advantage it has needed.

REG’s Growth

Accordingly, the company has been on a production tear, growing 39% annually since 2010, reaching 567 million gallons of production in 2016, and displacing 3 million tons of CO2 last year.

The company was growing with the industrial sector, in many ways — global biobased diesel production had risen from just over 4 billion gallons at the height of the “green fuels craze” in 2008 to more than 10 billion in 2016, and LMC is projecting the global production will top 14 billion gallons by 2020.

The boom has been particularly on in California, where sales of biomass-based diesel rose, according to the California Air Resources Board, from less than 20 million gallons in Q4 2012 o 110 million gallons in Q4 2016.

One trouble spot in boom times? Surging imports from Argentina and Indonesia in 2016 — according to REG, an 843 percent increase over 2014 for Argentina and 117% increase for Indonesia. The US Department of Commerce will determine on August 22nd whether countervailing duties will be imposed over charges of dumping. The European Commission imposed antidumping duties on Argentine and Indonesia biodiesel for five years starting in Q4 2013, crushing the volume of fuels shipped to the EU.

Overall in 2016 the company recorded a record $2.0 billion in revenue and recorded $102 million in adjusted EBITDA. Overall, EBITDA has been growing even faster than the gallonage — the company has recorded a 67% annual growth rate in earnings since 2010 when the com[any was essentially a break-even proposition, before RFS2 kicked in strongly starting in 2011.

Overall, revenue has doubled since 2012; although the company’s annual EBITDA has been on the up-and-down, following the mercurial policy ups and downs in DC. and the low energy prices seen since 2015. EBITDA reached a high of $148M in 2013 and dipped to $50M in 2015 before recovering last year.

However, the balance sheet has been strengthened — net working capital has doubled since 2012 and book value has almost doubles, and the company had $82 million in cash and just $217 million in debt, which is down from a high of $252 million in 2014.

Feedstock Market Outlook

In its analyst presentations, REG saw corn oil supplies expanding with a growth in US ethanol exports, and an uptick in animal rendering fats with meat production numbers climbing. Oh said that the company would continue to intensify its efforts on waste feedstocks. The company presented this overview of historical price data on feedstocks and molecule prices — the “crush spread”:

The big growth opportunity? The EU

REG acquired its first production capacity in Eastern Europe, Petrotec, not long ago, and strategically there’s a strong rationale, with a advanced biofuels target under the proposed Renewable Energy Directive set in the 1.5-9% range, or an overall 6.5 billion gallons market. “ REG noted that the “RED II proposal aims to expand success by growing and emphasizing the lowest carbon advanced biofuels.”

Geismar, the Rock Star

The old Dynamic Fuels plant, which REG acquired in 2014 after it had been idled for nearly two years, never produced more than 75% of its nameplate capacity in any given month, and what REG described as “significant Mechanical & Processing Issues” dropped utilization as low as 20% in selected months. With new catalysts and upgrades to the technology, the Geismar plant reached 100% of nameplate in December 2016 and has produced in aggregate more than it’s nameplate capacity since then. The company acquired 82 acres at the GEismar site and is aiming at expansion at a site strategically located less than a mile from the Mississippi and less than 3 miles from the Bengal pipeline. Another set of upgrades are taking place in June.

The biggest opportunity is capacity expansion, and Geismar is slated for a 37 million gallon capacity increase, to north of 110 million gallons. An interesting opportunity worth noting? Specialty chemicals. The company says that its “Specialty Products Unit adds 10 MMGY of RHD capacity with an option to produce significantly higher margin specialty chemicals.”

Terminals and Energy Services

REG is aiming at life beyond producing fuels and chemicals, sold in to various third-party terminals. The company has identified seven terminal growth opportunity regions in the US.

The Life Sciences gambit

In 2015, REG acquired LS9 as the base for an entry into specialty chemicals and more. The division has been 11 years in the making with $135 million invested — and not much to show by way of revenue, although there have been a steady stream of brand-name partners such as ExxonMobil. The REG Life Sciences unit is a “fatty acid derivative platform” from idea to manufacturing, with a small facility already in place in Florida.

The company has identified 11,000 “unique structures” and assembled nearly 200 patents — to date, one multi-functional fatty acid (musk) has reached “phase 4 -pre-launch” and a second sale id expected in Q3 2017. Nine other products are in the development pipeline, i various stages of partner discussions — ranging from nutrition, esters plastics, fragrances, and polyamides.

Overall, REG Life Sciences aims to compete in four markets — flavors & fragrances, the C8/C10 platform, speciality polyamides and novel building blocks, with a total addressable market size of $25.3 billion, growing by more than 5 percent per year.

The Digest’s Take

Here’s your takeaway. REG is staying the course and ready to execute its strategy as unveiled with its investors last month in New York.

Transitions at the top always create nervousness. They involve regret for the loss of valued leaders. In this case, no reason for nerves. And reason to re-focus on REG’s big, big opportunity. If it executes the strategy, builds a large and strongly committed investor base, and gets the decisions right on expansion opportunities. A great strategy is validated by great execution.

Let’s salute Dan Oh and the company he built — the people and the systems that remain will be his substantial and substantive legacy. Now, let’s salute Randy Howard and the company that’s emerging — with growth opportunities that any company in this sector would envy.

Now, it’ll be noses to the grindstone in Ames as the company tackles decisions on optimization and expansion — Geismar, terminals, upgrades in the existing fleet, M&A opportunities, generating cash out of REG Life Sciences. It’s a heady set of opportunities and choices for REG as it aims to go from a 3-year high in the stock price to something even more special.

Jim Lane is editor and publisher  of Biofuels Digest where this article was originally published. Biofuels Digest is the most widely read  Biofuels daily read by 14,000+ organizations. Subscribe here.

July 05, 2017

The New US Solar Trade Dispute

by Paula Mints

In 2012 SolarWorld, facing significant price and margin pressure from cells/modules imported from China, filed trade petitions in Europe and the US under section 337 of the 1930 Trade Act. As a refresher on the Trade Act of 1930; this was the infamous Smoot-Hawley Act which began as a protection for farmers but after much debate fed by many special interests it was eventually attached to a wide variety of imports (~900). Other countries retaliated with their own tariffs. The US trade deficit ballooned. Smoot-Hawley did not push the world into the Great Depression but it certainly was a card in the Depression playing deck.

In 1934, as part of the New Deal, President Franklin Roosevelt pushed the Reciprocal Trade Agreements Act through and the short reign of protectionism in the US ended.

Back to 2012, following an investigation, tariffs on cells and modules imported from China were put in place. Despite high anxiety in the US and Europe over potential price increases, and a highly divided solar industry prices did not increase significantly. In many cases, for larger buyers, the tariffs were absorbed.

Goal of action: Attempt to correct the import/export solar panel imbalance.
Result of action: Aside from industry participants and observers lining up on one side or the other it was Business as Usual. Prices increased slightly for smaller buyers and did not decrease as rapidly for smaller buyers.

In 2014 SolarWorld amended its original petition to include cells imported from Taiwan. Significant tariffs were put in place. Despite renewed high anxiety in the US over potential price increases, prices did not increase significantly. In many cases, for larger buyers, the tariffs were absorbed.

Goal of action: Attempt to correct the import/export solar panel imbalance.
Result of action: Despite angry shouts from both sides of the dispute (for and against) it was business as usual again. In old fashioned measurement terms, the needle on prices barely budged for larger buyers, and though prices increased for smaller buyers this was sometimesoffset by manufacturer or distributor sales on inventory. In late 2016 China slowed it exploding market sending global PV capacity immediately into an oversupply situation. Overnight prices crashed and margins collapsed. To support current production manufacturers began selling future production to large buyers at extremely low prices. Price decreases were in some cases available to buyers of smaller quantities.

Prices, in some cases, dipped below $0.30/Wp, lower than the price of a cell and below the cost of wafer-to-cell-to module production. Manufacturers, trapped in a spiral of buyer expectations and low margins, doubled down by selling future production to large quantity buyers in the $0.30/Wp to $0.40/Wp range.

Goal of action: Concerning the significant price drops, this was an attempt to sell off manufacturer inventory and it went awry. The goal of future pricing was to support current production.
Result of action: Lower prices for cells and modules for all buyers and extended unprofitability for manufacturers leading to a new round of manufacturer consolidation and creating a perfect situation for new tariffs and other government actions on imports. Meanwhile, sales of future production at low prices trapped manufacturers in a downward pricing spiral.
Figure 1 offers average prices, average costs and shipments from 2006 through 2016. Average prices and costs are the weighted average price (or cost) represent a global weighted average of the price paid for modules or the cost of manufacturing modules during a specific period. 

mints trade war fig 1.png

In April 2017 US-based (and 63% Chinese Owned) monocrystalline cell manufacturer Suniva filed for bankruptcy and shut down its cell and module facilities in the US. Simultaneously it filed a new petition under Section 201 of the Trade act of 1974 asking for a 0.78/Wp minimum price on all crystalline module imports and an additional $0.40/Wp tariff on imported crystalline cells.
The Trade Act of 1974, in theory, was designed to expand US manufacturing participation in global markets and reduce trade barriers. It also – and this is important – gave the President broad fast-track authority.  Under it the US president can give temporary relief to an industry.  Gerald Ford, who became the 38th president after the resignation of Richard Nixon, was president at the time.  The Trade Act of 1974 was deemed necessary because it gave the president a stronger negotiating position during the Tokyo multilateral trade negotiations. It was set to expire in 1980 and has been extended several times. President Bush used Section 201 in 2002 to increase tariffs on some steel imports to the US.

Section 201 of the 1974 Trade Act sets a higher bar for petitioners than the previous trade dispute.  The injury must be serious. The ITC (US International Trade Commission) has 120 to 150 days to report its findings to the president.

In early May SolarWorld Germany (SRWRF) declared itself insolvent and its US subsidiary while stating it would continue operations filed its intent to lay off its employees.  In late May SolarWorld joined Suniva’s petition.  
Goal of action: The goal of the latest petition seems to be to make a statement.   Result of action: Suniva is unlikely to survive. SolarWorld may pull itself out of danger.  US cell manufacturing is already comatose.  The most likely result will be higher prices for all participants. Should the petition be made retroactive for any period it will cause margin distress for US installers, developer and EPC. 
Nota bene, the 2012/14 petitions established a date for the tariffs to be implemented that took into account the timeframe required to investigate. That is, the tariff would go into effect at an earlier date than the decision.  The current tariff minimum import price petition does not include a date marker but this it is by no means certain that an earlier date wouldn’t be established if the proceedings go forward. The ultimate decider in the current case is President Trump.

Who did the earlier tariffs benefit? 
Several years later the solar industry still takes sides concerning the 2012 and 2014 trade dispute. Concerning the US, the 2012/2014 dispute did not lead to an increase in US cell manufacturing. One reason for this is long timeline from installing equipment, through pilot scale production to commercial activity.  It takes time. It takes money.  The decision to invest time and money in a vulnerable incentive-driven market is nontrivial. 
In 2016 the US had 1% of US cell manufacturing capability and 1% of module assembly capability.  The cell is the electricity generating component of the module without which the module is just a frame. Module assemblers buy cells. As the US has significantly more demand than it does crystalline capacity US module assemblers must import cells. Table 1 presents US cell manufacturing capacity, shipment and US market demand from 2011 through 2016. 
mints trade war table 2.png

Observing Table 1, US manufacturing capacity remained flat during the period from 2011 through 2016 viewed through the lens of compound annual growth. On the face of it, the US supply and demand story seems clear, however, looking closer bumps in the supply/demand road are apparent.  To understand the market, the macro view, represented by compound annual growth rates, is informative, but the bumps in the road, that is the detail, are even more important.

mints trade war table 1.png

Table 2 offers a bumpier view of US supply and demand during the period after the first tariffs in 2012.  In 2013 US capacity to produce cells, again, the electricity generating component of the module, decreased by 16% decreasing again in 2015 by 9%.  In 2013 shipments decreased by 9% before seeing a 6% recovery in 2014. 
Demand, meaning modules acquired from all countries, increased by 70% in 2013, 40% in 2014, 25% in 2015 and 73% in 2016. Demand during this period and for the foreseeable future (assuming no changes) was and is primarily driven by the ITC.
In 2015 US capacity to produce cells increased by 60 percent as manufacturers brought new capacity online. Shipments increased by 38% primarily to serve the growing US market. Despite new capacity the US still could not serve its own market.  The new capacity that was available in 2015 was additional, that is, brought on line or added by manufacturers currently operating. It takes years, decades in many cases, to add new manufacturing capacity.  The only way new capacity can be brought on line in a country is to truncate the pilot scale to commercial production timeline. When manufacturers move too rapidly through pilot scale production the result is almost always poorer quality.

Table 3 offers four scenarios for 2017, low, conservative and accelerated. Table 3 provides two conservative scenarios based on manufacturing capacity. The reason for this is that though SolarWorld will likely shutter some capacity and lay off employees it may survive the year as it has done before. Should installers become anxious about SolarWorld’s survival and stop buying its modules the ripple effect of this would ensure the company’s failure. 

mints trade war table 3.png

The direct goal of the current tariff/minimum price action is murky. Following its bankruptcy Suniva took investment with the caveat that it file the petition. The goal of protecting US manufacturing is difficult to support as the US has very little cell manufacturing and cannot serve its own market. The US has more module assembly capacity but must buy cells to assemble from other countries. The petition affects crystalline cells and not thin films, at least for now. There is not enough global thin film capacity to serve the US market. 
Should the current tariff petition be enacted prices for cells and modules all demand side participants will increase and US manufacturing will not become more robust. The only to increase US cell manufacturing is to invest overtime and reward buyers to choosing US produced cells and even then, other components will need to be imported.

What the trade petition means to you
End users: It is highly unlikely that system prices will increase. Expectations for low system prices are cemented in (and highly publicized). End users do not have to choose to install solar. End users have buying power. 

Residential Installers: This group will feel the squeeze stuck between buyers who do not have to choose solar and distributors/manufacturers who will likely pass on higher prices.  Warning, however, though the current petition does not set a date for tariffs it still could.   Distributors: This group will face higher prices but can usually pass on at least part of the cost to installers.  As with installers, though the current petition does not set a date for tariffs it still could.    

Developers and EPC: Price increases will be smaller for this group but there will be price increases and slower decreases. Thin film manufacturers will be free to raise prices, though as there is not enough thin film capacity to fulfill current demand supply constraints are likely. As with installers and distributors, though the current petition does not set a date for tariffs it still could.       

US Module Assemblers: Prices for crystalline cells will increase and this group will have to pay them to stay in business. Margins will feel the pain and it will be difficult to pass much of the price premium to customers  Investors and Developers: With low PPA bidding the norm, higher prices for modules will affect profitability. If the modules have already been purchased beware of retroactive pricing – not in place yet but you never know. If modules have not been purchased you will pay more per Wp. 

Thin film manufacturers: This group is probably secretly (or not so secretly) hoping the US minimum price and $0.40/Wp tariff on crystalline cell imports is enacted. Why? – no more price pressure. Expect prices for thin films to increase almost immediately while supplies remain constrained.  High end monocrystalline providers such as LG and SunPower: These manufacturers have already met the minimum price but may get hit with the $0.40/Wp on imported cells.  If so, these manufacturers will have to absorb the tariff.   

Paula Mints is founder of SPV Market Research, a classic solar market research practice focused on gathering data through primary research and providing analyses of the global solar industry.  You can find her on Twitter @PaulaMints1 and read her blog here.

June 30, 2017

Stock Picks for US Energy Dominance

Tom Konrad, Ph.D. CFA

Thursday night (Friday morning in Sinapore) CNBC Asia's Street Signs program must have had an interview cancellation, because they needed someone to give them 3 energy stock picks in response the Trump's "Energy Dominance" speech on last minute notice.  They sent me (and probably a bunch of other people) an email two and a half hours before air.  I did not see it until 20 minutes before the actual interview.  I warned them that I do clean energy, not fossil fuels, but apparently they had no other takers who were awake and able to give energy stock picks at 11:23pm ET on a moment's notice.

I think they found me because I was on Capital Connection Asia in late January.  

I don't think I was quite what the host, Martin Soong was looking for.  He improvised well by turning from the Trump clip saying "if you want to do something entirely different, you might invest in alternative energy..."

I'm still trying to get video, but here's my memory of the interview.

MS: How is clean energy doing under Trump?
TK:  Great.  There was a little stumble after he was elected, but then the market figured out that he's living in the 20th century while the economy has moved on to the 21st.  Clean energy has turned the corner, and is now the cheapest source of new electricity. The market is realizing that, even if Trump doesn't.

MS: Do you have stock picks?

TK:  Atlantica Yield (ABY), Covanta Holding Co (CVA), and General Cable (BGC).  
I went on to describe why I like Atlantica - you can read about that and Covanta in my last 10 Clean Energy Stocks for 2017 update.
General Cable was a last minute add for me.  I'm very nervous about the market right now, so there are not many stocks I'm enthusiastic about.  I was tempted to mention Seaspan (SSW) Preferred shares (SSW-PRG), but they'd asked for energy stocks, not efficient transportation.  You can read about Seaspan Preferred in my recent update as well.  

My picks in January had been Pattern Energy Group (PEGI), and Hannon Armstrong (HASI.) Both have gained significantly (17% and 22%) since then, and so they're still top holdings, but not the most likely to make further large gains in the near term.
I picked General Cable instead.  It's a bit of a stretch to call it an energy stock, but at least the connection between the manufacturer of electric and communication cables and the energy sector is obvious.  Given more than 20 minutes, I might have picked something else, or just stuck with the two I'm most enthusiastic about.  

Martin Soong wanted to talk about ETFs, we did not talk about Covanta or General Cable at all.

MS: What about clean energy ETFs?  I've looked at six that are up about 10% for the year.

TK: ETFs are okay if you're unwilling to pick stocks, but clean energy is such a new sector, pricing is not yet efficient, and there is a lot of room for stock pickers to get an edge.

MS: But the ETFs are up 10% for the year.  Why not just invest in those?

TK: My Green Global Equity Income Portfolio is up 17%.

MS: I have to admit, that's good performance.

And he ended the interview.

Unfortunately, I had misstated my performance.  I don't spend much time thinking about past performance: Future performance and how I can improve it is much more interesting.  For the record, my Green Global Equity Income Portfolio (GGEIP) was up 13.5% for the year to date.... not as good as I'd thought, but still ahead of the alternative energy ETFs he was looking at.  

Despite my mistake on my track record, I stick to my assertion that clean energy remains a stock picker's market.  Until clean energy investing becomes main stream, there will be a lot of room for stock pickers like me to beat the indexes.  Perhaps I should have mentioned that GGEIP was  up 30.5% in 2016, although I achieved that using options and other strategies not available in clean energy ETFs, not just stock picking.

DISCLOSURE: Tom Konrad has long positions in ABY, CVA, BGC, PEGI, HASI, and SSW-PRG, and own puts on SSW (an effective short position.)

June 22, 2017

Power REIT: No News Is Good News

Tom Konrad Ph.D., CFA

I first wrote about Power REIT (NYSE MKT:PW) in 2012, when the tiny real estate investment trust unveiled its plans to become what would have been the first Yieldco by investing in the land underlying solar and wind farms... before the term 'Yieldco' had even been invented.  In the years since, the company made some progress buying land under solar farms.  According to the most recent shareholder presentation, they now own land under seven solar farms totaling 601 acres and 108 MW, in addition to their legacy railroad asset. 

These assets produce Core Funds From Operations (FFO, a cash flow metric commonly used in among REITs as a measure of the company's ability to pay a dividend) of $0.60 per share. When the dividend is reinstated (more on that below) we can expect that it will be between 70% and 100% of Core FFO, or $0.40 to $0.60 per share.  As a microcap REIT, I would expect the yield of be in the 7 to 8 percent range, justifying a stock price of between $5 and $8.50.  The stock has recently been trading at the low end of this range, or $6.50 to $7.00.

Other Yieldcos (the mostly non-REIT companies that invest in solar and wind farms and use the cash flow to pay dividends) currently have yields between 4% (NextEra Energy Partners (NYSE:NEP)) and 7.5% (8point3 Energy Partners (CAFD)). As I recently wrote, I believe CAFD's dividend is unsustainable, so 7.5% is a good high end estimate for the yield on a microcap Yieldco.  When PW resumes its dividend, it should be worth $6 to $8 a share if valued as a Yieldco.

A Yieldco Wrapped in a Legal Enigma

Based on its potential to pay a dividend, Power REIT seems fairly valued or mildly undervalued. 

But nobody is looking just at the potential dividend.  The big story about Power REIT is its appeal in a civil case against the lessees of its railroad asset.  I'm not going to spill any more ink about this legal case, as I'm not a lawyer and I have no idea what the chance of a successful outcome might be.  What I do know is that, if the appeal fails, Power REIT is reasonably valued today.  I also know that if Power REIT were to prevail in any way, the benefits to shareholders could be enormous.  The debt that the lessees owe Power REIT (but which they claim is not payable) is worth more than Power REIT itself.  Add in legal fees and back interest, and it's easy to see the stock price tripling.  You can read about the details of the case in one of my articles here, or a more recent piece by an attorney (Al Speisman) who thinks Power REIT has a good chance of winning, here.

Why No Ruling Yet?

There is no set time frame for an appellate court ruling, but the case has now been under consideration for five months.  To me, that means that there are at least some aspects of the case that Third Circuit Court of Appeals finds hard to decide.  If the case were simple, the Court could have ruled already.

A case that is hard to decide must have a chance of going either way.  That means the judges must be considering overturning at least part of the District Court's ruling (which went almost entirely against Power REIT.)

The debt (settlement account) is worth about $9/share.  Legal costs (which Power REIT argues are reimbursable under the lease are another dollar or two per share.  Back interest could dwarf everything else, but I consider the chance of Power REIT being awarded any back interest to be low.  There is also the possibility that PW will have an opportunity to sign a new lease for the railroad, which could also benefit the company.

What are the chances of Power REIT winning anything in its appeal?  We don't know, but those chances seem to be rising the longer the Court of Appeals takes to rule.  Denying Power REIT's appeal might have been an easy decision.  Overturning part or all of the District Court's ruling requires more deliberation.  The Federal judges are still deliberating.

No news is good news. 

The upside is measured in stock price multiples.  Should we expect a double?  A triple?  Or "just" a 50% increase?  The chances of upside are increasing.  At the current price, the downside is minimal.  There could even be some upside from increased certainty around the company's future and tax write-offs in the case of a loss.

What's not to like?

Disclosure: Long PW, PW-PA, NEP.  Short calls on CAFD.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

June 19, 2017

China Everbright Greentech

by Debra Fiakas CFA

Investors based in the U.S. need to look far and wide for new stock issues from renewable energy companies.  Capital markets activity has slowed in the last couple of years, in part to due to their own success.  In reaching new efficiency in energy production, renewable energy companies are generating their own internal capital and are not as dependent upon the capital markets.  The Hong Kong market has come to the rescue of U.S. investors with a ‘green’ offering

China Everbright Greentech Ltd
. is now trading on the Hong Kong Exchange with the stock code 1257 following a successful offering of 560 million shares in April 2017.  The company raised $385.6 million (HK$3.0 billion) in new capital that will be used to develop business in the People’s Republic of China as well as research and development in advanced technologies.

A spin-off of parent China Everbright International, the waste-to-energy and water treatment developer, China Everbright Greentech invests in a variety of renewable energy projects.  These projects are capital-hungry and sometimes deliver volatile returns.  The spin out should help the parent to present more stable financial results.  Investors in the spinout are getting a more speculative play at a more compelling valuation.
China Everbright Greentech is a self-described “specialty environmental protection service provider.”  Its portfolio includes biomass, solar and wind energy production as well as hazardous waste treatment facilities.  Total energy product at the time of the IPO was 125.9 megawatts from solar and wind facilities and another 810 megawatts from biomass projects currently in the planning and construction stages.  Current hazardous waste treatment capacity is in excess of 500,000 tons per year.

Management has wasted no time in deploying new capital.  In late May 2017, the company announced definitive agreements for three new hazardous waste treatment projects in mainland China.  The total investment of US$102 million (RMB680 million) will add 120,000 tons per year in waste processing capacity after all construction phases are completed.

The company’s public offering document provides details on revenue and profits.  Sales value has increased in each of the last three years, with profits following.  In 2016, the company delivered HK$629.5 million (US$81.8 million) in profit on HK$3.0 billion (US$390.0 million) in total sales, representing a profit margin of 21%.  Operations generated HK$886.2 million (US$115.2 million) in cash flow.

China Everbright International remains the controlling shareholder in its greentech spin-off.  However, the offering makes room for investors of all stripes to participate in what appears to be a successful formula for growth and income.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

June 14, 2017

Should I Sell My Mutual Fund To Go Solar?

by Tom Konrad Ph.D., CFA

An enthusiastic solar volunteer recently asked me: “What can I invest in to prepare for the next financial crisis?”

The situation made the question deeply ironic. The woman asking me was trying to help people invest in solar systems through Solarize, a nonprofit, community-sponsored group buying and discount program. Our town of Marbletown, New York and the neighboring towns of Rochester and Olive have just launched Solarize Rondout Valley, a campaign open to residential and commercial building owners in Ulster County.

Solarize campaigns are designed to make it easier and cheaper to go solar. While defensive stock market investments are my specialty, I can't think of a single financial investment that combines the expected high returns and relatively low risk of a home solar system. 

Just like buying value stocks when they are cheap, buying your solar system at a discount through Solarize or a similar program only increases the expected returns while lowering the risk. Solarize Rondout Valley offers a 14 percent discount compared to installers' standard prices. The installers can afford this discount because volunteers help them reach new customers.

Customer acquisition costs make up nearly 17 percent of the cost of a typical home solar system. The customers benefit because it boosts their returns. Even New York state and the federal government benefit, because lower prices reduce the size of tax credits, which are currently 25 percent and 30 percent of the purchase price of the solar system, respectively (capped at $5,000 for the state credit).

It turned out that my fellow volunteer had a roof she thought would be great for solar, but was hesitant about signing up herself. I told her solar was one of the best investments I know of for a financial crisis, because it will still be generating the same amount of electricity and savings, no matter what the markets do. And I asked her what sort of payback she thought she was getting from her mutual funds.

Two minutes later, she was our next signup for a free home solar assessment.

If you finish this article, live in Ulster County and own a home without solar, I'm betting you will be our next registrant. But even if you don't have a Solarize campaign going on near you, this article should give you the tools you need to evaluate any installer's bid as a financial investment.

Investment criteria

When considering any investment, most professional investors focus on these criteria:

 1.    Expected return, or how much you expect to make on your investment.

 2.    Risk, which has two components:

 a)    The likelihood of things going wrong

 b)    The expected losses if things go wrong

 3.    Liquidity/cash flow: Can you get your money back when you need it?

Many professional investors, including myself, also focus on the moral aspect of our investments, but I will not focus on that variable here. If you think it's important to promote your local economy or reduce carbon emissions, it's clear to just about everyone that a home solar installation is the best choice. The financial comparison is a lot less readily discernible, so that is what I will focus on here.

A note on mutual funds

There are more mutual funds than anyone can count, so, for simplicity, I will focus on two that readers are most likely to own. According to Investopedia, the two biggest mutual funds this year are the Vanguard 500 Index Fund Admiral Shares (VFIAX) and Fidelity Government Cash Reserves (FDRXX). These funds hold more investor money than any other mutual funds. Even if you do not own either of these funds, most investors own something similar.

VFIAX is a stock market index fund, designed to mimic the return of buying a proportionate share of the entire market. For the purposes of this analysis, most funds that contain the words “stock market index” in their name will have substantially similar investment characteristics. If it makes sense for you to sell VFIAX to invest in home solar, it will make sense to sell any of these other stock market index funds for the same reasons.

FDRXX is a money market fund, and almost every investor owns some money market or short-term bond fund in their portfolio. If it makes sense for you to sell FDRXX to invest in home solar, it will make sense to sell any of these other money market or short term bond funds for the same purpose.

Example home solar installations

The economics of home solar vary widely depending on local and state incentives, future local electricity prices, installation cost, local climate and the angle and degree of shading of your roof. In my experience, a reputable local installer is likely to give you reliable estimates for all of these except for future electricity prices. 

As examples, I will use two fairly typical installations using prices from Solarize Rondout Valley. The first system is a best-case scenario, installed on a house with a large, open section of roof with moderate tilt oriented at least a little south and with limited shading. A 5-kilowatt installation using 18 panels and 320 square feet of roof space will cost $3 per watt ($15,000) before state and federal tax incentives at the discounted Solarize price. The New York state tax incentive is 25 percent of installation cost up to $5,000, while the federal Investment Tax Credit is 30 percent, so the net cost after incentives for this installation will be $6,750. Because of the orientation and limited shading, this array will produce about 1,300 kilowatt-hours per year, per installed kilowatt (6,500 kilowatt-hours total) in Ulster County. Call this System A.

On the other end of the spectrum, consider a 7-kilowatt array on two sides of a building with the panels facing due east and west, and with some shading. The customer has high electricity usage and wants to get as much production out of the given roof space as possible, and so opts to use 19 of SunPower's (SPWR) highly efficient 360-watt AC panels using only 340 square feet of roof space. Each of these panels has its own microinverter to best handle the shading. While this installation will probably still produce 7,000 kilowatt-hours per year (1,000 kilowatt-hours per year, per installed kilowatt) despite the less-than-optimal conditions, the premium SunPower panels will cost $4 per watt, or $28,000 before tax incentives. After tax, the system will cost $14,600. Call this System B.

To find out the financial returns, we also have to make assumptions about the price of electricity saved. I will use 14 cents per kilowatt-hour, increasing at a rate of 1 percent for the next 25 years. This is more conservative than most installers' assumptions of annual electricity price increases of 3 percent or more, but I find it pays to be conservative when making investment decisions.


With these assumptions, we can use an online return calculator such as PVCalc. Below are the assumptions for System A, as I entered them into PVCalc.

I assumed a 25-year life, 1,300 kilowatt-hours produced and skipped the “own consumption," as well as "feed-in tariffs" and "tax" sections -- which do not apply in New York state. Setup cost is the cost per kilowatt after tax incentives ($6,750 for 5 kilowatts), and financing is 100 percent the customer's funds, because we are considering selling a mutual fund to pay for the system.

(Note that the euro '€' symbol is displayed by default in this European calculator under levelized cost, even though the levelized energy cost displayed is actually $0.076, not €0.076.)

PVCalc gives the following results for System A.

System A Results

I think the most useful factors here are “levelized energy cost" and internal rate of return (IRR). 

The levelized energy cost of 7.6 cents per kilowatt-hour is far below the price we pay for retail electricity in New York. IRR is a financial measure that allows us to compare the system on an apples-to-apples basis with fixed price investments that bear interest, such as CDs, bonds and money market funds like FDRXX. An IRR of 12.7 percent is a better return by far than you can find on any investment available to the retail public.

The economics of System B are less attractive because we're paying for an additional panel and more expensive panels in order to produce only a little more electricity than System A on a suboptimal roof.

Still, System B may be a better bet than many mutual funds. Here are the results from PVCalc.

System B results
You will note that the levelized energy cost is close to break-even at 14.9 cents compared to the 14 cents, plus the 1 percent annual increase I used for this scenario. That said, the IRR is 4.3 percent, meaning that it is still worth considering selling a money market mutual fund like FDRXX to buy this system. FDRXX has a yield of just 0.1 percent. So as long as the risks and limited liquidity of a home solar system (discussed below) are acceptable to you, it will make financial sense to sell a money market mutual fund like FDRXX to buy System B.

It is more difficult to gauge the expected return of a stock market mutual fund like VFIAX, but over 25 years, it is possible to come up with some reasonable estimates. Since we are looking at a 25-year life of the solar system, we should consider a similar time period for our mutual funds. Historically, long-term stock market returns have been driven by the valuation of the stock market at the beginning of the period. One widely used valuation measure is Robert Shiller's cyclically adjusted price-to-earnings ratio (CAPE). The CAPE is currently high by historical standards, meaning that stock market and VFIAX returns for the next 25 years are likely to be below par. 

Extremely long-term stock market returns have been in the 9 percent to 10 percent range, but a CAPE this high has usually preceded long periods where returns have much lower, like in 1929 and 1966. The CAPE was even higher in 2000, and stock market annual returns have been around 3 percent over the past 17 years. With these past results as a guide, we can expect long-term stock market returns to be between 3 percent and 8 percent over the next 25 years.

From this we should subtract the expense ratio of a mutual fund, which is a negligible 0.1 percent for VFIAX, but could be much higher for other stock market mutual funds. We should also reduce the return to reflect the expected tax on dividends and capital gains of about 15 percent. All together, the expected return for VFIAX is between 2.5 percent and 7.5 percent. People in high income-tax brackets should reduce these expected returns even further.

If you are worried about future stock market returns, even the mediocre 4.3 percent expected annual return from System B looks good against a 2.5 percent after tax return for VFIAX. If you are a stock market optimist, you should jump at the chance to sell VFIAX if you can get the expected 12.7 percent annual return from System A, but you will probably find System B less enticing.


Risks for mutual funds

Expected return is not the only consideration; we also need to consider risk. Stock market mutual funds like VFIAX are known to be risky, and in the next 25 years, we can reasonably expect to have one or two financial crises like we saw in 2001 and 2008. Given the high CAPE ratio discussed above, a bear market in the next few years seems more likely than not. 

Over long periods, the stock market does tend to make up for past losses, so a 2.5 percent annual return for VFIAX over the next 25 years is a reasonable worst-case scenario. 

The attraction of a money market mutual fund like FDRXX is the limited downside. The fund should be able to pay its 0.1 percent interest without losing value (at least before inflation) over the next 25 years. The biggest risk for FDRXX is actually inflation itself. If inflation accelerates, and short term interest rates do not keep up, the real value of FDRXX will fall faster than the dividends it pays can make up for. Even if dividend payments rise to keep up with higher inflation, these are taxable, and they are very likely to continue to fall short of inflation after tax.

Given the the country's high debt, and the Trump administration's stimulus plans, rising inflation is quite possible. If it does rise, the interest paid to holders of FDRXX should rise with it.  Since that interest is taxable, rising inflation will lead to small net losses for holders of FDRXX.

Risks for solar

Unlike FDRXX, a solar installation should benefit in the high-inflation scenario, since electricity prices and savings should rise with inflation. Nor should a prolonged stock market downturn hurt the returns from a solar installation. Another way to put this is that, as investments, solar installations have the attractive property of holding their value when financial investments are falling. This makes investing in even a relatively unattractive solar installation like System B a good way to diversify a larger investment portfolio.

The main risks for solar installations are falling electricity prices, the chance that the system breaks down, and the chance it is damaged in a house fire and insurance does not cover its replacement. There is also regulatory risk: the chance that regulators may change the way solar owners are paid for the electricity they generate.

The breakdown of solar risks

Falling electricity prices

Lower electricity prices equate to lower savings from solar. Most people assume that electricity prices will continue to rise over the long term, as they always have in the past, but this may not be a valid assumption. The falling prices for renewables and, perhaps most importantly, natural gas have been causing electricity prices to fall in recent years, and renewable energy technologies like wind and solar are almost certain to continue their price declines. These price declines are likely to be at least partially offset by the need to repair and expand our aging electric transmission and distribution infrastructure. How these two trends will balance is hard to predict. 

A scenario where we see electricity prices continue to fall as fast as 1 percent per year seems quite possible. If we put this 1 percent annual decline into PVCalc, the IRR of each system falls by 2 percent. The IRR for System A becomes 10.7 percent, which is still pretty hard to beat. The IRR for System B falls to an unattractive 2.2 percent, but this is still better than we can expect from a money market mutual fund like FDRXX.


Most home solar systems come with warranties. Solar panels usually have a 25-year power warranty that guarantees that electricity generation will not fall too much faster than expected. The expected return calculations already account for some degradation, the rate of which is specified in the “degradation” field of PVCalc. The rest of the system usually carries a 10- to 12-year product warranty, and the electricity produced in the first years of a solar system is the most important in determining the expected return. 

If, for instance, in the highly unlikely case that System A were to break down and be completely worthless after 15 years, we can see the effect on return by putting 15 into the “useful life” field. In this case, the IRR of System A falls only to 10.2 percent from the initial 12.7 percent, still a far better return than we should expect from a stock market mutual fund over the next 15 years.

Part of the reason System B was more expensive was that it was made with SunPower AC panels, which come with a comprehensive 25-year warranty on all of the expensive system components. Hence, if System B were to fail during the 25-year useful life I assumed (and it will likely last longer), it could be fixed under warranty.

House fires

Including an annual insurance premium of 0.5 percent of the initial system cost reduces the expected return for System A to 11.2 percent. In that scenario, the expected return for System B changes to to 4.0 percent from 4.3 percent, so the cost of insuring against property damage to a solar system is manageable. Such insurance makes sense if the solar system is accounts for a significant portion of your net assets.

Regulatory risk

In the stock market, companies often deal with regulatory risk. Large importers like Walmart are worried about President Trump's proposal for a “border adjustment tax,” because it would increase their costs. A recent petition filed by bankrupt Suniva with the International Trade Commission could result in a 40 cents per watt tariff levied on solar cells imported into the U.S. This worries solar financiers and residential solar installers.

The recent rise of stock market index mutual funds like VFIAX since the election also has to do with regulation, namely, the anticipation that regulations will be reduced and businesses will become more profitable. If those reforms fail to happen or the profits fail to materialize, the market and mutual funds will fall.

Regulatory risk can also affect the value of a home solar system by changing the expected future payments. Net metering and other payment structures to compensate homeowners for the power they send to the grid are created by state regulators, and what regulators give, regulators can take away. Although state utility commissions have a great deal of power to change rates, they are generally appointed by elected state officials. As such, they are subject to political pressure, and usually avoid actions that will be unpopular with a large number of voters. Yet they also have a mandate to ensure the financial stability of the utilities they oversee. This can lead to unpleasant surprises for solar customers if utilities persuade regulators that their financial health is at risk.

The most stark example of regulatory risk for solar was when the Nevada Public Utilities Commission reduced solar customers' payment for net excess generation by three-quarters in December 2015. The commission also tripled fixed charges -- and retroactively applied all of these changes to existing solar customers. For someone considering investing in home solar today, it is the fact that the change was retroactive which should be most disconcerting, since the possibility of a future retroactive change makes it impossible to accurately estimate the future returns for solar.

Any possibility for a retroactive change should concern homeowners considering going solar, but the Nevada example should be comforting to many. This is because it is the exception that proves the rule: No other state regulator has ever retroactively reduced payments for existing solar customers. Moreover, the public outcry was such that the retroactive aspects of the ruling were eventually reversed.

Although regulatory risk is generally low for home solar, it does vary from state to state. The safest states are those like New York that have recently reached decisions regarding the compensation for home solar.  The New York PSC recently ruled that existing residential solar customers could keep net metering for the life of their systems, while homeowners who install solar over the next five years would benefit from net metering for 20 years. The certainty of receiving net metering rates for 20 years should be sufficient for New York homeowners to make an informed investment decision.

Most homeowners should be fairly confident that whatever rules apply to their system at the time it is installed will last (at least for them) a long time. But there is still some chance of retroactive changes. The reason the Nevada regulators' action was so drastic was that the rapid growth of solar caught them by surprise. State regulators that are currently planning ahead for the time when solar takes off in their state should be able to manage a more orderly transition to new rules that adequately address both the costs and benefits of adding large amounts of residential solar on the grid.

All told, regulatory risk should be less of a worry for home solar customers than for owners of stock market mutual funds like VFIAX. Money market funds like FDRXX have minimal regulatory risk; however, it is even less than that of solar.  

Opportunity cost and timing

If you are considering selling a mutual fund, opportunity cost is the risk that it will go up in price after you sell. Nobody likes to sell today, only to find that they could have sold for a lot more at a later date.  Conversely, the opportunity cost of not selling a mutual fund is that the price of the fund may fall before it is sold.

For a homeowner installing solar, opportunity cost is the risk that the cost of home solar installations will fall after they sign the contract. The opportunity costs of not installing solar are that the cost to install a solar system might go up, or that the compensation and incentives may fall.

Although the costs of solar installations have been declining over the long term, in the shorter term, prices seem more likely to rise than fall. The Suniva petition mentioned above could add 40 cents per watt to the cost of solar cells manufactured outside of the U.S. within the next year. Since the U.S. no longer has a significant manufacturing base, that cost will directly increase the cost of a solar installation. 

The Trump administration and Congress are also planning on tax reform in the near term. The largest solar incentive, the 30 percent Investment Tax Credit (ITC), could be a target for cuts in order to pay for Republicans' tax priorities. It is very unlikely that tax reform will be retroactive, so solar installations completed in 2017 should still be able to benefit from the ITC. Even if the ITC is not cut as part of tax reform, it is currently scheduled to phase out between 2019 and 2021.

State incentives for solar may also decline in the near term. In New York, the NY-Sun state incentive for solar installers is set to decline from its current 40 cents per watt to 20 cents sometime this summer. Your solar installer should be able to tell you what is happening with incentives in your state, although what they say should be taken with a grain of salt, since they have an incentive to exaggerate any upcoming declines. There are also other resources. DSIRE, for instance, offers a comprehensive database for both state and federal renewable energy and energy efficiency incentives.

Finally, for people in my home Ulster County or nearby Orange County who are currently or about to sponsor group buying discount campaigns like Solarize, these campaigns only run for three months. The discount will end on July 31 in Ulster County and September 1 in Orange County.

All told, the medium-term trend for the cost of a home solar installation is likely to be up.

While the price of a money market mutual fund like FDRXX does not change over time, the price of a stock market fund like VFIAX will rise or fall with the market as a whole. Two widely used methods for evaluating the near-term risk/reward of the stock market are the CAPE ratio discussed in the expected return section and the VIX, or Volatility Index. 

The CAPE ratio is currently high by historical standards, meaning that the risk of a stock market decline is greater than usual, while the chance of the stock market going up in the near term is lower than usual.

Conversely, the VIX is usually high when stock prices are low, and low when stock prices are high. In mid-June, the VIX was trading around $10.50, which is lower than it has been at any time in the last 10 years. It is currently lower than it was at any time since before the financial crisis in 2008. As the VIX fell to its recent low from a 2008 high, VFIAX has risen 167 percent, or a compounded 12 percent per year for the last eight and a half years.

In terms of timing and opportunity cost, taking money out of mutual funds and putting it into solar seems like an excellent risk/reward tradeoff in June 2017.


The biggest downside for a home solar installation is liquidity. The only way to get your money out of a solar system is to sell your home, or wait for it to come back to you over time in utility bill savings. The great virtue of mutual funds is that you can sell them and get cash within 24 hours. If you expect to need the money you have in mutual funds in the next few years, you are better off using some other sort of financing such as a loan to pay for your solar system than selling your mutual funds.


For a homeowner looking for a long-term investment, or one with money in mutual funds looking for more attractive investments, home solar is an excellent choice. For many homeowners, it offers very attractive returns compared to almost any mutual fund. Since every solar installation is different, finding that expected return is best done using a dedicated solar or other financial calculator, such as PVCalc. 

While a higher expected return is often a good reason to invest in solar, there are usually other important considerations. People who expect to need the money they are investing in the next few years should avoid difficult-to-sell investments like solar. 

Most other considerations favor a solar investment over most mutual funds:

  • Stock or equity mutual funds are generally considered much more risky than a home solar installation.
  • Gains from mutual funds are taxable, while electricity bill savings from solar are not.
  • Current stock market indicators show greater-than-usual risks and lower-than-usual potential rewards.
  • While the price of solar is likely to decline over the long term, recent sharp declines and political and regulatory risks mean that solar installations could easily become more expensive over the next few months or years.

You may not own a home, or your roof may be shaded, in need of replacement, or otherwise unsuitable for solar. If it is, a reputable solar installer will tell you so. 

If your roof is right for solar, there may never be a better time to sell your risky mutual fund and put it in something that is as safe as houses: a home solar system.

Tom Konrad Ph.D., CFA is the editor of AltEnergyStocks.com and an investment analyst specializing in environmentally responsible dividend income investing. He is Chair of the Environmental Conservation Commission for the Town of Marbletown , New York.

June 12, 2017

Electrovaya's Battery Bargain

by Debra Fiakas CFA

Last week management of Electrovaya Inc. (EFL: TSX; EFLVF:  OTC/QB) were forced to issue a statement stating there were no fundamental developments to explain a dramatic decline in its share price.  The stock was trimmed back by 30% in two days under exceptional trading volume.  Electrovaya has developed proprietary lithium ion polymer batteries for grid storage and transportation applications.  Other than financial results for the quarter ending March 2017, the Company has had little to tell investors about the batteries, its customers or any other topic.

Electrovaya distinguishes its lithium ion batteries among competitors with a ceramic separator that improves battery safety.  Zero hazardous accidents have been reported for the batteries with this innovation used in smart cars.  Competitors have reported battery failures some of which have resulted in car fires.  Inadequate insulation of electrodes is often cited as a reason for such ‘thermal runaway’ in batteries.

The company’s business pipeline appears to be gaining volume.  During the last earnings conference call management reported new orders in the materials handling sector.  Additionally, one of its battery modules in being tested for residential energy storage applications in the U.S., Europe and Asia.

Management has characterized the year 2017 as a transition year for Electrovaya.  The company reported CDN$19.5 million in total sales in the fiscal year ending September 2016.    At this level of production, gross profit was 25% of sale and not large enough to cover operating costs.  Nonetheless, greater efficiency is expected as the company increases utilization of new production capacity recently acquired in Germany.
The company used CDN$8.1 million in cash to support operations in the 2016 fiscal year.  Cash resources were dangerously depleted at the end of September 2016, at CDN$668,000.  A new loan of $17 million has fortified the coffers.  We estimate the company has sufficient resources to support operations for at least another year, longer if the pace of business picks up.  An expansion in order volume could lead to greater production efficiency is and higher gross margin.

For investors with confidence in Electrovaya management to deliver on its strategic plan, the dramatic decline in price represents a compelling opportunity to pick up shares at a bargain price.  The company recently appointed a new director of sales for the U.S. materials handling market.  The plan is to build on recent new relationship with a Fortune 100 company with a fleet of forklifts.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

June 08, 2017

From Paris to Drawdown

by John Fullerton

Yes, it was a shameful poke in the world’s eye by the dangerously narcissistic, temporary occupant of the White House.

Like other unconscionable and unfathomable acts of the early 21st century—a period of historic great change already—Trump’s pulling out of the Paris Climate Agreement has sent me searching for the deeper meaning of it all, while the pundits flail away.  

The attack on the World Trade Center, an iconic symbol of globalization if there ever was one, triggered for me a period of introspection and a personal existential crisis as it opened up a possible dark side of my previously unquestioned Wall Street-influenced worldview.  Then the financial crisis drove a stake in the heart of our failed neoliberal economics and finance ideology, leaving in its wake profound and still unanswered questions.  Brexit shined a light on the flawed architecture and economic assumptions underlying the European Union, while Trump’s unimaginable election should force America’s self-anointed elites, in particular, to face their own shadow.

Is there not a deeper message being offered up to us as we undergo the shock therapy that is the Trump phenomenon, with his extraordinary ignorance, egotism, and moral ineptitude, most recently evidenced by his unconscionable withdrawal from Paris?  It’s worth our reflection: Trump as cosmic messenger, the wake-up call we deserve.

Consider the reality. The Paris Agreement is not an enforceable treaty with binding emissions limits.  Nor is it even an adequate statement of intention, since even if all signatories live up to their promises, the best scientific projections suggest we will not stay below the intended 2-degree warming ceiling.  And, we know we actually need to stay below 1.5 degrees warming, a radically different proposition.  Finally, nothing in the Agreement addresses the existential threat it poses to all Petro States since the math implies that 80% of existing fossil fuel reserves, the lifeblood of these societies, must remain in the ground, demanding unprecedented economic transitions requiring a new development paradigm, and that it will that take decades of investment and hard work.  See Venezuela for a preview of the challenges to come.

Russia is such a Petro-State.  Hmm…Calling Jared?

So perhaps the first deeper message we need to hear, disguised below Trump’s disgraceful act is: “The Paris Agreement amounts to little more than appeasement; get serious, people.”  

So far, the initial response within the United States and globally is actually quite hopeful.  States led by California, cities led by Pittsburgh, and a vast cross-section of the business community have been emboldened to show the world (and ourselves) that the “current occupant” does not get to decide for its people on a matter of such grave importance.  “We’re still in!”  Perhaps the sleeping bear – we, the people – has finally been poked?

Second, one primary reason the Agreement was not a binding treaty is that all participants understood that Obama could never deliver the dysfunctional U.S. Congress.  So the deeper message we must confront is that many of the leading global institutions of governance, from the United Nations to the United States, to the European Union, are all incapable of addressing the urgent and interconnected global governance crises of the 21st century.  Where are the serious plans to address this reality, while at the same time reacting to the unending crises of the day?

Third, despite decades of scientific analysis and diplomacy around climate change, we are still working off a horribly inadequate playbook that reduces the complex challenge of restoring balance to the earth’s carbon cycle to simply a call by nations to “cut fossil fuel emissions” by some seemingly random, politically negotiated amount based on what each nation was willing to commit to, that collectively is grossly inadequate to the task at hand.

Just in time, Paul Hawken and colleagues have recently published Drawdown. The name calls out the real goal we must embrace: “drawdown” of the concentration of greenhouse gasses in the atmosphere, rather than the insufficient objective of reducing emissions.  We are at 402 PPM today and need to get below 350 in the face of a growing population and rising standards of living for the majority of humanity.  That’s the task.  It demands an integrated, multi-dimensional, rigorous plan.  Drawdown provides the analytical foundation for such a plan, documenting the 100 top viable solutions using available technology, and conservative assumptions about their realistic scale-up rates and economics over a thirty-year period between 2020 and 2050.  

Good news:  the math says we can do this!  It identifies 1000 Giga Tons reduction in atmospheric CO2 (or equivalent), and requires collectively a highly diversified investment of $30 trillion over thirty years, generating economic savings (in the aggregate) of two and half times that amount, on top of avoiding the worst-case consequences of climate change.  To be clear, this represents a profound and unprecedented shift in the allocation of resources from business as usual.  That’s the deal.

The results from the Drawdown analysis are not what most will expect.  First of all, the single largest solution is not solar or wind.  It’s refrigerant management.  HFCs, the “solution” to the ozone layer problem of the past, turns out to have somewhere between 1,000 and 9,000 times the greenhouse effect of CO2.  We must simply swap out the AC, which will have nine times the impact of converting to electric vehicles (only number 26 on the Drawdown list).  Who will be the Elon Musk of AC?

Perhaps more revealing is the combined impact of family planning and educating women, which, when looked at together, would move to the top, exceeding onshore and offshore wind combined.  Population is often a taboo subject.  But an extra billion people all desiring to live a middle-class lifestyle makes a massive difference, so we need to be able to talk about it as part of a comprehensive plan.

And perhaps most hopeful, the report rightly turns our attention to the amazing natural “technology” we take for granted: photosynthesis, the basis of all life on this planet.  Drawdown demands we focus on the massive carbon sinks where carbon is safely stored, in addition to reducing emissions.  Remarkably, few realize that our soils are the second largest carbon sink after the oceans, comparable to the world’s forests.  Small, achievable percentage changes in the stock of carbon held in our soils, through profitable regenerative agriculture hold massive potential for drawdown, without even factoring in all the ancillary benefits to human health and, therefore, our healthcare crisis, water retention, desertification, and species loss.  The role of regenerative agriculture and land use of all varieties, from no-till crop farming to holistic grazing accounts for fifteen of the top twenty-five drawdown solutions.

So the message we need to hear underlying Trump’s Paris fiasco:  The current occupant will be judged by history; but so will we:  wake-up call.  The U.S Congress and the Trump enablers in his Administration have a chance to restore their integrity, but no one is depending on it.  National leadership on climate has long been outside the U.S. federal government and that’s OK, but it’s a lost opportunity.  U.S. states, cities, the U.S. military, and the private sector are already mobilized and that will now only accelerate.  

We must shift our attention from grand diplomatic gestures by institutions of governance designed for a different time to a rigorous, empowering plan where there is no silver bullet but unlimited and empowering opportunities where the real leaders are already defining our future.  Those leaders are us.

The goal is simple: drawdown.  It’s no easy feat, and time is not on our side.  Let’s roll, people.

John Fullerton is the founder and president of Capital Institute, a collaborative working to illuminate how our economy and financial system can operate to promote a more just, regenerative, and thus sustainable way of living on this earth. He is the author of “Regenerative Capitalism: How Universal Principles and Patterns Will Shape the New Economy.” Through the work of Capital Institute, regular public speaking engagements, and university lectures, John has become a recognized thought leader, exploring the future of Capitalism. John is also a recognized “impact investment” practitioner as the principal of Level 3 Capital Advisors, LLC.

June 04, 2017

Ten Clean Energy Stocks For 2017: First Quarter Earnings

Tom Konrad Ph.D., CFA

In the two months since the last update, most of the stocks in my Ten Clean Energy Stocks model portfolio have reported first quarter earnings.  There were few surprises, and those were mostly pleasant ones, allowing the model portfolio to add to its gains, and pull a little farther ahead of its benchmark. 

For the year to the end of May, the model portfolio is up 13.8%, 2% ahead of its benchmark.  The benchmark is an 80/20 blend of the clean energy income benchmark (the Yieldco ETF YLCO) and the clean energy growth benchmark (Clean Energy ETF PBW), with the ratio matching the 80/20 mix of income and growth stocks in the model portfolio.

The 8 income stocks again led the pack, with an average total return of 15.2% for the year to date.  The Green Global Equity Income Portfolio (GGEIP), an income and green focused strategy I manage also did well, up 13.5%.  For comparison, the income benchmark YLCO produced a solid 11.4% return.

The two growth stocks recovered from losses early in the year and are now up 9.4%, but still behind PBW at 12.9%.

10 for 17 total return


Stock discussion

Income Stocks

Pattern Energy Group (NASD:PEGI)

12/31/16 Price: $18.99.  Annual Dividend: $1.63 (8.6%). Expected 2017 dividend: $1.64 to $1.67.  Low Target: $18.  High Target: $30. 
5/31/17 Price: $22.56.  YTD Dividend: $0.408 (2.2%).  Annualized Dividend: $1.655.  YTD Total Return: 21.2%

Wind-focused Yieldco Pattern Energy Group advanced in strongly in April ahead of first quarter earnings.  Earnings did not disappoint, and the Yieldco added to those gains in May.  Guidance for 2017 Cash Flow Available for Distribution (CAFD) is $140 to $165 million, which would be 5% to 24% increase on 2016 CAFD. 

Growth has been slowing for Pattern, mainly because the low share price following the Yieldco bust at the end of 2015 has prevented the company from raising much equity capital.  I expect that the share price will need to rise into the high 20s before we see large equity issuance from Pattern.  With lower growth, they are also lowering their quarterly dividend increases.  Since the IPO in 2014, the average quarterly increase has been 2.7%, but the company only increased its dividend 2% in the fourth quarter of 2016 and 1.4% this quarter.  This lower rate of increases seems prudent, given that CAFD may only grow 5% this year at the low end.

Less prudent in a time when the company needs to be careful with its cash is the Yeildco's consideration of an investment in the early stage projects of its parent, Pattern Development.  In general, I think it is a good idea for Yieldcos to invest in project development with some of their resources, and eventually, as they grow larger, do much of their project development in house.  That said, the time to invest in relatively risky but potentially high return businesses is when the stock is highly valued.  When money is tight, as it is now for Patten and most other Yieldcos, it's best to focus on investments that will increase the dividend in the short term.  The time to invest in Pattern Development will be after the stock price recovers. Even small investments in early stage projects like the one being considered will only delay further stock price recovery.

8point3 Energy Partners (NASD:CAFD)
12/31/16 Price: $12.98.  Annual Dividend: $1.00 (7.7%). Expected 2017 dividend: $1.00 to $1.05.  Low Target: $10.  High Target: $20.
5/31/17 Price: $13.64.  YTD Dividend: $0.257 (2.0%)  Annualized Dividend: $1.028.  YTD Total Return: 7.1%

I took a deeper look at Solar-only Yieldco 8point3's plans to refinance its company level debt with amortizing debt in March.  The company abandoned these plans April when one of its sponsors, First Solar (FSLR), announced that it was considering selling its stake in the Yieldco.

While I believe the refinancing plans were prudent, I found that they would have reduced 8point3's CAFD below the level needed to sustain its current dividend.  To make matters worse, the Yieldco announced a dividend increase while the refinancing plans were still in place.  This behavior basically meant that 8point3 was hoping that its unsustainable dividend increases would cause investors to buy the stock and drive up the stock price.  This hoped-for stock rebound would allow 8point3 to make new investments and increase cash flow enough to avoid a dividend cut.

In short, 8point3 was acting like it expected a return to the Yieldco bubble of 2014 and early 2015.

The abandonment of 8point3's (prudent) plans to refinance its company-level interest only debt with project-level amortizing debt leaves sufficient cash flow to pay its current dividend, but does not address the reason for that plan in the first place.  8point3's debt matures in 2020, and it is an open question if lenders will be willing to refinance it at comparable terms.  If the stock price recovers, the company will issue new equity and grow itself out of the problem.  If not, the only option open to 8point3 in 2019 may be refinancing with project level, amortizing debt.  That will greatly reduce CAFD, leading to a large dividend cut.  The company's recent dividend increases only make this future problem worse.

This strategy of hoping that the stock market will bail the company out of its financing problems, at the same time as one (if not both) of its sponsors are looking for the exits is, in my opinion, irresponsible corporate management.  While the high yield puts a floor on the stock price in the near term, I believe that long term investors are becoming increasingly skeptical of the company.  This skepticism should also put a ceiling on the share price, and prevent management's hopes of a share price recovery from coming to fruition. 

As the maturity of 8point3's debt moves closer, the consequences of the inevitable refinancing will loom larger in investors' minds.  I don't know when it will happen, but at some point, the stock price will have to drop to reflect 8point3's much lower expected CAFD and dividend after refinancing.

Because of this, I have started selling short calls on the stock, in order to profit from my prediction that the share price is likely to be capped in the near term, and fall in the medium term.

Hannon Armstrong Sustainable Infrastructure (NYSE:HASI)

12/31/16 Price: $18.99.  Annual Dividend: $1.32 (7.0%).  Expected 2017 dividend: $1.34 to $1.36.  Low Target: $15.  High Target: $30. 
5/31/17 Price: $21.91.  YTD Dividend: $0.33 (1.7%).  Annualized Dividend: $1.32.  YTD Total Return: 17.1%

In my last update, I said that Hannon Armstrong's recent secondary stock offering had depressed the stock and that the then current price of $19.20 represented a buying opportunity.  The stock of this sustainable infrastructure financier has since risen 14%.  The dividend is still attractive and it still has plenty of room for gains, but is no longer a screaming deal.

The first quarter earnings release was admirably boring, showing steady growth. 

NRG Yield, A shares (NYSE:NYLD/A)
12/31/16 Price: $15.36.  Annual Dividend: $1.00 (6.5%). 
Expected 2017 dividend: $1.00 to $1.10.  Low Target: $12.  High Target: $25. 
5/31/17 Price: $17.20.  YTD Dividend: $0.53.  Annualized Dividend: $1.08.  YTD Total Return: 15.5%

Yieldco NRG Yield (NYLD and NYLD/A) had a mixed quarter, with improved availability of its wind and solar assets, offset by unfavorable weather.  It does not matter how well your solar plant is running if it does not stop raining.  The company's conventional fleet also had problems with forced outages, although some of the losses were recovered through insurance.

These problems were mostly offset by new acquisitions.  Although, like many Yieldcos, NRG Yield's share price has been depressed, its stock price has been recovering and it is able to raise some equity capital to accretively invest in new projects.  It also has $144 million in availability from its existing borrowing facilities.  This growth potential means that the Yeildco is still on track to raise its dividend by 15% in 2017 over the previous year. 

Nor should it lack for projects to buy.  In addition to its identified ROFO list, its parent NRG is under pressure to sell its renewable businesses from an activist shareholder.  This might lead to accelerated purchases of some assets at better-than-expected prices.

Atlantica Yield, PLC (NASD:ABY)
12/31/16 Price: $19.35.  Annual Dividend: $0.65 (3.4%). Expected 2017 dividend: $0.65 to $1.45. Low Target: $10.  High Target: $30.
5/31/17 Price: $20.89.  YTD Dividend: $0.25 (2.6%).  Annualized Dividend: $1.00.  YTD Total Return: 10.6%

Atlantica Yield continues to impress me, but not the market.  Along with first quarter earnings, the company announced that it had "obtained a waiver in Kaxu which waives any past potential cross-default with Abengoa in the project finance agreement." After Kaxu, the company needs to obtain only one more such waiver in order to free itself from the after-effects of its former parent Abengoa's bankruptcy. 

The remaining project, ACT, represents 300 MW of conventional power generation in Mexico, and accounted for 13% of revenue in 2016.  The muted reaction of investors to first quarter earnings may have been in response to the company's decision not to raise the dividend until it obtains the final waiver for ACT.  Given ACT's share for revenue and cash flow, the board could have easily justified increasing the quarterly dividend to $0.30.  The fact that they chose to keep the dividend at $0.25 is the exact opposite of the "raise the dividend and hope investors come" strategy that concerns me at 8point3 Energy Partners (see above.) 

Contrasting Atlantica and 8point3

In sharp contrast to 8point3, Atlantica is preserving corporate capital and using it to make small investments which will lead to long term dividend growth, such as the $10 million investment in a California-Arizona transmission line announced in the first quarter. 

Like all income investors, I like dividend increases, but I like prudent uses of capital even more.  With Yieldco stocks still out of favor, it's much better to fund growth with retained cash flow as Atlantica is doing than to squander current resources in the hope that the stock price will recover and shareholders will be willing to fund today's dividend increase after it has already happened.

Another telling point of contrast between Atlantica and 8point3 is Atlantica's stated 3x target for the ratio of corporate level debt to pre-debt service CAFD.  For Atlanica, this ratio stood at a cautious 2.6 at the end of the first quarter.  8point3 does not use (or at least disclose) this ratio, but we can estimate it.  For 2017, 8point3 is projecting approximately $95 million of CAFD and $25 million of debt service.  All $714 million debt is corporate level, so 8point3's outlook puts the same ratio at just below 6- twice Atlantica's target.

The point of a ratio like this is to ensure that changes in the cost of servicing corporate debt will have a limited impact on dividends.  8point3 is currently paying 3.5% per year for debt service.  This must be refinanced by 2020.  If it is all refinanced at the same 5% rate as Atlantica just refinanced some of their corporate level interest-only debt, the annual debt service cost will rise from $25 million to $36 million, reducing annual CAFD to $80 million, or $1 per share. 

Even this is a best-case scenario that assumes no the company can refinance everything with interest only debt.  If 8point3 tried to meet Atlanitca's 3 times target, it would need to refinance more than half of its debt with amortizing project level debt, annual CAFD would fall to $0.88 a share. That puts the current dividend rate of $1.08/year at 123% of 8point3's long term sustainable CAFD.  This ratio of dividends to CAFD is called the payout ratio, and most Yieldcos target payout ratios of 80% to 90%.   Atlantica's target payout ratio is 80%, and its current dividend of $0.25 per quarter is only 56% of CAFD guidance for 2017.  This leaves a lot of room for Atlantica to increase its dividend later this year.

NextEra Energy Partners (NYSE:NEP)
12/31/16 Price: $25.54.  Annual Dividend: $1.36 (5.3%). 
Expected 2017 dividend: $1.38 to $1.50.  Low Target: $20.  High Target: $40. 
5/31/17 Price: $34.54.  YTD Dividend: $0.718 (2.8%).  Annualized Dividend: $1.46.  YTD Total Return: 21.9%

NextEra Energy Partners also compares favorably with other Yieldcos on measures such as payout ratio and company level debt.  Its outlook for long term CAFD from its current properties is approximately $310-340 million, or $2 to $2.20 per share, compared to 2017 distributions of $1.58-$1.62 per share.  That gives a payout ratio of around 80%. 

Management does not plan not to issue additional equity until the share price recovers.  If the share price does not recover, the company may have trouble delivering on it 5 year dividend growth target of 12% to 15% per year, but not until at least 2019, and there is no danger of a dividend cut like the one we could see for 8point3 in the same time frame.  And in Nextera Energy Partners' case, the necessary share price recovery is already underway.

Other Income Stocks

Covanta Holding Corp. (NYSE:CVA)
12/31/16 Price: $15.60.  Annual Dividend: $1.00 (6.4%).  Expected 2017 dividend: $1.00 to $1.06.  Low Target: $10.  High Target: $30. 
5/31/17 Price: $14.75.  YTD Dividend: $0.25 (1.6%)  Annualized Dividend: $1.00.  YTD Total Return: -3.9%

Along with Atlantica, waste-to-energy developer and operator Covanta continues to suffer because of market weakness in power prices and commodity metals.  Earnings were significantly negative at -$0.41 per share, but like Yieldcos, much of this loss is in the form of depreciation, and so it does not have much bearing on the company's ability to maintain its dividend.  The company's Free Cash Flow guidance for 2017 is $100 million to $150 million, which should be sufficient to maintain its $129 million in annual dividend payments until cash flow increases because of growth investments or recovering commodity markets.

The company's Dublin facility accepted its first waste delivery and remains on track  for commercial operation in the fourth quarter of this year. 

Seaspan Corporation, Series G Preferred (NYSE:SSW-PRG)

12/31/16 Price: $19.94.  Annual Dividend: $2.05 (10.3%).  Expected 2017 dividend: $2.05.  Low Target: $18.  High Target: $27. 
5/31/17 Price: $21.22.  YTD Dividend: $1.023 (5.1%).  Annualized Dividend: $2.05.  YTD Total Return: 11.3%

Leading independent charter owner of container ships had a very bullish first quarter earnings report, noting that the weakness in pricing container ship leases seemed to have hit bottom.  Other shipping companies, such as Maersk (MAERSK-B.CO) have noted similar improvements.  Despite this, the company's common stock continued to drop in May, and its preferred stock (such as SSW-PRG) has not delivered significant gains.  I think this makes now a particularly good time to buy the company's preferred shares, or even speculate on a sharp recovery of the common stock.  I did both in recent weeks, buying a little of both the preferred E and H series shares, and buying some long dated $7.5 calls on the common stock as it temporarily fell to near $5.

Growth Stocks

MiX Telematics Limited (NASD:MIXT).
12/31/16 Price: $6.19.  Annual Dividend: $0.14 (2.3%).  Expected 2017 dividend: $0.14 to $0.16.  Low Target: $4.  High Target: $15. 
5/31/17 Price: $7.12.  YTD Dividend: $0.037 (0.6%).  Annualized Dividend: $0.14.  YTD Total Return: 9.5%

Everything seems to be coming together for vehicle and fleet management software as a service provider MiX Telematics.  For the last 2-3 quarters, we've been seeing renewed growth in subscriptions in most of the company's segments.  Subscription revenue came in ahead of guidance for the fourth quarter and fiscal year ending March 31st. 

The recovery of oil prices to around $50 a barrel has led to a rapid increase in activity should lead to renewed growth in subscriptions MiX's oil and gas customers.  This segment was a drag on MiX's results in 2016, but should continue to be a tailwind for the rest of this year.

Aspen Aerogels (NYSE:ASPN)

12/31/16 Price: $4.13.  Annual Dividend and expected 2017 dividend: None.  Low Target: $3.  High Target: $10. 
5/31/17 Price: $4.52.  YTD Total Return: 9.4%

As I expected, Aspen Aerogels delivered unimpressive first quarter earnings.  What I did not expect was that the stock would rally for no reason I could see other than a good long term valuation even if the near term prospects still seem weak.  When a stock falls for no reason I can determine, I usually buy.  When it rises, as Aspen did, I remain on the sidelines. 

Final Thoughts

Although the world political and economic climate remains volatile, the US stock market has remained calm so far this year.  How long that can continue is anyone's guess, but I think defensive investments like cash, attractively valued income stocks, and real income investments like home solar remain the best places to put your money. 

On home solar, I recently published an article comparing it as an investment to commonly held mutual funds.  Spoiler: the mutual funds did not fare well.  For defensive income stocks, Atlantica Yield, Covanta, and Seaspan Preferred shares are all looking very attractive right now.  As for cash, keep some around.  I suspect we will see some much better valuations in the stock market over the next 6 months to a year.
Disclosure: Long HASI, MIXT, PEGI, NYLD/A, CVA, ABY, NEP, SSW-PRG, ASPN, GLBL, TERP.  Long puts on SSW (an effective short position held as a hedge on SSW-PRG.  Short calls on CAFD.)

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

May 30, 2017

Smarting Up Electrical Grids

by Debra Fiakas CFA

My recent post “Bull Case in Rick Perry’s Grid Study” highlighted efforts by U.S. Energy Secretary Rick Perry to help the coal industry with a study of the U.S. electrical grid.  Coal has long claimed advantage as a ‘dispatchable’ power source, i.e. a consistently available power source suitable to supply power for the base load.  Technology is making base load less important.  Indeed, modernized or ‘smart’ electrical grids are making it possible to take advantage of low-cost renewable power sources even though they produce power intermittently and are therefore considered ‘not dispatchable’.

The preference of market-based electric grids for the lowest-cost producer is what has got the coal industry in a knot as power generated from cheap natural gas wins out the daily bidding process.  Even intermittent power sources such as wind and solar can beat out coal-fired power plants.      When wind and power sources are in operation at some scale their marginal cost is low (and getting lower according to the National Renewable Energy Laboratory) and therefore the asking price to the electrical grid is low.  As electricity demand escalates the grid operator casts about for additional power from the next lowest priced power source.  At some time during normal operating conditions, as more power is needed, wind and solar sources will rank as the next lowest-cost power source and beat out a coal-fired power source.

Investors can take a cue from the Perry grid study by going long companies with technologies and know-how that make it possible to deliver power at the lowest possible cost.  Following are few companies that are helping to ‘smart up’ the U.S. electricity grid.

An electric grid is smart when its can optimize electricity utilization and interact with consumers and markets.  EnerNOC, Inc. (ENOC:  Nasdaq) describes itself as a world leader in energy intelligence.  Among other energy management products for industry and business, the company provides demand response solutions and energy management software to customers in the U.S. and around the world.
Demand response is a communications link between the power grid operator and large electricity users, making it possible for grid operators to cue these large customers that electricity demand is on the rise.  Participating electricity users can then temporarily reduce their energy use during these periods of peak demand and get rewarded with special low rates.  Even with offering lower rates the utilities and grid operator benefit from the smoothing effect the demand response system has on electricity demand.  The grid operator does not as frequently have to reach out to higher-cost power providers and can more frequently tap power from intermittent power generators.

EnerNOC reported a net loss of $41.9 million on total revenue of $398.7 million in total sales during the twelve months ending March 2017.  As worrisome as that large loss might seem, it is not as troubling as the fact that the company burned up $39 million in cash resources to support operations during that period.  To keep things going as EnerNOC struggles to right the ship, the company has tapped credit markets.  The total debt to equity ratio is 141.88.  The company has $74 million in cash on its balance sheet suggesting that it still has some staying power to see its strategic growth plan back to breakeven.   

MasTec, Inc. (MTZ:  NYSE) is an engineering, procurement and construction company focused on the energy and utility infrastructure sector.  An electric grid is considered smart when its can self-monitor its equipment and components.  Among a long list of infrastructures, MasTec delivers on smart grid projects for utilities, including smart-metering, energy controls and monitors, and other technology solutions designed to regulate power flows.

The company is also experienced in wind, solar and geothermal power construction, but has made wind power a specialty.  For example, MasTec constructed 32 miles of 34 kilovolt electric power lines to collected power from a new wind farm for Transcanada.  In White Lake, South Dakota, MasTec erected 108 wind towers with 1.5 megawatt turbines for the Crow Lake Wind Farm owned by the Basin Electric Power Cooperative.  MasTec uses its extensive knowledge of electric generation and transmission to connect and deliver high voltage power in the most efficient network.

In the twelve months ending March 2017, MasTec earned $174.9 million in net income or $2.13 per share on $5.3 billion in total revenue.  Operating cash flow generated during the period totaled $343.9 million, representing a sales-to-cash conversion rate of 6.5%.  If that achievement is not impressive enough, note that return on equity is 17%.

Analysts expect the good times to continue rolling for MasTec. The consensus estimate is for $2.46 per share in the year 2017.  This represents a growth rate of 15.5%.  We note that MTZ shares are trading at 15.1 times forward earnings, suggesting that the stock is just at fair value. 
Quanta Services (PWR:  NYSE) is another engineering, procurement and construction company based in the U.S. and claims to be the largest electric transmission and distribution specialty contractor in North America.  The company has an engineering design and planning team focused exclusively on smart grid technologies.  The company puts particular emphasis on information technology systems as needed for achieving a truly ‘smart’ grid.  Two-way communications systems, automated feeder switches and phasor measurement units to monitor grid stability are part of a sophisticated network solution.  With a robust IT solution the grid is able to integrate renewable energy sources by nimbly switching among sources as they generate power.  This process levels out power availability, thereby reducing dependence upon high-cost ‘dispatchable’ sources.

Quanta is significantly larger than MasTec as an EPC services provider, but is not quite as profitable.  Quanta reported net income of $226.5 million or $1.45 per share on $8.1 billion in total sales in the twelve months ending March 2017.  Sales-to-cash conversion was only 2.1% in the year.  Furthermore, Quanta is only earned 6.9% on equity.

Shares of Quanta are priced at 13.4 times forward earnings and therefore present a bit of a bargain compared to MTZ.  Perhaps more importantly, PWR shares are a less volatile with a beta of 0.74 compared to a beta of 1.88 for MTZ.

Silver Springs Network, Inc
. (SSNI:  Nasdaq) offers a solutions to enable communications between devices and the power grid.  The SilverLink system provides utilities with data to improve and even automate power management decisions.  The company is particularly focused on integrating distributed energy resources to the electrical grid, and touts its communications and intelligent control solutions for utilities.  Silver Springs also uses a novel concept of ‘virtual power plants’ to created greater reliability in distributed energy resources.
Silver Springs reported a loss of $26.3 million or $0.51 per share on $312.7 million in total sales in the twelve months ending March 2017.  However, cash flow from operations was a healthy $18.6 million or 5.9% of sales.  The benefits of internal cash generation can be seen on the balance sheet with $116.6 million in cash at the end of March 2017 and no debt.

Analysts anticipate even better times ahead the consensus estimate is for net profits $0.30 per share in 2018.  The stock is currently trading at 32.8 times that consensus estimate.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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