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March 31, 2009

Cleantech, Optimism Squared and the Family Reunion Investment Test

Last November, Merrill Lynch released "The Sixth Revolution: The Coming of Cleantech," a thematic report from strategist Steven Milunovich that heralded cleantech as a new investment theme and forecast a coming age of plenty. A few days later venture capital icon Vinod Khosla warned a Palo Alto audience “500 million people on earth enjoy a lifestyle that 9 billion people will want in 2050.” The differences between these two informed viewpoints are more than a little stark, but they highlight a frightening truth about cleantech: for the first time in human history the fundamental drivers of a technological revolution are constraints rather than opportunities.

It is remarkably different this time!

Last weekend, I re-read the Milunovich report and spent several hours pondering the fundamental forces that drove the technological revolutions identified in the following table.


Technological Revolution
Historical Era
FIRST
The "British Industrial Revolution"
From 1771
SECOND
The Age of Steam and Railways
From 1829
THIRD
The Age of Steel, Electricity and Heavy Engineering
From 1875
FOURTH
The Age of Oil, the Automobile and Mass Production
From 1908
FIFTH
The Age of Information and Telecommunications
From 1971
SIXTH
The Age of Cleantech and Biotech
From 2003

I'm not an avid historian, but I recall that the popular reactions to the first five technological revolutions ranged from violent resistance to innovations that threatened job security (e.g. Luddites in England and saboteurs in France) to polite disdain or outright derision of innovations that were not seen as threats (e.g. Fulton's Folly). I still cringe when I remember college boy conversations where I taunted classmates with questions like "You may be able to buy a home computer in ten years but why would anybody ever want one?" The point is we didn't understand how important the innovations were until we viewed them in 20/20 hindsight. This dynamic gave important technologies time to evolve naturally, establish their value and then change the world in ways we couldn't have imagined. The process invariably took decades.

Where the first five revolutions were driven by the individual desire to do something better, faster and cheaper, it seems that cleantech is driven by a different dynamic. We collectively know that water, food, energy and commodities are not resources we can waste with impunity. We collectively understand that 6.2 billion people know how the rest of us live and each of the have-nots wants a fair share of the dream. We collectively fear a tipping point where unrestrained consumption of fossil fuels will irreparably damage our planet. We collectively worry that the world we pass to our children will face catastrophic conflict and horrific environmental consequences because of decisions that were made in a different era by our grandparents, our parents and us. So instead of viewing cleantech developments with a healthy dose of skepticism and requiring inventors to prove their worth, we collectively grasp at the latest research results and grossly overestimate their real value. A great example of this phenomenon are widely circulated stories about an MIT research project that would make it possible to recharge a GM Volt in less than five minutes by plugging it into the nearest available 125,000 watt power source.

Our problems are grave and almost everyone recognizes the desperate need for relevant scale solutions to persistent shortages of water, food, energy and commodities. But instead of acting like adults, accepting personal responsibility and doing the little things like home weatherization that could help alleviate the problems, we demand profound changes without considering whether the changes are enduring solutions or simple band-aids. We then compound the foolishness with the insane delusion that technological development is instantaneous and success is certain.

My favorite story of unbridled optimism is about a straight-laced father who thinks his son is overly optimistic and decides to teach the boy a lesson by telling him that a load of garden manure is his birthday gift. The manure is delivered and dumped in the driveway and the father puts a big red bow on top of the pile. When the son gets home from school, he promptly dives head-first into the manure pile and starts digging. When the surprised father asks what's going on, the boy replies, "There has to be a pony in here somewhere!"

It's a crazy world and an infantile time, but once the tantrum phase passes, we'll do what adults have always done. We'll get up in the morning, we'll go to work and we'll solve our problems. The first casualty will be unbridled optimism. The second will be waste in all its pernicious forms. Ultimately, rational cost-benefit analysis will prevail and we'll begin to find enduring solutions to critical problems.

Warren Buffet advocates investing in companies you understand, companies that that sell products and services you know, trust and use. Unfortunately, that methodology is almost impossible in cleantech because most of the players are new, few can point to a long and successful operating history and the principal disclosures investors rely on are forward-looking statements from people that are trying to promote an agenda or build a company; people who are by nature optimists. Any time you put an optimist's forward-looking perspective into the hands of an optimistic reader, the only possible result is optimism squared and that's a very dangerous equation for investors.

Unlike many financial bloggers, I know my opinions and outlook are far from mainstream. To compensate for that deficit, I've developed a simple technique I call the "family reunion test" to evaluate cleantech investments. It all boils down to a simple question: "How many of the people who attended our last family reunion are likely to buy this product or service at today's price?" If I conclude that most of my extended family members would be likely buyers, then it's probably a good investment. If I find myself all alone in the likely buyer class, then it's probably a good investment to avoid. Rigorously applied, the family reunion test is an amazingly accurate forecasting tool.

The battery industry is in a state of turmoil because none of the technologies we've relied on in the past are able to satisfy the extreme demands of a cleantech future. At $250 a kWh, lead-acid batteries are cheap and reliable, but they have weight, power and cycle life limitations that make them sub-optimal for plug-in vehicles. Li-ion batteries have exceptional weight, power and cycle life performance, but at $1,000 a kWh they're just too expensive for most cleantech applications. The net result is a race to the middle as lead-acid battery manufacturers work feverishly to improve performance while Li-ion battery developers work feverishly to reduce costs.

In the swamps of Degoba, Yoda told Luke Skywalker "Do or do not ... there is no try." The same wisdom holds in the battery industry. Don't talk about your plans ... talk about your accomplishments! In the meantime, investors would do well to remember that optimistic forecasts from interested parties are every bit as meaningful as the trash talk, hype and drama that precede every WWE championship.

Over the last several months I've delved into several arcane technical aspects of the battery industry. While the detail is useful for technophiles, it can be mind-numbing detail for the average reader. As penance for my past sins, I've prepared the following table that provides a simple summary overview of the differences between lead-acid battery manufacturers and Li-ion battery developers.


Lead-acid batteries
$250 per kWh of useful capacity
Li-ion batteries
$1,000 per kWh of useful capacity
Manufacturing
infrastructure
Efficient factories already exist and capacity can be rapidly and cheaply expanded.
Substantially all existing capacity is located in Asia and billions will need to be spent on new factories that will take years to build and equip.
Distribution
infrastructure
Efficient sales, distribution and customer support networks already exist. Billions will need to be spent on sales, distribution and customer support networks.
Recycling
infrastructure
Nationwide recycling capacity already exists, over 98% of lead-acid batteries are currently recycled and the recovered materials can be used to make new batteries.
Recycling techniques are in the R&D stage, there are no large-scale recycling facilities and the recovered materials are not pure enough to use in new batteries.
Technological
challenge
Improve energy density, power and cycle life; goals that appear reasonable in light of several recent advances I've discussed in prior articles.
Slash manufacturing costs by at least 50% in the short-term; a goal that is patently unreasonable for an industry that has historically achieved savings of less than 5% per year.
Raw material
availability
All essential raw materials are available in adequate quantities from domestic sources.
Essential raw materials are imported and there are important unanswered questions about future availability and price.
Financial
stability
The principal U.S. manufacturers are well financed and able to attract additional capital when necessary.
The principal U.S. developers are effectively bankrupt and cannot expand (survive?) without loans and grants from the government.
Market
valuations
Experienced manufacturers are trading for a small fraction of per share sales.
Developers with limited manufacturing history are trading at several times forecasted sales.

We are in the early stages of a technological revolution that is unlike anything the mind of man remembers. Instead of being opportunity driven, cleantech will be constraint driven. Instead of giving important technologies adequate time to evolve naturally, establish their value and then change the world, we're trying to avoid technical Darwinism, pick a winner based on theory, conjecture and public relations, and then force decades of technical progress into a couple of years. Experience tells me that the most likely outcome is catastrophic failure.

Ultimately, it boils down to your personal goals. If you want a long-term investment that will grow over time and derive immense benefit from the coming cleantech revolution, then the low-profile lead-acid battery manufacturers including Exide (XIDE) Enersys (ENS) and C&D Technologies (CHP) are probably the best choices for your portfolio. If you want a low-cost speculation on an advanced lead-carbon technology in the final development stages, then Axion Power International (AXPW.OB) may be a good choice. If you're more interested in fast paced trading in volatile markets then the high-profile Li-ion battery developers like Ener1 (HEV), Valence Technology (VLNC) and Altair Nanotechnologies (ALTI) may be best for you. In any event you should do your own research and understand what you're investing in before you place an order. My favorite place for reliable current information is the SEC's Edgar Website, which contains detailed disclosure from all of the companies I've mentioned.

I don't believe that Li-ion technology is doomed to fail. In fact I believe it has tremendous potential in a variety of markets where size and weight are mission critical constraints. However I can say without reservation that the challenges facing lead-acid manufacturers pale in comparison to the challenges facing Li-ion developers even if they get all the government support they could possibly want. To paraphrase a December 2008 note in the Wall Street Journal, Li-ion developers may well secure a place in a new electric-car industry. But at current prices, investors are being asked not just to dream, but to take success for granted.

Disclosure: Author holds a large long position in Axion Power International (AXPW.OB) and small long positions in Active Power (ACPW), Exide (XIDE), Enersys (ENS) and ZBB Energy (ZBB).

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981. From January 2004 through January 2008, he was securities counsel for and a director of Axion Power International, Inc. a small public company involved in advanced lead-acid battery research and development.

March 30, 2009

FLIR: The (IR) Image of a Stimulus Stock

I highlighted FLIR Systems (NASD:FLIR) as a way to participate in the growth of the energy auditing industry in late 2007.  I was ambivalent about it at the time: I very much liked the potential growth story, but felt the stock was overvalued.

Flir has fallen about 35% since late 2007, and 50% since its peak in July 2008 (while revenues have grown about 50%), prompting me to give it another look.  

 flIR.png

Infrared Stimulus

Weatherization of low income housing and Federal building retrofits are a major component of the American Recovery and Reinvestment Act (aka "Stimulus Package.")  This will require the hiring and training of thousands of new energy auditors, for whom infrared (IR) imaging is an extremely versatile tool, both in terms of finding out what problems need to be fixed, and for convincing the customer that they are necessary.  IR imaging is not necessary for an effective energy audit, but it is increasingly becoming part of the energy auditor's standard kit. I expect that new energy auditors are likely to flock to the technology because of its strong visual appeal.  In addition, it requires training to use IR cameras properly, a service which Flir also provides.  

Because an IR audit is cheaper than a full energy audit, some state weatherization programs or utility Demand Side Management programs will choose to to adopt IR audits as the sole energy audit used in their program.  I think that this is likely, because Xcel Energy (XEL) initially proposed the use of IR audits in their most recent Demand Side Management Plan last fall.  Although, due to the efforts of the Energy Efficiency Business Coalition (EEBC), for whom I was consulting at the time, the final plan used the considerably more robust HERS audits.  If EEBC had not intervened, the plan almost certainly would have been approved with infrared audits as the sole requirement, which is why I expect that result in some of the many other national programs starting as the result of the Stimulus package. In cases where IR are not the sole requirement, properly used IR cameras are extremely useful tools in the energy auditor's kit, increasing both the speed and accuracy in detecting problems, so are likly to have some role in all such programs.

Flir's equipment is also used in maintenance and diagnostics of a large range of commercial equipment.  Much like rail maintenance stock Portec (PRPX), while manufactures are delaying new investment, such delays may increase the demand for Flir's imaging equipment to help assure that older equipment continues to function efficiently.  For instance, their GasFindIR range of cameras is designed to detect leaks of organic gasses, such as methane.   While stopping leaks is valuable in its own right, the potency of methane as a greenhouse gas means that a greenhouse gas cap and trade legislation will likely provide additional incentives to detect and fix gas leaks.

Growth Story

FLIR Systems is a growth story based on the rapidly decreasing price of thermal imaging systems, which leads to a rapidly growing market quickly expanding to new applications.  So far, the financial crisis has done little to reduce sales growth, and margins remain extremely robust, with a net operating margin of 26% and a return on equity of 28%, both of which have been increasing even with decreasing minor use of financial leverage.

While the stock price was plunging along with the market, revenue continued to grow at a robust 38% from FY 2007 to FY 2008, and the strength continued in the final quarter of 2008.  Management expects revenue to continue to grow at a more subdued 11-16% in 2009, without assuming any improvements in global economic conditions.  They have a low debt-to equity ratio of 0.23 which fell in 2008 and FLIR has continued to lower debt this year by allowing holders of its senior convertible notes to exchange them for equity.  Even with this declining leverage, their financial statements show no sign of difficulty in collecting payments from customers.  

With the stock at $21, the P/E ratio is now down to 17, about half of what it was when I first looked at the company.  I recently sold puts to acquire shares if the price falls below $15.

The Other 70%

Flir is not a pure-play energy efficiency stock.  According to the most recent annual report, the Thermography division, which includes the energy efficiency applications discussed above, accounted for approximately 30% of revenues in 2008, while its Commercial Vision Systems unit accounted for 17% and its Government Systems unit for 53%.  

Its Government Systems unit supplies military, police, and paramilitary with advanced infrared imaging equipment.  While defense stocks as a whole may not be a safe have in this recession, some analysts see FLIR's military supplier role as an advantage, because they expect government spending on small ticket items (as opposed to tanks and fighter jets) to remain robust.  Since I've never analyzed this sector, I can't take a strong position on this, but imaging systems seem to be military hardware which make a lot of sense in our current wars in Iraq and Afghanistan.

When considering an investment in Flir, it's important to understand that the company's primary markets are military and security, and they are likely to remain so, as all divisions are on robust growth trajectories.  Many clean energy investors may be uncomfortable with military contracting from a moral standpoint, but I feel that sensing systems are as likely to save civilian lives as they are to end them.  

From a financial analysis standpoint, I simply know that I don't understand the industry.  I can say, however, that this segment seems the safest part of the company's business, largely because they have a large an growing backlog in the segment.  One other upside is the fact that Flir is lumped with other military contractors and few other alternative energy investors are looking at the company.  Most of the analysts who follow it specialize in military contractors... such analysts are therefore as unlikely to understand the true potential of the energy efficiency market as we are to understand the potential of the military market.

Tom Konrad, Ph.D.

DISCLOSURE: Tom Konrad has a long position in FLIR.
DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

 

March 28, 2009

Do You Need To Invest In Oil To Benefit From Expensive Oil?

Two months ago, Tom told us how he'd dipped a toe into the black stuff (i.e. bought the OIL etf) on grounds that current supply destruction related to the depressed price of crude oil would eventually lead to the same kind of supply-demand crunch that led oil to spike during the 2004 to mid-2008 period.

If you need evidence that the current price of crude is wreaking havoc in the world of oil & gas exploration, look no further than Alberta and its oil sands. The oil sands contain the second largest oil reserves in the world after Saudi Arabia, but more importantly will account for the lion's share of incremental supply as conventional oil production continues to decline. The province's economy, which had been growing at a breakneck pace for the past five years, has come to a grinding halt: employment insurance claims grew by twice the Canadian average over the past year; personal bankruptcies jumped by 61%; and home foreclosures are on the rise. This is the result of significant project cancellations that will no-doubt limit Alberta's ability to ramp-up output once prices climb back again.

It is thus no surprise that Cambridge Energy Research Associates and others are warning about the economic hazards of curtailing investments into conventional and alternative energy.  

Alt Energy & Fossil Energy

Oil being the most followed of the energy commodities, it is no surprise that it is receiving most of the media attention. Arguably, natural gas and coal prices should matter more to alt energy investors than oil prices: according to REN21, of the $71 billion invested in renewable energy in 2007, 47% went into wind and 30% into solar PV. Both technologies are used for power generation (investments into transportation alternatives are comparatively small) and, in the US, coal and natural gas are the dominant fuels in power production. The relentless focus of the popular press and other pundits on the the economic case for alternative energy being closely tied to the price of crude oil is thus mostly misplaced.

Case in point, last November, a reader wrote me with a correlation analysis conducted over a 5-year period (or, where there wasn't five years' worth of data, since inception). The correlation coefficients between the returns on crude oil and those on alt energy securities were as follows: GEX, 0.19; PBW, 0.14; TAN, 0.18; and the index underlying FAN, 0.19. These are, by most measures, pretty low correlation coefficients. Given the reader's reputation, I trusted the numbers. 

Nevertheless, in alt energy investing as in life, perception is often reality. Given the many signs pointing toward a rapid escalation in crude prices - demand can and will rebound far quicker than supply - I decided to re-explore the relationship between fossil and alt energies. If a strong positive correlation can be found between alt energy investments and crude oil, natural gas and coal investments, there may not be a need to dip a toe into the black (or colorless) stuff at all - one can focus on alt energy alone and still enjoy the ride up.

In order to verify this, I ran a basic correlation analysis with the daily returns on the KOL (coal), OIL (crude) and UNG (nat gas) ETFs/ETN on the one end, and the daily returns on the alt energy ETFs on the other. I got the return data from Yahoo Finance using the Adjusted Close prices that include dividends and splits. Given the results above from our reader's analysis, I only went back six months to see if the (lack of a) relationship still held.   

OIL and UNG track the prices of futures contracts in the underlying commodities, so they are pretty decent securities to use to estimate the returns on crude and nat gas investments. KOL, on the other hand, tracks a basket of coal company stocks. It's the closest thing I could find but it's not ideal as stock returns don't necessarily track commodity returns. For instance, large mining firms will often sell a high proportion of their output through fixed-price contracts, preventing them from benefiting from sudden surges in spot prices. 

The boxes delineate general alt energy ETFs (ICLN to GEX), the solar ETFs (TAN, KWT) and the wind ETFs (FAN, PWND). There aren't any notable differences between the ETF categories, with the most significant differences being between the fossil fuel ETFs/ETN and the alt energy ETFs.   

The relationship between alt energy stocks and coal stocks appears relatively strong. However, in the absence of return data on coal, it's hard to tell whether investing in alt energy stocks (or coal stocks for that matter) is an optimal way of playing increasing coal prices. Given the structure of the coal market, with significantly less involvement by purely financial actors than in oil or natural gas markets, this is a hard one to play for retail investors, although data appears to suggest there is a play.

Though the correlation appears to have strengthened somewhat between crude oil and alt energy investments in the last six months, it remains weak enough that if someone wants to play a return to expensive oil they are still better off dipping a toe (or even an entire foot!) in the black stuff. The same holds for nat gas.

This quick and dirty analysis wouldn't withstand close methodological scrutiny. My only intent here was to see whether these relationships were worth exploring further - they are not. If you want to benefit from crude oil and nat gas price increases and have no ethical qualms about it, invest in them directly!

DISCLOSURE: Charles Morand has a long position in TAN.

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

March 25, 2009

How Likely Is A Big Rally For Alt Energy Stocks?

Last week, Jefferies & Co. held its Global Clean Technology Conference. Unsurprisingly, the tone wasn't as optimistic as in previous years, with cash and funding worries top of mind. Nearly two months ago, I discussed some tangible signs pointing to looming problems in the industry. However, despite all the gloom, it seems as though several firms (and investors!) are expecting the American Reinvestment and Recovery Act (ARRA) to provide the industry with a lifeline. But will this really be the case?

For one thing, the major environmental spending programs in the ARRA are relatively targeted (i.e. smart grid, storage, clean transportation) and, although a broad range of companies could benefit from measures such as an extension of the production tax credit, direct government cash payouts will not be forthcoming for all. What's more, it now looks like Obama's plan for a cap-and-trade system, which would have provided a major boost for clean power, will be scrapped. This is something I discussed a little while ago: while I do believe a cap-and-trade program will one day be part of the the US environmental regulatory landscape, it's a very tough sell at best - and political suicide at worst - in the midst of an economic slump that is leaving millions of unemployed in its wake. Whether environmentalists like it or not, the general public still sees greenhouse gas regulation as a negative-sum affair.

Can the ARRA single-handedly prevent the sector from going through a massive shake-out that will see many of the smaller firms wiped out or taken over? That's highly unlikely. Like any industry, alt energy's lifeblood is financing, and no legislation can fully make up for dysfunctional capital markets. At this point in the game, with many world governments having declared their unconditional support for clean energy, there's still one key ingredient missing: it's the banks, stupid! (At least according to Vestas' CEO in the interview below)

Given the slow pace at which normal credit conditions are returning and enduring doubts about the viability of many banks, I don't expect a broad-based rally in alt energy/cleantech stocks on the back of the ARRA this year. While certain select stocks will most certainly do well, the potential beneficiaries of the ARRA have by now mostly been identified. Those who expect a rapid return to the days when cleantech stocks outperformed just by virtue of being cleantech stocks are in for a nasty surprise; a general rally in equities, if it does occur in 2009, might pull the good (i.e. operating profits, free cash flows, high current ratios and low total debt levels) alt energy firms up but will leave the sketchy ones behind. This is a new era, and investors are a lot more risk-conscious than they used to be.

March 24, 2009

A Diamond In The Mutual Fund Rough

The credit crisis and ensuing collapse in equity markets hasn't been especially good for the mutual fund industry (especially of the equity type). Over the weekend, I ran a search on Morningstar's Fund Quickrank using "U.S. Stocks Funds" as a category and "Total return %: 1 Year" as a ranking field. The top-five ranked funds (as at March 20, 2009) and their performances are outlined in the table below, excluding fees. The group average, containing 9,978 funds, is -40.43%.  

Fund Name Ticker 1-Yr Total Return (%)
Gabelli ABC GABCX -1.52
Reynolds Blue Chip Growth BRIG -2.01
Apex Mid Cap Growth BMCGX -2.46
Franklin Biotechnology Discovery A FBDIX -3.49
Eaton Vance Worldwide Health Sci A ETHSX -4.12

Though the losses on these best-in-class funds pale in comparison to the 42% drop in the S&P 500 or the group average, the fact of the matter remains that most equity mutual fund investors didn't make any money over the past year. Run the screen for three years, and the search yields only three positive names (probably only 2 after fees) with a group average of -15.69%. The five year screen looks decidedly better with several funds in positive territory, although the group average still stands at -5.19%.

For the do-it-yourself investor, some of the these numbers might not look so bad in light of how overall markets have performed. However, for the risk-averse investor who was sold steady (and relatively secure) returns over the long-run, this is less than thrilling. It's no wonder, then, that mutual funds have been experiencing net outflows of late.

Unsurprisingly, alt energy/cleantech mutual funds have performed no better (or even worse!) than the industry as a whole, with one fund even folding this past year. This may have been enough to convince some investors that alt energy wasn't for them.

A Diamond In The Rough? 

Last week, I came across a Canadian alternative energy mutual fund that has had a stellar year throughout the morass: the Creststreet Alternative Energy Fund (CAM400). The fund is up 94% over the year ending Feb. 28, 2009, and closed up 194% in 2008.

The portfolio manager recognizes that these returns were generated when the fund was only about 12% of its current size (C$3M Vs. C$25M now) and are probably not sustainable. They were related mostly to trading rather than investing. The fund was short the Claymore/MAC Global Solar Energy Index ETF (TAN), the PowerShares WilderHill Clean Energy ETF (PBW) and PowerShares Global Clean Energy Portfolio ETF in the latter half of 2008 (PBD), which no-doubt explains some of the results.

According to the manager, the fund "will invest in anything that exploits an opportunity outside traditional, carbon-based-emitting sources of energy." That said, the fund did invest in oil&gas and even gold bullion. The fund manager claims to be targeting about 25% annually. With about 65% of fund value in cash, stock picks are being made right now so the next 12 months should tell whether the manager is as strong a stock picker as he is a trader!  

This fund isn't available to US investors. Nevertheless, given the manager's returns over the past 12 months, I figured some of the info (and especially the stock picks) he provided in the interview I read would be of interest. The stocks are in the table below.

Name Ticker TTM PE TTM EPS (US$) What Creststreet Says About It
RuggedCom RUGGF.PK 26.6 0.95 "The maker and seller of industrial-grade routers for utility substations has strong management, can benefit from North American fiscal stimulus plans and is a potential takeover candidate"
World Energy Solutions WLDE.PK N/A -0.10 "The firm, which hosts online auctions for the trading of electricity contracts and carbon credits, can potentially benefit from the implementation of U.S. carbon cap-and-trade legislation in the United States"
Ormat Technologies ORA 23.6 1.13 "The undisputed market share leader in geothermal power production and equipment sales should benefit from U.S. fiscal stimulus loan guarantees for renewable power production"
Comverge COMV N/A -4.43 "The firm sells gear to help consumers cut power use to relieve stress on electricity grids, and sells the power back to a utility. It's not yet profitable, but has a solid cash position and are poised to experience strong sales growth resulting from subsidies targeted to utilities to improve energy efficiency"

Besides the picks, the portfolio manager likes the smart grid and a potential cap-and-trade system as investment plays on the Obama Administration's policies.

DISCLOSURE: Charles Morand does not have a position in any of the stocks or funds discussed above or a commercial arrangement with Creststreet.

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimerhere.

March 23, 2009

Drawing the Right Lessons from the Texas "Wind" Emergency

On February 26, 2008, a drop in wind generation by about 1400 MW over ten minutes, coupled with an increase in demand of 4412 MW due to colder weather, and lower-than scheduled production from other power suppliers, led ERCOT, the Texas grid operator to cut 1100 MW of power to interruptible customers for about 90 minutes.  

Misconceptions

All these facts come from a Reuters article misleadingly titled "Loss of wind causes Texas power grid emergency."  I was dismayed a few weeks ago when this misleading reporting led the generally insightful Master Resource Report to conclude "This is a clear example of why solutions to storage and transmission are going to become increasingly critical as sources such as wind and solar become increasing parts of the generation mix.  This doesn't invalidate renewable power; it just means that the country has plenty of work to do and that there are plenty of investment opportunities besides just wind turbines and solar cells." [link to pdf]

It may be surprising to readers that I find anything objectionable in a call for more storage or transmission, although I'm a stronger proponent of transmission, which I consider more cost effective, even if there are far fewer barriers to adding storage.  

However, the lesson of the 2008 Texas emergency is that while we need more transmission, and, eventually, storage, there are other, cheaper and easier steps we can take to integrate wind and solar to considerably higher levels of penetration..

Not A "Wind" Emergency

The first thing to note about the incident is that the increase in electric demand was more than three times as large as the decrease in supply from wind.  Presumably, ERCOT had been dealing with such fluctuations in demand since long before wind came onto the system.  Part of the problem was that other power suppliers (presumably natural gas and coal, usually considered "reliable") were not delivering what they had promised.  Hence, the drop in wind production was probably only 20% of the overall problem, not 100%, as the headline led readers to believe.

Hero: The Smart Grid 

The next conclusion we can draw is that Demand Response (DR), in the form of interruptible service to large customers, prevented power outages.  Demand response an early form of the Smart Grid which is already working today.  It allows the grid operator to cut power consumption by other users who have previously agreed to such cuts in return for lower electricity rates or cash payments.  According to a 2005 study of DR programs from the American Council for an Energy Efficient Economy, the median cost of DR programs studied was $29 per kWh, and the average cost was $86 which compares quite favorably to the $500 or more per kW cost of a peaking gas turbine.   Demand Response was the hero of February 6, 2008, even if wind was not the villain.

Before we look for investments in energy storage or even transmission, we should be looking to even more cost effective resources for the integration of variable energy sources, such as Demand Response and other variations of the Smart Grid.  Both EnerNOC (ENOC) and Comverge (COMV) provide demand response services to utilities, and this is also one use for Smart Grid technology from such companies as Echelon (ELON), RuggedCom (RUGGF.PK), Telvent (TLVT), and Itron (ITRI).

Villain: The Dumb Grid

During the discussion at a January 21 seminar sponsored by the National Renewable Energy Laboratory and the National Oceanic and Atmospheric Administration, featuring speakers from wind forecasting companies 3Tier, WindLogics, and AWS Truewind, the speakers mentioned that the weather forecasters had been telling the system operator of the incoming cold front and likely drop in wind production, but that the system operators chose to make no preparations before the fact.  Had they done so, they could have ramped up standby generation before the cold front hit, and would not have needed to call on the interruptible power resources.

Given that much of the heating in Texas is electric, system operators must have known that a cold front would raise demand.  Why would system operators choose not to heed forecasters' warnings?  There may be many reasons, but in the end, they all probably come back to incentives.  Preparing for a predicted increase in demand would have been the intelligent response, but regulated utilities have very little incentive to use their resources intelligently.  After all, a regulated utility makes most of its profits based on an authorized return on capital based on the investments it can justify to the regulator as necessary to keep the system up and running.  If the utility is, for whatever reason, unable to use those resources effectively, it becomes easier to argue that more resources are needed, which will lead to more profit for utility shareholders, and a less stressful job for system operators..

In other words, regulated utilities have an incentive to use as little brainpower (for which they do not earn a return on capital) and as much capital investment as possible.   They have an incentive to be dumb.  Given such incentives, is it any surprise that they ignore warnings, and then blame the problem on the variability of wind?

Tom Konrad, Ph.D.

DISCLOSURE: Tom Konrad owns ENOC, COMV, ELON, RUGGF, and ITRI
DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

March 22, 2009

Lithium-ion Batteries and How Cheap Beat Cool in the Chevy Volt

Since November of last year, I’ve argued that cheap will beat cool when it comes to the commercialization of battery chemistries. As details on the design and construction of the Chevy Volt battery pack emerge and are publicized on sites like Green Car Congress and Popular Science, it’s clear that cheap Li-ion chemistry has already beaten cool Li-ion chemistry and many of the concerns I’ve expressed about using Li-ion batteries in cars have been considered and resolved by thoughtful automotive design engineers. It bodes well for the introduction of PHEVs as long as the tax incentives remain in place, but the long-term impact on developers of high-cost Li-phosphate and Li-titanate chemistries may be devastating.

Battery Cost The Chevy Volt will use Li-polymer batteries manufactured by Korea’s LG Chem. While Li-polymer batteries have had a spotty safety record in cell phones and laptops and do not begin to approach the extreme cycle-life of Li-phosphate and Li-titanate chemistries, they are far and away the cheapest variety of Li-ion batteries with prices in the $600 to $700 per kWh range as opposed to the $1,300 to $2,000 per kWh range.

Passenger Safety To resolve the basic safety issues associated with Li-ion batteries, GM has designed a T-shaped battery pack that sits in front of the rear axle and runs forward through the space that used to be taken up by the driveshaft. At first glance, the battery pack looks like it comes out of a battle tank instead of a passenger car. The topside of the battery pack looks far stronger than the bottom side of the battery pack and it’s clear that the basic geometry has been designed to deflect the potentially explosive force of a battery failure down and away from the passenger compartment. The absence of any visible deformation in the 35 mph crash test photos of the battery pack confirm that GM thinks armor plate is more cost-effective than exotic chemistry. Overall, GM’s battery pack design is a cheap but effective way to avoid potential personal injury risks.

Cycle Life Performance Li-polymer batteries are not renowned for the extreme cycle-life of their more glamorous and expensive cousins like Li-phosphate and Li-titanate. To optimize the cycle life of the batteries in the Volt, GM has chosen to install a 16 kWh battery pack in the Volt but only use 55% of the theoretical capacity to power the car. By limiting the maximum state of charge to 85% and switching to internal combustion when the state of charge falls to 30%, GM believes it can get a 10-year life out of batteries that would die much more quickly with a wider cycling range. Once again, GM has chosen a cheap but cost-effective way to balance battery capacity and cycle life.

Weight and Energy Density The final weight of the Volt battery pack is about 175 Kg. This works out to an energy density of roughly 50 Wh/Kg for useful battery capacity, about the same value as a high quality lead-acid battery.

Recycling While the Chevy Volt battery pack will be built to European recycling standards, those standards only relate to safe disposal of potentially toxic materials and do not get into issues like recovering materials of sufficient purity that they can be used to make new batteries. This is good from a pure disposal perspective, but suboptimal if one’s environmental sensitivities extend beyond landfills to include the environmental damage caused by mining and other resource extraction activities.

In the Chevy Volt, cheap has already beaten cool like I predicted it would. Since GM has established battery cost reduction as a primary goal for future generations of PHEVs, I would not be at all surprised to see GM and other auto makers paying particular attention to advanced lead-acid and lead-carbon chemistries over the next few years because the widely heralded energy density and size advantages of Li-ion chemistry evaporate when the technology is reduced to safe commercial practice. For investors, I think the lesson of the Chevy Volt is that premium priced energy storage stocks like Ener1 (HEV) and Valence Technology (VLNC) are likely to see lower market valuations while bargain basement energy storage stocks like Axion Power International (AXPW.OB) Exide Technologies (XIDE), Enersys (ENS) and C&D Technologies (CHP) are likely to see higher market valuations.

Disclosure: Author holds a large long position in Axion Power International (AXPW.OB) and small long positions in Active Power (ACPW), Exide (XIDE), Enersys (ENS) and ZBB Energy (ZBB).

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981. From January 2004 through January 2008, he was securities counsel for and a director of Axion Power International, Inc. a small public company involved in advanced lead-acid battery research and development.

March 20, 2009

Li-ion Battery Manufacturers – The Bleeding Edge of Energy Storage Technology

As a lawyer, I’ve had the privilege of working with some of the finest scientific minds in the world. They all started with brilliant concepts and impressive laboratory results, but a substantial majority failed to create a viable business. After countless clients that started well and ended up mired in a swamp, I’ve come to understand that technology is a two-edged sword. On the leading edge, developers of low cost technologies can build fortunes. On the bleeding edge, developers that can’t control their costs and manufacture competitive products often morph into the financial equivalent of a black hole. Sadly, I believe most current developers of advanced Li-ion batteries are on the bleeding edge of energy storage technology and are doomed to spend years if not decades hemorrhaging cash.

I frequently feel like Cassandra, the Greek princess who was given the gift of prophecy and then cursed so that no one would believe her. When I read reports about how an MIT researcher has developed a new material that will allow Li-ion batteries to recharge in seconds or how Japan’s national alternative energy development agency has targeted a 50% reduction in Li-ion battery costs over the next year, I don’t get excited over the mirage of progress. Instead, I start asking buzz kill questions like “How much will these new materials add to the cost of a battery?” and “How can anybody reasonably target a 50% price reduction over the next year when the average has been 5% for the last 20 years?” The answers, of course, are “plenty” and “they can’t.” The stories are cheerleading and hype, not rigorous analysis; and we all know what happens when optimistic forecasts collide with immutable economic laws.

The fact is that everyone, including me, wants an easy, quick and painless solution to our growing energy dilemma. However wishes, hopes, dreams and desires can’t change the fact that until somebody overcomes the cost, performance, abuse tolerance and cycle-life issues that the DOE has analyzed in depth and I’ve discussed in earlier blogs, there will be no Li-ion solution for the average consumer’s energy storage needs. Progress is being made, but it’s an uphill battle where the goal is measured in miles and the progress is measured in feet.

Every time I mention the elephant in the living room, I’m inundated with comments suggesting that the data I’ve cited is old or unreliable. The contrary authority invariably says something like “Lyons said that most estimates put the near-future cost for battery manufacturing at $250-300 per kWh once economies of scale are ramped up” or points me to a Chinese website. The only response I can offer is balderdash! With annual revenues of several billion dollars, the Li-ion battery sector already has plenty of scale. What it lacks are meaningful potential economies.

Economies of scale are modest savings that can reduce per unit cost as a profitable business grows. They arise from factors like discounts on raw materials purchases, greater worker specialization, lower financing costs and reduced spending on ancillary items like research and development. For a more detailed discussion of the topic, see “What Are Economies of Scale? An estimated 75% of the cost of a battery goes for raw materials. So unless you insist on believing in a commodity fairy that will slash raw materials costs despite rapidly escalating global demand, you can’t honestly believe that vaguely defined economies of scale will make insanely expensive products affordable. Even the happy talk articles like the most recent one from Japan merely serve to prove the point:

“NEDO also analyzed battery cost (not a cell but a battery pack) as of March 2009. It estimates that the cost is about ¥200,000/kWh (approx US$2,016/kWh) for both types of batteries.”

In January I published a comparative breakeven analysis for an EV-40 and an EV 100 using the $1,333 per kWh value for Li-ion batteries that I took from a July 2008 Sandia Laboratories report on its Solar Energy Grid Integration Systems – Energy Storage Program. That analysis showed that an EV-40 could not break even at gas prices of less than $3.70 and an EV-100 could not break even at gas prices of less than $9.20. Even if I use the latest happy-talk target out of Japan and give effect to the vainly anticipated battery price collapse, the breakeven points work out to $3.02 for an EV-40 and $7.54 for an EV-100. At those prices, there are only two classes of buyers, the emotionally committed and the mathematically challenged. This is not encouraging news in a recession.

When evaluating any company, the first thing I want to know is whether it can sell a product and earn a reasonable gross margin on the sale because without gross income net income is impossible. In general, high gross margins are wonderful things and low gross margins are very bad things.

The universe of publicly traded Li-ion battery manufacturers is small so there are not a large number of reliable data points. Nevertheless, I was able to do some digging through SEC filings and cobble together the following table that compares historical product sales, gross profit and gross margin data for five active Li-ion battery manufacturers (Click on the table for a PDF version).


From both a revenue growth and gross margin perspective, Advanced Battery (ABAT) has been an impressive performer and seems to be on the leading edge of Li-ion technologies. At the other end of the spectrum, Valence Technology (VLNC) and A123 Systems seem to be stuck on the bleeding edge. While Ener1 (HEV) and China BAK Battery (CBAK) have modest gross margins, their performance falls far short of leading edge; in fact, they’d be poor performers among the conventional battery manufacturers that I’ve identified in the following table.


Over the course of my career I’ve had substantial experience with both leading edge and bleeding edge companies. As a lawyer, I try to discourage potential clients from starting down a road that has a low chance of commercial success because life is short and dealing with disappointed investors is never pleasant. Once a project begins I carefully watch for signs that a client is tending away from the leading edge and toward the bleeding edge because an early failure is invariably easier to cope with than a client that lives on the bleeding edge for years. Factors I view as warning flags that a company is approaching the bleeding edge include:

Countertrend revenues

When companies like Ener1’s Korean subsidiary report revenue declines while their peers are reporting substantial revenue increases, I see yellow and orange flags.

Gross margins

High gross margins are usually a reliable indicator of a superior product and small gross margins can be tolerable in high volume industries, but negative margins are a red flag.

Debt financing

In the absence of a long and well-established earnings history, substantial debt is toxic and leading edge companies don’t have substantial liabilities to anyone.

Related party debt

A heavy reliance on insider financing is normal during the formative years, but when the insiders of public companies like Valence and Ener1 purchase secured debt instead of straight equity the risk to common stockholders skyrockets.

Idle factories

In the absence of a cogent explanation, idle factories are a red flag that the owner cannot manufacture and sell a commercially viable product. There are always opportunities for viable products and a manufacturer like Ener1 that can’t harvest the low hanging fruit will rarely succeed with more sophisticated customers.

Operating expenses

Leading edge companies like Advanced Battery aggressively control operating expenses at all levels, which permits them to take over 70% of their gross margin to the bottom line. Profligate spenders like Ener1, Valence and A123 are far closer to the bleeding edge.

Nosebleed valuations

When a market leader like Advanced Battery trades at 6.8 times earnings and has a market capitalization of $110 million, no reasonable investor can justify market capitalizations of $193 million or $483 million, respectively, for companies like Valence and Ener1 that have never even come close to reporting a profit.

PR perspective

Leading edge companies talk about events while bleeding edge companies publicize goals. What will happen if the DOE reviews A123’s $1.8 billion loan request or Ener1’s $480 million loan request and decides the requests don’t meet regulatory requirements?

Veiled hubris

New entrants in a technological field are almost never better at manufacturing and marketing than their entrenched competitors who offer comparable products. Li-titanate batteries from Ener1 may compete with Toshiba’s SCiB line, but they are unlikely to be demonstrably better or cheaper. Likewise Li-phosphate batteries from Valence and A123 may compete with products from BYD, but assuming competitive superiority without demonstrable proof is the pinnacle of veiled hubris.

On August 15, 2008, when the Dow (^DJI) was at 11,660 and the Ardour Global Index (^AGIGL) was at 3,370; I offered a short-list of pure play energy storage companies that were likely to benefit from an unprecedented surge in demand for manufactured energy storage devices that will be driven by cleantech, the sixth industrial revolution.

The intervening eight months have been a tough time as the Dow has collapsed to 7,401, a shocking 36.5% decline; and the Ardour Index has plummeted to 1,285, a breathtaking 62% plunge. As a group, my short list of pure play energy storage companies has tracked the Ardour Index and fallen an average of 60%. The following chart compares closing prices of those companies on August 15, 2008 with their closing prices on March 19, 2009.


Combined, the short list companies have a current market capitalization of $2.1 billion. As I previously reported, Federal grants for advanced battery manufacturing will inject $2 billion in new capital into the battery industry over the next two years and grants for electricity delivery and reliability projects are likely to bump that total by another $1 to $1.5 billion. Moreover, effectively unlimited debt financing will be available through an alphabet soup of DOE guaranteed loan programs. In combination, the likely impact on the energy storage sector is mind-boggling.

If one assumes that the DOE does not understand the difference between the leading edge and the bleeding edge and it decides to treat all applicants equally, there is a remote chance that the bleeding edge battery manufacturing companies will have sufficient resources to justify their current market capitalizations when the dust settles, but those market capitalizations are not likely to increase significantly from current nosebleed levels. Instead, the market performance is likely to come from companies that focus on their accomplishments rather than their goals.

At heart I’m an incurable optimist and I firmly believe that “In America we get up in the morning, we go to work and we solve our problems.” (From The Lost Constitution by William Martin). But our problems are not going to be solved by airbrushed centerfolds that thrive on the bleeding edge and promise simple and economically implausible solutions to incredibly complex problems.

Disclosure: Author holds a large long position in Axion Power International (AXPW.OB) and small long positions in Active Power (ACPW), Exide (XIDE), Enersys (ENS) and ZBB Energy (ZBB).

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981. From January 2004 through January 2008, he was securities counsel for and a director of Axion Power International, Inc. a small public company involved in advanced lead-acid battery research and development.

March 19, 2009

Investing In Wood Pellets, Part I

Last week, I mentioned that I had attended a conference focused on opportunities in the biomass and bioenergy sectors. One of the article ideas I got from this conference was on the emerging market for wood pellets (tightly packed sawdust and other wood shavings) for heat and electricity. How interesting that, over the weekend, the magazine Science published an article suggesting that the US should ramp up its use of wood for small-scale heat and electricity production (the article is not available free of charge but you can find a summary here).



The Wood (Pellet) Advantage

It must be stated from the get-go that wood harvested at sustainable levels will never account for a significant percentage (i.e. >20%) of total energy consumption. The Science article states that total US energy consumption currently stands at around 100 quads annually, and that wood-based energy makes up about 2% of this. At sustainable harvest levels, the authors estimate that wood could represent about 5 quads, or roughly the amount of energy contained in the Strategic Petroleum Reserve. That number is for all wood-based energy and not only pellets, so the potential market for the latter is even smaller.

That said, wood pellets are rapidly gaining acceptance as a readily-available, carbon-neutral fuel source that can be used on its own or co-fired in coal plants. The global trade in wood pellets is not especially extensive just yet, so pricing data can be a little difficult to obtain. Various sources I looked at seem to put the price range at between $150-200/ton. The International Energy Agency conducted a detailed study of the global marketplace for wood pellets in 2007, and reported that pellets cost in the neighbourhood of $11.50/million BTU. It is therefore no surprise that with residential fuel oil and, increasingly, nat gas prices pushing above that level in 2007 and 2008, wood pellets bbecame a popular option in the colder US Northeast and Northwest.

Environmentally, wood pellets are considered greenhouse-gas neutral as wood is existing biomass (i.e. not ancient biomass trapped beneath miles of Earth's crust) and it is assumed that forest re-growth will, in time, sequester the carbon dioxide emitted through photosynthesis.

With regards to conventional air pollutants, SOx emissions are reduced almost on a 1-to-1 basis when pellets are co-fired with coal (i.e. a 20% pellet/80% coal mix will reduce SOx emissions by 20%). The relationship between wood and NOx is apparently not as straight forward and I didn't find a good source on this.  

The Science article claims that advanced wood combustion technologies can reach thermal efficiencies of around 90%, which compares very favorably with other fossil-fired technologies.

The Wood Pellet Trade

At the end of 2006, pellet demand in the US stood at around 1.4 million tons, a >200% jump on 2002. Pellets in the US are used mostly in residential and small-scale applications and very little if at all in large-scale power generation. Although pellet popularity is growing, the US market remains comparatively small.  

The real story volume-wise has been occurring in Europe, where renewable power generation and greenhouse-has emissions regulations have triggered a boom in wood pellet use. Current EU commitments call for 20% of final energy consumption to come from renewables by 2020 and the meeting of the Kyoto Protocol's targets. It is estimated that the EU currently supplies about 4% of its total electricity from wood waste (vs. 2% in the US) and this number is expected to double by 2010. Current consumption is now greater than 6 million tons annually.

In 2006, EU nations consumed around 5.5 million tons of pellets, but produced only 4.5 millions, an 18% 'deficit'. Canada is currently the largest pellet exporter to the EU but there is also significant export potential in the US, as evidenced by the fact that pellet manufacturing capacity has been expanding rapidly.

In the US, the low price of coal and its prominence in power generation (coal accounted for roughly 48% of electricity generated in the US in 2008) present the biggest challenges to the growth of the wood pellets market. However, upcoming greenhouse gas regulations could change this. Because wood pellets are considered greenhouse gas neutral, co-firing them with coal reduces CO2 emissions on a 1-to-1 basis.

This has been one of the major drivers in Europe, and can represent a comparatively cheap way of transitioning toward cleaner power generation technologies. Given the relative abundance of biomass across North America (don't forget Canada, the biomass superstore to the North), federal greenhouse gas caps could jump start the wood pellets market here.

Wood Pellets Stocks

This is admittedly a sector I knew very little about, so ramping up my industry knowledge alone took a bit of time. When I started my search for stocks on this, nothing evident jumped at me. I therefore thought I would break this article into two, with the next part dedicated only to company analyses. I will publish it next week. In the meantime, if you know of stocks related to this, please let me know.

March 18, 2009

If a Clean Energy Mutual Fund Falls in the Forest...

When I was researching my Comparison of Clean Energy Mutual Funds and Clean Energy Tracking Portfolio articles, I came across something strange: the American Trust Energy Alternatives Fund (ATEAX) did not seem to have a listing on American Trust's website.  However, finance sites were still publishing price and holdings data, and there was no recent news, so I didn't think much of it, since other funds seemed superior based on both costs and fund holdings.

Last week, I noticed that the fund's price had not changed since the end of February, so I did a little digging.  Here is what I found:

  • The fund's website, from this August 2008 article, is down.
  • The fund manager, Carey Callaghan, has not done any interviews in that capacity since 2008, although he seemed to be doing one or two a month before then.
  • A cached page on Google from Fidelity (which distributed the fund) stated that it was "closed to all investors."  The original page no longer exists.

It's not particularly surprising that the fund closed.  It was launched in July 2008, shortly before the financial crisis began.  A mutual fund needs to acquire significant assets in order to pay for its costs out of management fees, and even distribution by Fidelity was not enough to help a new fund acquire assets in the last half of 2008.

Since the fund only had a few million dollars under management, it's not particularly surprising that its disappearance made no ripple.

Updates

The exponential growth in the number of available clean energy funds I talked about in the intro to my Costs of Green Funds article has broken down:

funds over time 2.bmp

Also, since ATEAX is defunct, I will be comparing my Clean Energy Tracking Portfolio to only the remaining five funds.  As of the close on March 13th, the five stock portfolio is up 5.6% (including commissions), compared to the remaining 5 funds, which have fallen 0.9% (after front-end load), with a range of -1.2% to +1.7%.  Although it is still early days, my tracking portfolio is clearly tracking the funds very poorly.  When it comes to tracking portfolios, a significant out performance is just as bad as a significant underperformance, because it brings into question the procedure used to form the tracking portfolio.  

If I were to revise my procedure to come up with a better tracking portfolio I would:

  1. Look at the top 10 holdings of the remaining funds, not just the top 5.
  2. Try to match the allocation to various clean energy sectors that the funds were using.  

Efficiency and Smart Grid Outperform

Because I decided to use one equally-weighted stock in each sector, I was relatively underexposed to solar and wind compared to the funds, and over-exposed to Efficiency and Electric Grid stocks.  The difference in sector allocation probably accounts for much of my tracking portfolio's out performance over the last couple weeks.  As I discussed in my article about the American Recovery and Reinvestment Act, as well as in my repeated emphasis on the sectors over the last two years, these sectors have always been likely to outperform.   

If I expected Energy Efficiency and Grid stocks to outperform, why do the clean energy funds have such a heavy emphasis on Solar and Wind Stocks?  It's probably not because I'm smarter than they are.  More likely, it's because, if you don't want your mutual fund to fold like the unfortunate American Trust, you need to sell your fund to investors.  And investors get excited about wind and solar... they get much less excited about energy efficiency. 

When I last asked readers what stocks I should research, I got one request for a combination electric grid and wind stock (which I had covered previously,) no requests for efficiency stocks, four requests for Solar, and two requests for pure wind stocks.  With demand like that, I could probably increase my readership if I spent more time talking about solar, and the mutual funds are simply doing what's in their best interest: they buy solar and wind so that their investors will buy the funds.

Mutual funds are giving investors what they want.  If that means buying trendy sectors, then trendy sectors are what the funds buy.

Tom Konrad, Ph.D.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

March 16, 2009

The Ontario Feed-in Tariff For Alternative Energy

Last month, I wrote about how Ontario, North America's 6th largest jurisdiction by population, had tabled a Green Energy Act to boost the alternative energy industry's growth in the province. In that post, I mentioned that officials would soon release the rules for a feed-in tariff (FIT) system. FITs, which pay fixed rates for renewable power, are all but absent in North America, although they are popular incentive in Europe. Germany's FIT is largely responsible for that country's dominance in solar PV today despite mediocre sun conditions. 

Ontario released the draft rules and proposed prices for its FIT a few hours ago. Proposed prices are as follows:

Fuel Type Size Tranches C$/kWh US$/kWh (x0.79)
Biomass* Any size 12.2 9.6
Biogas* ≤ 5 MW 14.7 11.6
> 5 MW 10.4 8.2
Waterpower* ≤ 50 MW 12.9 10.2
≤ 2 MW (community-based or aboriginal) 13.4 10.6
Landfill gas* ≤ 5 MW 11.1 8.8
> 5 MW 10.3 8.1
Solar PV ≤ 10 kW (rooftop) 80.2 63.4
10 - 100 kW (rooftop) 71.3 56.3
100 - 150 kW (rooftop) 63.5 50.2
> 500 kW (rooftop) 53.9 42.6
≤ 10 MW (ground mounted) 44.3 35.0
Wind Any size onshore 13.5 10.7
Any size offshore 19.0 15.0
Community-based or aboriginal (≤ 10 MW) 14.4 11.4
* 35% premium during weekday on-peak hours (11am to 7pm) and 10% discount during off-speak hours

The suggested pricing levels are relatively high and, as discussed in my original article on this topic, should benefit the clean energy independent power producers active in the province. Of special interest is the fact that Ontario is proposing to implement a tariff for offshore wind, and could thus be the first Great Lakes jurisdiction to see significant offshore installations go up (that is, if they get the tariff right!). The solar PV tariffs are based on the tiered German approach and should trigger significant installations if credit doesn't prove to be a problem for households and businesses.      

To be continued...

March 15, 2009

What the ARRA Means for Clean Energy: One State's Example

Last week, several branches of the Colorado state government organized a symposium on "How Colorado Electric/Gas Utilities and Their Customers Can Benefit from the American Recovery and Reinvestment Act (ARRA)."  I attended, with an ear to how the likely implementation would affect Clean Energy Stocks.

Overall, Colorado seems to be taking a very organized approach to a monumental task.  According to Colorado Public Utilities Commission (PUC) Chairman Ron Binz, who officiated at the conference, they intend to organize proposals into an overall thematic plan for spending stimulus money.  In addition, they are working to eliminate barriers to regulated utilities participating.  In particular, the PUC "will allow expedited review of applications filed to request financial incentives including ratemaking treatment."

The symposium was four hours long with no breaks.  For readers seeking some specific information, here is a link to my notes.  What follows are my thoughts on what it may mean for different clean energy sectors.

Solar Stocks and Wind Stocks 

Solar seems unlikely to be a big winner from the ARRA.  This makes sense because the point of the bill was to stimulate jobs.  Solar, especially Solar Photovoltaic (PV) panels, are very capital intensive investments, meaning that few jobs would be created per dollar spent.  Solar PV has long been the poster-boy for green energy, yet its high-tech capital-intensive nature means PV installations create fewer jobs per dollar invested than most other clean energy technologies, and many fewer than the most effective, energy efficiency.

Sitting next to me was a representative of a major solar project developer whom I've known for a couple years.  After the panel on electric generation, he commented to me "that was a total waste of time."

The prospects for wind seem slightly more hopeful, according to Brian Greenman, principal at Greenman Financial Advisors.  Brian is another member of the Denver the renewable energy community whom I've known for several years.  His firm has established a niche been providing a wide variety of financial services to wind project developers across the Great Plains.  He says that there is a real chance that the Department of Energy loan guarantee program may begin guaranteeing loans; something which has not occurred for clean energy deals since it was established in the 2005 EPAct.  The major hold-up has been uncertainty about the potentially enormous size of the subsidy cost.  Now, new money has been appropriated, and once new rules are established, this subsidy cost is likely to either be regularized, or eliminated entirely.  The main roadblock stopping wind projects right now is the inability to obtain financing, a problem which should resolve more quickly with a functional federal loan guarantee program allowing wind projects to borrow up to 80% of the capital needed at rates of less than 0.5% above US treasury bills.  Large solar projects may also be able to qualify for such guarantees, but this is a bigger deal for wind because of the much larger program size.

The bad news is that these loan guarantees are unlikely to be available until the last quarter of the year, even with expedited rule-making. 

Smart Grid 

Of the utilities with existing Smart Grid efforts, all seemed interested in accelerating roll-out.  Black Hills Corporation (BKH) has an AMI-roll out using meters from Elster, currently going on in Pueblo, which they hope to use ARRA money to accelerate, and to expand to more rural areas where it might not otherwise be economic for them.  The Poudre Valley Rural Electric Association has a program focused on commercial customers using a Landis + Gyr solution. Xcel Energy (XEL) has an extensive Smart Grid pilot program in Boulder Colorado, with seven partners.  The City of Fort Collins has an ongoing Fort ZED project with a wide variety of partners.

These expansions should be good news for the equipment providers, but a look at the partners brings up one of the perennial headaches of investors interested in the smart grid: nearly all the companies listed above or in the partnerships are privately held.  While there are publicly traded smart grid companies, the wide variety of solutions and companies offering them make it difficult for a public investor be confident that the companies he owns will be the ones which do well long term.  The best solution I have come up with is to own a little bit of all the smart grid companies I find, with a focus on the lower-tech solutions such as Demand Response, and established metering companies which I consider likely to acquire smaller private players.  Charles provided a list of four smart grid stocks in December, while I took a look at three more (Itron (ITRI), Echelon (ELON), and EnerNOC(ENOC)) in November.  To these, I'd add General Electric(GE) and Telvent (TLVT). I don't know of any projects by these companies in Colorado, but if the trends here are any guide, companies which already have existing projects with utilities can reasonably expect those projects to accelerate.

One other trend of note was that the utilities were generally much more interested in the potential of the smart grid to make their distribution systems more efficient.  For example Xcel's representative said that their goals, in order of priority, were improved utility efficiencies, improved asset operations, asset life extension, recapacitating existing infrastructure, and (lastly) new assets and services.  All of these except the last are upstream improvements which are unlikely to be seen by the customer.  While smart grid applications which allow residential users to understand our own power consumption may be more exciting to us, these are unlikely to be the first applications which the utilities choose to roll out in a big way.

Energy Efficiency

Energy Efficiency stocks are likely to be big winners, simply because of the amount of money in the stimulus directed towards building retrofits, both for low income and federal buildings.  If anything, however, energy efficiency can be more difficult to invest in than Smart Grid, because good efficiency measures tend to have more to do with system integration than with products.  That said, there are a few products which seem likely to get a boost.  First and foremost is insulation, which will be used extensively in weatherizing homes and businesses.  Owens Corning (OC) gives the best exposure to this sector, since major competitors Johns-Manville is owned by Berkshire Hathaway (BRKA), and CertainTeed is owned by Paris-traded Saint-Gobain, a more broadly diversified building products group.

Other energy efficiency products which are likely to see a boost from ARRA funds are ground source heat pumps, which will be likely to feature in multifamily residential and commercial building retrofits.  I profiled heat pump companies Waterfurnace Renewable Energy (WFIFF.PK) and  LSB Industries (LXU) in December, in anticipation of the stimulus package.  LED lighting company Cree, Inc is also well placed to take advantage of energy efficient building retrofits.  Other companies which may benefit are small innovators which have efficiency improvements targeted towards specific applications.  One such is AltEnergyStocks.com sponsor Power Efficiency Corp (PEFF.OB), which sells controllers which improve motor efficiency in variable-load applications such as escalators and rock crushers.  

Geothermal Stocks

Despite Geothermal Power's small contribution to overall electricity generation, both Xcel Energy and Tri-State Generation and Transmission mentioned geothermal power as something they were looking to pursue with ARRA funds.  If these plans come to fruition, likely beneficiaries are the industry leader Ormat (ORA), a vertically integrated geothermal company, which I consider attractively priced around $25, and Raser Technologies (RZ).  Raser could be particularly well positioned to benefit from the stimulus because they focus on building and commissioning geothermal plants much faster than industry incumbents such as Ormat by using off-the shelf turbines from United Technologies Corp. (UTX), allowing them to get projects up and running much faster than their competitors.  This should be a particular advantage when competing for stimulus dollars because of the emphasis on speed in the ARRA, which requires projects to be completed by 2012.

Electric Transmission

The Western Area Power Administration (WAPA), a federal agency, was given both new funding and authority to plan and build new electric transmission in its territory to deliver power from renewable sources.  They have already begun the planning process, and their representative was enthusiastic about the process.  These projects will likely be in partnership with private companies, and so several of the transmission companies we listed in anticipation of the stimulus package are likely to benefit.

Batteries and Energy Storage

Although batteries were not mentioned directly in this utility-oriented symposium, two speakers mentioned that they would be interested in using plug-in hybrid electric vehicles as part of a smart grid pilot project.  Both Xcel and Tri-State mentioned that they had specific Compressed Air Energy Storage (CAES) projects they would look to fund through the stimulus package.  CAES is the second most cost effective way to store electricity on a large scale (the first being Thermal Energy Storage in conjunction with Concentrating Solar Power), but I do not know of any public companies focused on this technology.

Finally, the symposium did not focus on transportation infrastructure, and so I have not mentioned rail and transit companies which may also benefit.  See our Clean Transportation archives for some of our ideas in these sectors.

Tom Konrad, Ph.D.

DISCLOSURE: Tom Konrad is long ITRI, ELON, ENOC, GE, TLVT, WFIFF, LXU, ORA, RZ and PEFF.  PEFF is also an advertiser on AltEnergyStocks.com.

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

 

March 13, 2009

Lead-Carbon Batteries: A Game Changer for Alternative Energy Storage – Part II

I woke up this morning with a dreadful case of writer’s block and feared that I might have to take a week or two off while awaiting the end of the current SEC reporting cycle. Mercifully, one of my readers sent an e-mail message that asked some pointed questions about lead-carbon battery technologies and the relative strengths and weaknesses of the principal lead-carbon battery developers. So instead of dashing off a quick reply, I thought it might be interesting to share both the message and a detailed response. Besides, it seems like a great way to kill two birds with one stone.

Mr. Petersen,

You've convinced me the storage future for key applications is lead-carbon (see for example AEP's project for distributed storage on it's network, a topology I expect will be common, perfect for Axion). I've greatly enjoyed your common sense, economics trumps whiz-bang technology, perspective. I've spent the last half of my career in IT and have seen it time after time. [Hyperlink added by Author]

Would you now please comment on whether Axion still has a competitive future given the Furakawa-East Penn license and production of the CSIRO lead-carbon battery. As best I can tell at a marketing or performance level the CSIRO battery is an Axion look alike. Also, looks like they will get first mover advantage, maybe for years since I can't see how Axion can move quickly or scale production, given it's limited resources. I'm concerned Axion's time may have passed. I’ve also seen lots of small companies with better mousetraps fail for lack of resources and marketing.

Also, are there patent conflicts between what Axion has and the CSIRO patents (spent the first half of my career as a lawyer)? What's current status of the Mega C litigation? Any chance some of Axion's former Canadian penny stock past can come back and bite it, or is Mega successor's upside limited to its 7m shares? What exactly do Axion's patents protect? If not from East Penn's perform/look alike product, are they worthless? My brief search only disclosed a TM registration.

The final issue of concern for me is that both companies are in Pennsylvania, which gives Rendel and other pols a problem in helping Axion with a request for Obama money. Prior to East Penn's news it looked to me Axion was pretty well wired with local politicians. Given all that, to me their future looks bleak. I'm guessing it's either Obama, massive dilution, or giving away it's future to a larger "partner".

In short can you stop replaying the technology story - I got it - and take the kind of informed business look at Axion's prospects you are in position to publish. It would be deeply appreciated. I am unable to perform any reasonable due diligence on my own with this small company. I appreciate your legal and former relationships with Axion make this an area where you need to be careful, but anything you could put in print to your fans would be most appreciated. I'd really like to bet on them - but I'm only so crazy.

Mr. Smith

Ultrabattery Status Australia’s Commonwealth Scientific and Industrial Research Organization (CSIRO) has developed a lead-carbon energy storage device that it refers to as the “Ultrabattery” and licensed the technology to Japan’s Furukawa Battery Co. (Frankfurt - FBB.F). Furukawa, in turn, has sublicensed the NAFTA rights to East Penn Manufacturing.

CSIRO and Furukawa road tested prototypes of the Ultrabattery in a modified Honda Insight HEV in late 2007. They subsequently sent Ultrabattery prototypes to Sandia National Laboratories for inclusion in a series of partial state of charge cycle-life performance tests that Sandia conducted in 2008. While the tests were hugely successful, Furukawa currently classifies the Ultrabattery as an R&D stage technology and the Green Car Congress reports that the product is not scheduled for commercial introduction until late 2010. Since the Ultrabattery is more complex than a normal lead-acid battery, it seems reasonable to assume that it will probably take another year or so to get an Ultrabattery production line up and running in the U.S., which implies a domestic release date of late 2011.

PbC Status When Axion Power International (AXPW.OB) began making and testing prototype PbC devices in late 2003, a top priority goal was to develop a lead-carbon battery technology that could be easily implemented in existing lead-acid battery plants with minimal changes to manufacturing equipment and processes. The New Castle asset purchase in early 2006 was a critical step in Axion’s development plan because it gave the research staff the power to change a design parameter in the laboratory and then immediately integrate that design change into a manufactured prototype using existing manufacturing facilities.

During its first two years in New Castle, Axion’s development effort focused on optimizing electrode performance using labor-intensive manual fabrication techniques. When it finally developed an electrode design that met the performance goals and worked well in the existing manufacturing plant, Axion began negotiating utility scale tests and manufacturing hundreds of pre-commercial PbC prototypes for use in those tests. Pictures of Axion’s Power Cube, which was built for a NYSERDA-funded utility substation upgrade deferral demonstration project, are available on Axion’s website.

Over the last year, Axion’s focus has shifted to developing automated fabrication methods for electrode assemblies. Custom equipment for the carbon sheeting and electrode fabrication processes has been on order since last year. When that equipment is installed, Axion expects to be able to fabricate electrode assemblies for about 1,000 PbC devices per day, or 250,000 units per year. Since I’m no longer privy to inside information, I don’t know what the current status of the equipment orders is, but I hope we’ll hear something in the next earnings call.

First Mover Advantage While I can’t assess the status of Furukawa’s ongoing development work, I have to give the first mover advantage to Axion. Its automated electrode fabrication equipment should be operational this year, which will give Axion a one to two year head start over the Ultrabattery. If the PbC devices are well received, the electrode line can be rapidly expanded to fully utilize Axion’s existing battery manufacturing capacity and permit the sale of electrode assemblies to other manufacturers. The current round of equipment orders is already financed. Additions will not be necessary unless the PbC devices are successful. If Axion is selling 250,000 PbC devices per year at a reasonable price and profit margin, expansion financing and dilution should not be significant problems.

Over the long-term, Axion plans to implement a platform technology business model like Intel’s where it will focus on making electrode assemblies for sale to battery manufacturers that want to offer PbC devices. The advantages of a successful platform technology business model are clear. Specialized facilities for the fabrication of electrode assemblies will be far cheaper to build than new battery manufacturing plants. It’s also easier to increase production if you can leverage a broad pre-existing base of manufacturing, marketing, distribution and customer support infrastructure.

Patent Status The Ultrabattery and Axion's PbC device are similar, but there are important technical differences. The Ultrabattery page on Furukawa’s website includes three schematic drawings; a conventional lead-acid battery is shown on the upper-left, an asymmetric capacitor like Axion’s PbC is shown on the upper-right and the Ultrabattery is centered beneath the two. I used the U.S. Patent Office’s online search utility and could not find a CSIRO patent for the Ultrabattery. I then did a broader Google search and found a recent entry on The Patent Search Blog that said a European patent application for the Ultrabattery was published in September 2008 (priority date March 20, 2007). So it appears that CSIRO does not have any issued patents for the Ultrabattery. In comparison, Axion owns six issued U.S. patents for the PbC device (Nos. 6,466,429, 6,628,504, 6,706,079, 7,006,346, 7,110,242 and 7,119,047) and has seven additional patent applications pending. While I am not a patent lawyer, Axion’s patent position seems to be the stronger of the two.

Prior Litigation To begin with, I want to be perfectly clear that Axion does not have a “Canadian penny stock past.” It has fought to the death with a group of Canadian stock promoters who tried to claim an ownership interest in its PbC technology, but Axion has never been implicated in a questionable penny stock promotion.

I hate Mega-C questions because it was a long and emotionally draining battle. Comparing the Mega-C bankruptcy case and the associated adversary proceedings to a can of worms would be a grave insult to worms everywhere. The final outcome of four years of litigation was that 5.7 million Axion shares are held in court-supervised trusts that will sell enough shares to pay the costs of Mega-C’s bankruptcy and the claims of its creditors, and then distribute the remaining shares to holders of allowed equity claims. As a result of several adversary proceedings that were brought and resolved in connection with Mega-C’s bankruptcy, the individuals that I would have considered a threat to Axion have been effectively neutralized. While I’m reluctant to use the word never, I think the risk of future substantive claims is very remote.

Potential Stimulus Axion, East Penn, C&D Technologies (CHP) and Enersys (ENS) are all based in Pennsylvania. Frankly, I wouldn’t be surprised to see all four companies apply for a portion of the $2 billion in advanced battery manufacturing grants and the $4.5 billion in smart grid deployment grants included in the Obama stimulus plan. It’s important to remember, however, that manufacturing lead-acid batteries is far less expensive than making other types of batteries and while Li-ion producers may request billion dollar grants, requests from lead-acid manufacturers are likely to be far more modest despite the cost advantages of lead-acid products.

Given the importance of battery manufacturing to Pennsylvania’s economy, I would expect the political powers to offer whole-hearted support to all eligible in-State manufacturers. Moreover, as the political battle lines are drawn in D.C., I think Senator Specter’s decision to cross the aisle and vote in favor of the stimulus bill may prove helpful.

Due Diligence Resources When I want to perform a due diligence investigation on a public company, the first place I visit is the SEC’s EDGAR Company Search page. All you need to do is type a company name in the text box and the site will bring up a complete list of the company’s SEC reports that you can select and review on-line. If you want to know about Axion, a good starting point will be the prospectus for a resale registration statement that Axion filed last August and the prospectus supplement that it filed in November.

Disclosure: Author holds a large long position in Axion Power International (AXPW.OB) and small long positions in Active Power (ACPW), Exide (XIDE), Enersys (ENS) and ZBB Energy (ZBB).

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981. From January 2004 through January 2008, he was securities counsel for and a director of Axion Power International, Inc. a small public company involved in advanced lead-acid battery research and development.

March 12, 2009

Alt Energy Investment Opportunities In The Ag Sector: Intro

I just got back from Growing the Margins, a conference and trade show focused on the bio-mass/gas/energy/products sectors with a focus on the farm and food industries. These are not sectors I have traditionally paid a great deal of attention to, despite the fact that there are very interesting things happening in both.

The most notable contribution to alt energy from farm industry over the past five years has been corn ethanol, an enterprise I have long believed to be economically and environmentally unsustainable. To be sure, ethanol, but especially second-generation ethanol, got a fair bit of attention, as current US targets are expected to trigger significant demand over the next couple of decades. But there was also a lot of talk about a number of other lesser-known topics that gave me article ideas. Here are the three main ones:

  • Farm-based and other small- and mid-scale biogas projects related to green power incentive programs and the ever widening search for carbon offsets. Although there are no direct ways for investors to play this, there may be some interesting lateral opportunities in firms providing equipment ranging from geomembranes for emissions capture to small-scale turbines.
  • The emerging wood pellets for power generation industry, something Tom touched on somewhat a while back.
  • The carbon offsets industry. Although I won't limit my discussion to farm- or biomass-based offset projects, I got the idea from a workshop there.   

I'm happy to entertain other ideas so feel free to send suggestions. The first of this series will be published on Monday, and I will add links to the list as articles are published.         

March 11, 2009

Casey Energy Opportunities: Review

I was a subscriber to Doug Casey's International Speculator from 2004 to 2006, and I consider his research into the junior mining sector the best I've come across, although his libertarian political views are usually at odds with my own.  

Last month, Casey Research invited AltEnergyStocks.com to join their affiliate program, meaning that we would earn referral fees if our readers subscribed to their newsletters using the links on our site.  Like most people, I like getting paid, but my integrity is also important to me, so I wasn't comfortable writing an article simply hyping their products.  Instead, I hit on the idea of writing a review, much like I reviewed the International Speculator in 2007 (for no compensation at the time.)

With a focus on energy stocks, Casey Energy Opportunities seemed most likely to interest our readers.

Casey Energy Opportunities (CEO)

The CEO format was familiar from my days as a Speculator subscriber. It begins with an in-depth look at a sector, such as Energy Income Trusts in the February issue.  Charles took a look at Clean Energy Income Trusts, while I highlighted the Algonquin Power Income Fund (AGQNF.PK) in January.  While we bring you short articles focusing only on clean energy, CEO goes into much more depth, comparing the available funds based on a number of important factors related to the companies financial strength and upside potential.  Using these factors, they ferret out two stocks to recommend, one low and one high risk, and then take a detailed look at each, using Doug's signature Eight P's framework for evaluating resource stocks.

Of particular interest to AltEnergyStocks readers will be their recent looks at hydropower stocks (they found two run-of-river hydropower companies I didn't know about,) as well as a look at Geothermal stocks.  Investors concerned about Peak Oil will find even more opportunities, all demonstrating the depth of research necessary when looking at risky resource companies.  

These in-depth looks are accompanied by excellent background articles explaining how the technology and companies operate in a sector.  The geothermal issue, for instance, not only looked at geothermal power production, but also the emerging technology of enhanced geothermal systems (EGS), (a technology I consider comparable to and much more promising than "Clean Coal") and Geothermal heat pumps, as well as describing the difference between dry steam, flash steam, and binary cycle geothermal generation. 

CEO also publishes a quarterly update on all the stocks they've covered.  In the current market, this will be particularly interesting to new subscribers, since many of CEO's old picks will have fallen (and hence have more upside potential) since they were first recommended.

The Bottom Line

At $49 a quarter, or $179 a year, CEO potential subscribers should consider how much the access to Casey Research can benefit them.  Although CEO does highlight relatively safe plays in their in-depth looks at particular sectors, these picks won't come much of a surprise to people who spend a couple hours researching those sectors on their own.  

On the other hand, I feel CEO is very valuable for picking small, off-the-beaten path junior resource stocks.  It's not uncommon for these stocks to triple in a year, but many of them also go nowhere or fall rapidly as well, and declines in commodity prices or the availability of financing will hurt these companies worse than the market as a whole.  I would only invest in such stocks with a relatively small slice of my portfolio.  If you are ready to commit $10,000 or more to such stocks, a year's subscription should easily pay for itself.  If you don't have $10,000 ready to invest, you can take advantage of the 3 month free trial by canceling your subscription within 90 days.

These subscription plans are available here.

Tom Konrad, Ph.D.

DISCLOSURE: AltEnergyStocks.com receives a referral fee for paid subscriptions bought through the links above (although we don't get anything if you cancel your subscription during the trial period.)  Such referral fees help us continue providing the services you value.

March 08, 2009

The Buffett Shareholder Letter & Alt Energy

It is fair to say that most people continue to equate the terms "alternative" and "energy" with expensive, unreliable and plain unpractical. This naturally leads a majority of people to view alternative energy investing as a high-risk play on some unproven technology with an uncertain probability of success.

This is a perception we've tried to dispel on several occasions, whether we were talking about blue chip alt energy stocks, dividend alt energy stocks or utility alt energy stocks.

It's also fair to say that most people don't typically associate value investing and, by extension, Warren Buffett, with alternative energy. Yet after finishing to read the 2008 edition of his annual letter to Berkshire Hathaway's shareholders, I couldn't help but think that there were a couple of interesting nuggets (I know, I'm a week late).

A Few Classic Buffett Quotes

Although they have nothing to do with alternative energy, I couldn't help but include the few quotes below:

  • On the markets: "By yearend [2008], investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game."
  • On the economy: "By the fourth quarter [2008], the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have never before witnessed." [Italics mine]
  • On markets and the economy: "We're certain, for example, that the economy will be in shambles throughout 2009 - and, for that matter, probably well beyond - but that conclusion does not tell us whether the stock market will rise or fall."
  • On investor psychology: "When investing, pessimism is your friend, euphoria the enemy."
  • On acquisition opportunities at the GEICO unit: "[...] Tony and I feel like two mosquitoes in a nudist camp. Juicy targets are everywhere." [This is my personal favorite]

Warren Buffett On Alt (and not so alt) Energy

Wind Power

Berkshire's Regulated Utility business owns 87.4% of MidAmerican Energy Holdings which, in turn, owns a number of power and gas utilities. Buffett mentions he loves it when this business comes up with new projects "because in this capital-intensive business these ventures are often large. Such projects offer Berkshire the opportunity to put out substantial sums at decent returns."

And it so happens that many of these new projects have been in wind power. Buffett notes that MidAmerican's investments in wind capacity have made "Iowa number one among all states in the percentage of its generation capacity that comes from wind."

He further notes that since Berkshire purchased MidAmerican, "wind-based facilities have grown from zero to almost 20% of total capacity." When MidAmerican bought out PacifiCorp in 2006, installed wind capacity was expanded from 33 MW to 794 MW, a nearly 500% expansion.

In 2008 alone, the Oracle tells us, MidAmerican spent $1.8 billion on wind generation. Assuming a cost per installed MW of $2.5 million, that's about 720 MW - not bad for an energy source that's expensive, unreliable and unpractical. And so where has MidAmerican gone under Berkshire ownership? It has become the regulated utility with the largest ownership of wind capacity in the US.

Keep in mind that all this investment activity most likely had to be approved by Buffett, and that he is no "flavor of the month" guy - if the economics made no sense there would be no Berkshire money going into wind. The exact nature of their thinking on wind (i.e. is it a play on the PTC?) is unknown, but their actions certainly indicate a strong interest. 

Oil Prices   

Buffett identifies one of his biggest investment mistakes of 2008 as buying ConocoPhillips when oil and gas prices were still high. He "in no way anticipated the dramatic fall in energy prices that occurred in the last half of the year." But he makes this prediction: "I still believe the odds are good that oil sells far higher in the future than the current $40-50 price."

Not much of a prediction huh? This is someone who thinks the following of forecasts: "But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and loosing years [in equity markets] in advance. (In our usual opinionated view, we don't think anyone else can either.)"

Of course he would never say how much higher, nor does he need to for people to find him credible. But given Buffett's typical time horizons (i.e. decades), it's probably fair to assume that he sees what many of us alt energy investors do: a fundamental and, in the long run, unbridgeable (at a reasonable cost) gap between supply and demand for oil.

Conclusion

This doesn't leave us with much in terms of concrete investment ideas. However, it does confirm that some of the trends upon which the alt energy investment thesis is based are occurring, and that they are being picked up by some of the sharpest investing minds out there.

March 06, 2009

Cost-effective Energy Storage is the Orphan Stepchild of Alternative Energy

In connection with this week’s launch of their new “What Matters” website McKinsey & Company published a pair of essays that should be of particular interest to alternative energy investors. The first essay, “Electron-Democracy,” describes the coming smart grid as a system that will be built outward from a core of centralized power plants, but increasingly be supported and stabilized by incremental energy flows between small producers and consumers that can respond nimbly to market demand with lower capital costs and more robust protection against disruption. Putting the pieces together, the authors suggest that:

“. . . the distributed grid might look like this: intermittent wind and solar power generation would be complemented by load-supplementing fuel cell plants, in much the same way that peak power and base load power plants interact today. Electric vehicles (EVs), plug-in hybrid electric vehicles (PHEVs), and batteries would serve as grid energy storage when excess energy is being produced.”

This outlook, which is rapidly building consensus, is a fundamental force that will drive investments in alternative energy for decades to come. In fact, it’s the raison d’être for wide swaths of the alternative energy industry.

The second essay, “Time to fix the wiring,” is a far more important contribution from Dr. Steven Chu, the new Secretary of Energy. This essay is remarkable because it presents a frank, readable and easily understood summary of the economic and technological factors that will drive the smart grid’s development. It is also an extraordinary public vision statement from Secretary Chu that neither equivocates nor obfuscates. It may be attributable to age or a misspent youth, but I can’t remember the last time a Cabinet Member spoke his mind and explained his vision with a comparable level of unambiguous clarity.

In framing the issue, Secretary Chu wrote:

“It’s important to understand where we are now. Existing energy technologies won’t provide the scale or cost efficiency required to meet the world’s energy and climate challenges. Corn ethanol is not a sustainable or scalable solution. Solar energy generated from existing technologies remains much more expensive than energy from fossil fuels. While wind energy is becoming economically competitive and could account for 10 to 15 percent of the electricity generated in the United States by the year 2030 (up from less than 1 percent now, according to the US Energy Information Administration), it is an intermittent energy source. Better long-distance electricity transmission systems and cost-effective energy storage methods are needed before we can rely on such a source to supply roughly 25 percent or more of base-load electricity generation (the minimum amount of electrical power that must be made available). Geothermal energy, however, can be produced on demand. A recent Massachusetts Institute of Technology (MIT) report suggests that with the right R&D investments, it could supply 10 percent of US power needs by 2050 (up from about 0.5 percent now).”

Since I’ve taken more than my share of criticism over the last eight months for insisting that energy storage must be cost-effective, I was delighted to see Secretary Chu take a position that it’s all about price vs. performance.

Last November I wrote “Alternative Energy Storage: Cheap Will Beat Cool,” a Seeking Alpha article that basically said economic decisions by users of energy storage systems would ultimately favor cost-effective technology over best available technology. I then demonstrated that within the energy storage sector, the companies that made “cool” energy storage devices carried disproportionately high market valuations compared to companies that made “cheap” energy storage devices. In light of Secretary Chu’s use of the term “cost-effective” to modify “energy storage” I think it will be worthwhile to revisit those issues in greater depth.

This morning I downloaded summary information on the Ardour Global Alternative Energy Index (^AGIGL) and eliminated any companies that were not based in the U.S. I then went to Yahoo! Finance and downloaded market capitalization, price to sales and price to book value data for all of the U.S.-based companies. After eliminating six energy storage stocks, the 45 remaining U.S.-based alternative energy companies had a combined book value of $15.5 billion, combined sales of $16.2 billion and a combined market capitalization of $27.2 billion, which works out to an average of 1.75 times book value and 1.68 times sales.

As long-term readers know, I track a small group of pure-play US-based energy storage companies and take a very egalitarian approach. My only qualifying question is “does the company manufacture rechargeable batteries or other devices that store electricity for future use?” Collectively, the twelve US-based energy storage companies that I track have $1.5 billion in equity and $6.7 billion in sales, but carry a combined market capitalization of $1.7 billion, which works out to an average of 1.13 times book value and 0.25 times sales. So from a sector perspective, my energy storage group trades at a hefty discount to the industry averages implied by the Ardour Index.

Any time a sector like energy storage trades at a steep discount to a broader average like the Ardour Index, I start thinking about bargain hunting opportunities because experience has taught me that market valuation metrics within an industry will tend to coalesce over time. The following tables segregate the energy storage companies I track into two basic classes, “cool technologies” and “cheap technologies.” For purposes of distinguishing between the two classes, I arbitrarily picked a product price point of $500 per kWh of energy storage capacity.



Collectively, the six cool technology companies have $217 million in book value and $372 million in sales, but they carry a combined market capitalization of $861 million, which works out to an average of 4.0 times book value and 2.3 times sales. These numbers are much higher than average price to book value and price to sales ratios for alternative energy stocks included in the broader Ardour Index. Accordingly, it seems reasonable to suggest that the cool technology stocks are overvalued when compared to the rest of the alternative energy universe.

In comparison, the six cheap technology companies have $1.3 billion in book value and $6.3 billion in sales, but they only carry a combined market capitalization of $805 million, which works out to an average of 0.6 times book value and 0.1 times sales. These numbers are much lower than average price to book value and price to sales ratios for alternative energy stocks included in the broader Ardour Index. Therefore it seems reasonable to suggest that the cheap technology stocks are undervalued when compared to the rest of the alternative energy universe.

It strikes me as illogical that companies that focus on time-proven energy storage technologies trade at a significant discount to the Ardour Index averages while companies that focus on less reliable and more expensive technologies trade at a significant premium. It gets even odder when you consider that the bulk of the $2 billion in battery manufacturing subsidies in The American Recovery and Reinvestment Act of 2009 are supposed to be used for cost-effective technologies. This is more than a simple index problem. In fact, it appears to be a fundamental disconnect between sector valuations. Alternative energy and emerging storage technologies may be well respected, but nobody gives a second thought to the core group of cost-effective enabling technologies that will ultimately make alternative energy economically viable. I can’t justify the phenomenon, but it’s clear that cost-effective energy storage has become the orphan stepchild of the alternative energy industry. When faced with a market disconnect of this magnitude, I think alternative energy investors would be wise to remember the words of Benjamin Graham who said, “In the short run, the market acts like a voting machine, but in the long run it acts like a weighing machine.

Disclosure: Author holds a large long position in Axion Power International (AXPW.OB) and small long positions in Active Power (ACPW), Exide (XIDE), Enersys (ENS) and ZBB Energy (ZBB).

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works as a partner in the law firm of Fefer Petersen & Cie and represents North American, European and Asian clients, principally in the energy and alternative energy sectors. His international practice is limited to corporate securities and small company finance, where he focuses on guiding small growth-oriented companies through the corporate finance process, beginning with seed stage private placements, continuing through growth stage private financing and concluding with a reverse merger or public offering. Mr. Petersen is a 1979 graduate of the Notre Dame Law School and a 1976 graduate of Arizona State University. He was admitted to the Texas Bar Association in 1980 and licensed to practice as a CPA in 1981. From January 2004 through January 2008, he was securities counsel for and a director of Axion Power International, Inc. a small public company involved in advanced lead-acid battery research and development.

March 05, 2009

A Quick Clean Energy Tracking Portfolio

Yesterday, I outlined a strategy to approximately replicate the performance of a Clean Energy mutual fund at much lower cost, with only a couple hours of effort.  I gave a cost example based on $5000 invested in 5 stocks, with another $1000 worth of a single stock added in each subsequent year.  

This is the procedure I would use to select the initial five stocks.

  1. Collect all the top five or ten holdings of the available Clean Energy mutual funds.  This data is available from Morningstar, and on fund sponsor's home pages.
  2. A few of these holdings may be international, and not available through your stock broker to small purchasers.  Eliminate them from consideration.
  3. Organize the remaining companies by cleantech sector (we have stocks listed by sector on out Cleantech Stocks page, or you can select sectors yourself by reading the company profile on Morningstar, or the company's home page.
  4. In the top five sectors, rank the companies by recent performance (1-3 year.)  Recent underperformers tend to do better in subsequent years, so choose the worst performers. 

In subsequent years, look at your portfolio, and pick a single stock which you do not yet own from a sector which is relatively underrepresented in your current portfolio.  Such under-representation could occur because your other sectors have been outperforming that sector, or because you have been picking more stocks from other sectors in recent years.

Stocks Green Mutual Funds Own

Here are all the stocks listed in the top 5 holdings of the clean energy mutual funds compared in my recent article: American Trust Energy Alternatives Fund (ATEAX), the Calvert Global Alternative Energy Fund (CGAEX), Firsthand Alternative Energy (ALTEX), Guinness Atkinson Alternative Energy Fund (GAAEX), New Alternatives Fund (NALFX), and Winslow Green Growth Fund (WGGFX), along with CleanTech sector and 3 year performance (obtained from Morningstar.com.)  I have eliminated several which investors would need to purchase on foreign markets.  Many brokers have minimum transaction sizes and higher fees for such transactions.. 

If you were putting together a larger portfolio this way, you might also look at the top holdings of the Clean Energy ETFs, and/or expand the search to the top 10 holdings of each fund.

Stock In Fund(s) Sector 3 yr Annual
ADM American Trust Ethanol -5%
CTXS American Trust Efficiency -14%
WFFIF Winslow Efficiency -10%
LXU Winslow Efficiency 10%
ELON Firsthand Grid -10%
STP Firsthand Solar -45%
FSLR Winslow, AmericanTrust Solar 216%*
CIG Guinness Atkinson Utility -2%
FPL Calvert Utility 6%
SJI New Alternatives Utility 11%
VWSYF.PK New Alternatives Wind -17%*
GCTAF.PK Calvert Wind -6%
AMSC Winslow Wind 10%
* Average annual return based on less than 3 years' data.

Since we are looking for 5 stocks, and 6 different sectors appear in the chart, we have a choice of one sector not to include.  I personally don't feel that most of the utilities listed belong in a clean energy fund, because most of them produce more than half of their power from fossil fuels, with the exception of Cemig (CIG), which is mostly hydropower.  If Cemig were not in the list, I'd drop the utility sector.  However, since it is in the list I choose to drop the Ethanol sector instead, given the questionable environmental benefits of ethanol.  

Note that I am not making this decision based on the sector which I think will perform the best, because I am attempting to do this exercise using only information which a small investor who is interested in clean energy might have at his fingertips, and predicting stock moves is not something that should be tried by someone only willing to devote a few hours a year to their investments.

Taking the stock which has the worst previous 3 year performance from each of the remaining categories, I arrive at this portfolio, based on closing prices on February 27, 2009:

Company Shares* Price
Citrix Systems (CTXS) 48 $20.58
Echelon Corporation (ELON) 165 $5.99
SunTech Power (STP) 162 $6.09
Cemig (CIG) 72 $13.66
Vestas Wind Systems (VWSYF.PK) 22 $44.85
Total portfolio cost: $5,000 including $65 brokerage commissions

My hope is that this portfolio should roughly track a basket of the six mutual funds it is based on, but outperform due to its lower costs and the strategy of picking previous underperformers.  For comparison, here's the mutual fund portfolio:

Fund Shares Price
ATEAX (American Trust)  82.43 $10.11
CGAEX (Calvert) 122.19 $6.82
ALTEX (First Hand) 171.47 $4.86
GAAEX (Guinness Atkinson) 205.76 $4.05
NALFX (New Alternatives) 29.75 $26.68
WGGFX (Winslow Green Growth) 111.71 $7.46
Total portfolio cost: $5000, including $39.58 front-end load on NALFX

A year from now, I plan to take a look at how the two portfolios performed, and choose another stock to add.

Tom Konrad, Ph.D.

DISCLOSURE: Tom Konrad has long positions in  ADM, WFFIF, LXU, ELON, GCTAF, and AMSC.  GAAEX is an advertiser on AltEnergyStocks.com.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

March 04, 2009

Costs of Green Stocks vs Costs of Green Funds

Tom Konrad, Ph.D.

funds over time.bmpThe intense and growing investor interest in Clean Energy Investing can be seen in the recent growth of new clean energy mutual fund and Exchange traded fund issues.  Although competition for investors' money is heating up, and I've noticed a slow decline in fund fees, those fees are still quite high, with expense ratios ranging from 1% to 2.75% for Clean Energy mutual funds and 0.5% to 0.85% for Clean Energy ETFs.

For many investors, that leaves a lot of room for cost savings by investing in individual stocks.  Nearly all the benefits of diversification can be achieved with a 20-50 stock portfolio, if those stocks are chosen to minimize internal correlations.  An investor who decides to place 20% of his portfolio in Clean Energy should only need 4-10 stocks in the sector to achieve most of the benefits of diversification.  

For example, an investor with $20,000 in a diversified IRA might decide that this year's $5000 contribution should go into Clean Energy.  He could buy $1000 worth of five Clean Energy stocks to achieve a 20% allocation to clean energy without significantly reducing his overall diversification, and resolve to purchase another $1000 worth of a single clean energy stock each subsequent year, to maintain that approximate diversification.  The table and graph below show how his costs would compare to investing the same amount in sector mutual funds or ETFs, assuming a moderate $13 brokerage commission.  Many brokers offer much better commissions, which make stocks look even better in comparison to funds.

These calculations assume no price appreciation.  If price appreciation were included, ETF and mutual fund costs would be higher than those given, because these costs are based on a percentage of assets under management.

   

Cumulative commissions & expenses

Year Total invested Stocks lowest cost ETF lowest cost mutual fund
1 $5,000  $    65  $        37  $               65.50
2 $6,000  $    78  $        79  $             144.10
5 $9,000  $   117  $      233  $             458.50
10 $14,000  $   182  $      586  $           1,244.50
cost over time.bmp

The stock investor following this strategy will save money in the first year compared to even the least expensive mutual fund available (the Winslow Green Growth Fund), and by the second year compared to the least expensive clean energy ETF (the iShares S&P Global Clean Energy Index.)

A Quick Way to Choose Clean Energy Stocks

All this assumes the investor has the time to spend to pick appropriate stocks.  For a small investor like the one in the example, the time required will need to be minimal.  With literally hundreds of clean energy stocks to choose from, the task seems monumental.  It doesn't have to be.

One simple way is to look at the top holdings of a few clean energy mutual funds, and pick your stocks from among those.  By making sure to spread your holdings over different alternative energy sectors (Wind, Solar, Efficiency, etc.), you'll be able to maximize your diversification.  Our CleanTech Stocks page shows stock categories in the right-hand column.

The goal of this strategy would be to approximately replicate the performance of the funds, but to do so at much lower cost.   If this were done outside of a tax advantaged account such as an IRA, after-tax performance could be enhanced further by selling losing stocks in order to shield capital gains or even a little ordinary income from taxation, and replacing them with similar companies.

Tomorrow I'll take a look at Clean Energy mutual fund holdings to see what this portfolio might look like. (The link will be broken until then.)

DISCLOSURE: None.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

 

March 03, 2009

Dipping a Toe in the Golden Stuff

And I'm not talking about gold, but I liked the play on this title. Last December, I wrote about a report that claimed that solar stocks were the best play on the cleantech revolution. In that article, I analyzed the two solar ETFs: the Claymore/Mac Global Solar Index ETF (TAN) and the Market Vectors/Van Eck Global Solar Energy ETF (KWT).

At the end of the article, I said I had an open buy order on TAN. That buy order expired unfilled in January as the suckers rally progressed, but TAN then dropped to the kinds of levels I was looking for on Monday so I took a position at $5.



As I said in the December article, this is long-term. I don't expect this investment to realize its full potential for another 18 to 24 months, so patience is of essence. Of course, certain catalysts, such as a rapid rise in oil prices, could push this ETF up before then, and I would be more than happy to take a little profit if that happened (I haven't been taking a lot of that recently...). But my time horizon is two years plus here - this a play on the thesis put forth in the report that in the long run solar stocks have significant capital appreciation potential.

DISCLOSURE: Charles Morand has long position in TAN.

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

March 01, 2009

Two High-Speed Rail Stocks For The Stimulus Packages

A couple of weeks ago, we received an inquiry from a reader asking us to look into potential beneficiaries of the American Recovery and Reinvestment Act (ARRA)'s high-speed rail (HSR) provisions. This sounded like something our readers would want to read about so I decided to do it.

In a nutshell, here are the two main component's of ARRA's HSR approach:

  • $8 billion for for HSR corridors and other intercity passenger rail service (unclear at this point how much will go into each, although the companies discussed below can benefit from both)
  • The rules around state issuance of private activity bonds for HSR will be loosened, with trains no longer obligated to operate at speeds in excess of 150 mph but rather required to be able to attain 150 mph (this theoretically makes it easier for states to finance non-HSR projects, so this provision might actually hinder HSR development)

There is a significant amount of money being pumped into transit and rail through the ARRA - you can find a good summary on Transportation for America's website. I added up the figures in that summary and, if I didn't double-count or miss anything, it adds up to nearly $47 billion, significantly more than is going into the grid. HSR and intercity rail fare OK with about 17% of the total outlay. 

This level of expenditure is in line with a prediction I made about three weeks before Obama's election. Thus, while this article will focus on HSR, I think my initial thesis holds - providers of the various inputs that go into rail capex (e.g. ties, tracks, signaling equipment, etc.) should be in a strong position to benefit from some of this money.

High-speed Rail in 2009: The Companies 

My search for plays on HSR landed three names: Bombardier (BDRBF.PK), Alstom (AOMFF.PK) and Siemens (SI). Together, these companies have an over 55% share of the global rail market (across relevant markets). Bombardier is the leader at upwards of 20% followed by Alstom at a little under 20%. The other 45% plus of the market is made up mostly of small regional players with small market shares.

I decided to leave Siemens out of my analysis because for the 2008 fiscal year (YE Sept. 30), the Mobility segment, under which the rail activities fall, accounted for only about 8% of company top line, implying that unless a major contract is obtained the ARRA won't be needle-moving (at least not on the HSR side). For Bombardier (YE Jan. 31), the Bombardier Transportation segment made up 49.7% of sales in Q3 2008, with the balance going to Bombardier Aerospace. For Alstom (YE Mar. 31), for H1 08/09, the Transport segment made up 30% of sales with the balance going to the Power Systems and Power Service divisions. 

Assuming the entire $8 billion goes to HSR - an unlikely scenario - this would equate to about 54% of the two companies' transportation segments' combined sales for the last fiscal year available (Bombardier $7.8b and Alstom $ 7.0b). The amounts involved could therefore be significant for both firms, but would have the greatest relative impact on Bombardier because rail accounts for nearly 50% of revenue vs. 30% for Alstom.  

Bombardier has been active in HSR for some time, and it recently ramped up its efforts through a partnership with AnsaldoBreda aimed at increasing its technological capabilities. Alstom, for its part, is not only active in HSRR but is also a technology leader in the space. At this stage of the ARRA, it is too early to identify winners, and neither company is differentiated enough to stand out. However, both firms are global rail heavyweights that are sure to, at the very least, be very active in trying to secure a piece of the pie.

The HSR industry has high barriers to entry. Besides being highly capital intensive, this industry requires a fair bit of engineering firepower and strong relationships as there are only a few significant rail operators. This explains why the market is so concentrated. This market structure makes it easy to pick out potential plays.     

High-speed Rail: Stock Analyses

I recently read an article in Bloomberg Markets Magazine on Duilio Ramallo, a portfolio manager at Robeco with a value investing leaning. His fund is down about 28% over the last year vs. about 47% for the S&P 500, so he performed comparatively well. He mentioned that he looks for three characteristics when picking stocks: (1) attractive valuations; (2) high rates of returns, which I take to mean a corporation that generates high returns from its capital employed; and (3) a catalyst that will help the company realize its potential value.

I decided to look at these two firms through that lens, since their business model lends itself well to a value analysis (i.e. this is not a growth sector, at least not when compared to other industries we cover).

Valuation

The table below outlines basic information on both stocks, including basic valuation screens (PE and Price-to-book):

  Bombardier (BDRAF.PK) Alstom (AOMFF.PK)
Price ($) 2.34 48.50
Market Cap ($b) 4.3 13.8
Dividend Yield (%) 2.68 2.13
PE (x) ~5.2 ~10.7
Price-to-book (x) ~1.4 ~4.8
Net debt/[Net cash] ($b)* 0.63 [~1.47]
Debt-to-total cap (%)* 47 10
*Calculated directly from the latest financial statements - Oct. 31 for Bombardier and Sept. 30 for Alstom

As far as the basic valuation criteria go, Alstom is the priciest at nearly 2x Bombardier's PE and just under 3.5x its price-to-book. As stated earlier, the other side of Bombardier's business is aviation with a high degree of exposure to the regional jet market. Intuitively enough, regional aviation is unlikely to do well in the midst of an economic slump, and Bombardier has been feeling the pain.

Alstom, for its part, serves mostly utility customers (80% large utilities and 20% IPPs and industrials) through its two Power segments and is therefore less leveraged to the health of the economy, although it is certainly not immune. Alstom benefits from a great deal of revenue visibility because its order book is full, thus explaining the comparatively higher valuation it receives vs. Bombardier.    

Rate of Return  

The following table provides a time series comparison of Return on Invested Capital (ROIC)for both companies. ROIC is a popular metric with value investors - it gauges whether a firm is a strong capital user by looking at how much operating income it generates from the capital (debt and equity) invested in it.

ROIC Comparison (%)

  2008 2007 2006 2005
Bombardier 8.72 7.03 7.61 1.16
Alstom 21.34 10.68 5.57 -14.90

On the "rate of return" criterion, Alstom outperformed Bombardier in the past two fiscal years, with a very strong showing in 2008. The quick-and-dirty conclusion from this is that Alstom's management is better at deploying and managing capital resources than is Bombardier's. The more complex answer looks into the product mix and tries to find out whether Alstom can really do things better or whether it's just dabbling in more attractive product lines with higher margins.

I thus thought I'd compare the EBIT margins for the two companies' transportation segments for the past two fiscal years. This will give me a rough idea of the two firms' execution capabilities. This is what I found:

Transportation Segments EBIT Margin Comparison (%)

  2008 2007
Bombardier (YE Jan., 31) 4.4 3.9
Alstom (YE Mar, 31) 7.2 6.6
Figures as provided in company annual reports without adjustments

Based on this margin analysis, Alstom appears to have better execution and operational capabilities than does Bombardier.

Taken together, the metrics outlined above partly explain Alstom's higher valuation: low financial leverage, a strong net cash position, superior ROIC over the recent past and better EBIT margins for the comparable segment.

Catalyst

As far a catalyst goes - the last component of Ramallo's approach and a core component of any value analysis - that would be the ability for either or both companies to get their hands on significant ARRA money.

These two firms are the closest thing there is to global pure plays on rail. For instance, they are both active in the subway/metro market, and $6.9 billion will be going to transit, some of which will surely end up in urban rail systems. Given the amount of money going into rail under ARRA, the market will no doubt be watching both companies closely, as they stand to benefit not only from HSR expenditures but also from expenditures in other areas of rail.

Conclusion

As I said initially, it's too early to tell which company will get what under ARRA. Both firms aren't differentiated enough - technologically or otherwise - to be able to say with certainty whether one has an edge over the other.

From the analysis I provided above, the following emerges: Alstom is an overall "better" company in terms of its return on capital, and it is less risky owing to its low debt levels. Bombardier, on the other hand, is currently quite cheap. Moreover, the larger share of its revenue coming from rail means that ARRA could be more needle-moving for Bombardier than for Alstom. However, because its Power business has exposure to wind and solar, Alstom could benefit from ARRA's renewable energy provisions.

The final thing to keep in mind is that there are billions of dollars flowing into rail around the globe; North America is actually not a major market. In analyzing these two firms for investing purposes, their international exposure should undoubtedly be looked at. 

My take on this is that Bombardier has greater capital appreciation potential while Alstom is a safer play. Over the next 12 months, I pick Bombardier to outperform.

DISCLOSURE: Charles Morand does not have a position in any of the stocks discussed above.

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.


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