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August 28, 2011

Has the Sell-off Created Value Stocks Among Clean Energy Conglomerates?

Tom Konrad CFA

The silver lining of all market declines is the chance to buy stock in quality companies at attractive prices.  That opportunity has been notably absent over the last two years, which is why my focus has shifted to smaller and smaller companies in search of reasonable valuations over that time.  Although I still don't believe the market is cheap by any measure other than comparing it to a couple months ago, the volatility is starting to bring some individual bargains, especially on heavy selling days. 

For instance, I've started to acquire some of the waste management stocks that I looked at last week, although I'm still waiting on another round of selling to purchase others.  In particular, I am looking for companies with high dividend yields that are well covered by free cash flow and earnings.  I also want companies with low levels of debt to ensure that income would be relatively stable, even when revenues drop.

Clean Conglomerates

I like the waste sector because I think it will benefit as higher commodity and energy prices lead to more profitable recycling and waste to energy operations. 

In contrast, the companies I'll look at today are not in any one sector, but rather they are broader industrial companies with a range of businesses in the clean energy arena that have drawn my attention over the years. 

Because these companies are large and well covered by mainstream analysts, I don't feel that I have the resources to gain an informational advantage over other market participants.  Instead, my strategy with companies like these is to wait until a general market downturn produces good valuations, and buy those companies which have decent dividends supported by healthy capital structures, earnings, and cash flow, with the intent on holding them for the long term.

In particular, I'm looking for a dividend yield around 3% or more, with earnings and Free Cash Flow (FCF) yields considerably higher than the dividend, so that there is room for earnings and cash flow to fall without imperiling the dividend.  I'm also looking for moderate levels of debt, preferring companies that are mostly equity rather than debt financed. 

I looked at the following seven companies:

  1. ABB Ltd. (ABB), which attracts me because of their expertise in electricity transmission and distribution, especially high voltage DC transmission.  They've recently been expanding their cleantech offerings with acquisitions in smart grid, electric vehicle, and efficient motors sectors.
  2. AECOM Technology (ACM) provides planning and technical support services in the sectors as diverse as transportation, facilities, environmental, and energy markets.  Since efficient infrastructure requires careful planning, a shift towards greater efficiency should mean more business for AECOM. Many renewable energy projects (such as hydropower) also require a level of planning expertise not necessary in traditional fossil fuel projects.
  3. Roper Industries (ROP) makes medical and scientific imaging equipment, energy systems and controls, and radio frequency products and services.  Many of their activities are focused on saving money for utilities, such as better ways to deliver water, better logistics, and leak detection systems.  Such efforts do a lot to improve energy and resource efficiency as they help their customers' bottom lines.
  4. John Deere (DE) provides services and products to the agriculture and forestry industries, so I see it as a potential beneficiary of increased demand for biomass for biofuels and electricity generation.  
  5. Siemens (SI) is an electronics and electrical engineering company with significant wind turbine, electric transmission, and building efficiency offerings.
  6. General Electric (GE) has been pushing their commitment to energy efficiency and renewable energy for most of the last decade, with green technologies accounting for a growing share of revenues.
  7. Johnson Controls (JCI) is both a leading battery manufacturer, and is a leader in building automation, a key technology in increasing building efficiency. 
I compare the companies' dividend, earnings, and cash flow yields, and Debt/Equity ratios in the chart below.



Of the companies listed, only ABB, Deere, Siemens, GE, and Johnson Controls have even moderately attractive dividends.  Of these, only ABB and Siemens have a level of debt I consider low enough to give it flexibility to cope with a sluggish world economy.  Yet both these companies have uncomfortably low FCF to support their dividends.  Free cash flow can be quite volatile, so I would want to take a closer look to decide on the cause of the current low cash flows at the companies before making an investment.  Furthermore, neither stock is particularly attractive on the basis of earnings, since analyst's predicted growth may not materialize, and both trade near 17 times 2010 earnings.

Of all the companies I consider here, Roper Industries looks the healthiest, with strong alignment between earnings and cash flow and low debt, but as with ABB and Siemens, the current valuation is unattractive. 

Especially when you consider that company analysts tend to be overly optimistic as a whole, we should probably discount the 2011 and especially 2012 earnings estimates.  None of these stocks looks like a great value at current prices, despite having fallen between 12% (ABB) and 35% (AECOM) year to date.

I take the lack of great values as a sign that this market decline likely has farther to go.

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

August 25, 2011

It's Time to Kill the Electric Car, Drive a Stake Through its Heart and Burn the Corpse

John Petersen

I was recently invited to prepare a memorandum on the battery industry for the electric mobility working group of the World Energy Council, a global thought leadership forum established in 1923 that includes 93 national committees representing over 3,000 member organizations including governments, businesses and research institutions. Since my memorandum integrated several themes from this blog and tied them all together, I've decided to publish a lightly edited version for readers. To set the stage for the substantive discussion that follows, I’ll start with an 1883 quote from Thomas Edison:

“The storage battery is one of those peculiar things which appeals to the imagination, and no more perfect thing could be desired by stock swindlers than that very selfsame thing. Just as soon as a man gets working on the secondary battery it brings out his latent capacity for lying.”

At the time, Edison was a customer who wanted to buy batteries to improve the reliability of the Pearl Street Station, the first coal-fired utility in North America. An essential truth even Edison failed to recognize is that battery developers don't lie, but potential customers consistently lie to themselves. They hear about gee-whiz inventions, overestimate the practical importance of the innovations and then make quantum leaps of imagination from the reasonable to the absurd. Therefore, the most important task for investors is to critically and objectively examine their own assumptions and avoid hopium induced hallucinations.

Cleantech, the Sixth Industrial Revolution

I believe we are in the early stages of a new industrial revolution, the Age of Cleantech. The cleantech revolution will be different from all prior industrial revolutions because the IT revolution forever changed a dynamic that has existed since the dawn of civilization. It gave the poor and the ignorant access to the global information network, proved that there was more to life than deprivation and sparked a burning desire for something better in billions of people who were once content with mere subsistence. It's long-term significance will be more profound than the discovery and settlement of North America.

The inescapable new megatrend is that six billion people have been awakened to opportunity and are striving to earn a small slice of the lifestyle that 600 million of us enjoy and typically take for granted. If the six billion are even marginally successful and attain a paltry 10% purchasing power parity, global demand for everything must double. Therefore, the most important challenge of our age will be finding new ways to satisfy insatiable demand for water, food, construction materials, energy and every commodity you can imagine.

The first and easiest step will be to eliminate waste in all its pernicious forms to make more room at the economic table. After that, the challenges become far more daunting.

The Everything Shortage

There is a widely held but grossly inaccurate belief that energy prices and CO2 emissions are the most pressing problems facing humanity. The reason is simple – in advanced economies everybody buys energy commodities in minimally processed form several times a month. Each of those purchases reinforces a belief that energy prices are an intolerable burden. While few of us purchase other minimally processed commodities beyond energy and food, the following graph compares the prices of non-ferrous industrial metals with the price of crude oil and highlights an inescapable and highly inconvenient truth that almost nobody understands –


6.23.11 Metals vs Oil.png

To compound the problem, global production of energy resources is several orders of magnitude greater than global production of critical metals, as the following table based on data from the U.S. Geological Survey clearly shows.

7.10.11 Energy vs Metals.png

Metric tons per person vs. kilograms per person is an insurmountable disparity.

Most alternative energy and electric drive technologies can’t be implemented without large quantities of scarce metals. All of the metals in the table have critical competitive uses in other essential products and significantly increasing global production of any of them is problematic if not impossible. While improved recycling practices have the potential to help alleviate shortages of critical metals, a recent UN study of global recycling rates for 60 industrial and technology metals found that only 18 had end of life recycling rates over 50% while 34 had end of life recycling rates under 1%. The metals that are most important to alternative energy and electric drive are very difficult and expensive to recycle. So with the exception of lithium, which is a plentiful resource that only represents 5% or 6% of the metal content in Li-ion batteries, the world cannot produce enough technology metals to permit a widespread transition to alternative energy or electric drive.

Any alternative that can't be deployed at relevant scale isn’t an alternative at all. It’s merely an expensive distraction for the masses, a bit like the circus in ancient Rome.

The Diminishing Marginal Utility of Batteries

Once you understand that metal supplies are far more constrained than energy supplies, every evaluation of electric drive becomes a simple exercise in optimizing the fuel savings from each unit of metal used. The five generic levels of electrification and the typical fuel savings at each level are summarized below.

Vehicle configuration Battery Savings
Stop-start systems use lead-acid batteries to eliminate idling while a vehicle is stopped but do not provide any electric boost. 1.0 kWh 10%
Mild hybrids like the Honda Insight use NiMH batteries to recapture braking energy and provide up to 20 or 30 horsepower of acceleration boost. 1.5 kWh 25%
Full hybrids like the Toyota Prius use NiMH batteries to recapture braking energy, offer electric launch and provide up to 80 horsepower of acceleration boost. 1.5˚kWh 40%
Plug-in hybrids like the GM Volt use Li-ion batteries to offer 40 miles of electric range before a range extender engine kicks in to power the electric drive. 16 kWh 75%
Battery electric vehicles like the Nissan Leaf use Li-ion batteries to offer up to 100 miles of electric range under optimal conditions. 24 kWh 100%

While NiMH has been the preferred battery chemistry for mild and full hybrids since they were introduced in the late 90s, it is a terribly resource constrained chemistry because the “M” most commonly used in NiMH batteries is the rare earth metal lanthanum. With per capita global lanthanum production running at a rate of 5 grams per year, significant expansion of NiMH battery production is effectively impossible, which is the main reason that Li-ion is gaining traction for use in electric vehicles. While not free from doubt, many industry observers believe NiMH and Li-ion will be the preferred batteries for full hybrids while mild hybrids will use NiMH, Li-ion and advanced lead-acid batteries.

There are important technical differences between the high-power batteries required for hybrid drive and the high-energy batteries required for electric drive. The differences, however, are relatively insignificant when it comes to raw materials requirements. Therefore, it’s not unreasonable to use battery capacity as a rough proxy for metal consumption in a fuel economy optimization analysis. The following comparisons assume that a new car with an internal combustion engine will use 400 gallons of fuel for 12,000 miles of annual driving. For the sake of simplicity, they assume a total of 96 kWh of batteries are available to reduce societal fuel consumption. The numbers are easily scalable.
  • 96 kWh of batteries would be enough for a fleet of 64 Prius-class hybrids that will each save 160 gallons of fuel per year and generate a societal fuel savings of 10,240 gallons per year;
  • 96 kWh of batteries would be enough for a fleet of six Volt-class plug-in hybrids that will each save 300 gallons of fuel per year and generate a societal fuel savings of 1,800 gallons per year; and
  • 96 kWh of batteries would be enough for a fleet of four Leaf class electric vehicles that will each save 400 gallons of fuel per year and generate a societal fuel savings of 1,600 gallons per year.
This example highlights the fundamental flaw in all vehicle electrification schemes. When batteries are used to recover and reuse braking energy that would otherwise be wasted, a single kWh of capacity can save up to 107 gallons of fuel per year. When batteries are used as fuel tank replacements, a single kWh of capacity can only save 19 gallons of fuel per year and most of the fuel savings at the vehicle level will be offset by increased fuel consumption in power plants.

Using batteries to enable energy efficiency technologies like recuperative braking is sensible conservation.

Using batteries as fuel tank replacements is a zero-sum game that consumes huge quantities of metals for the sole purpose of substituting electricity for oil. Since roughly 45% of domestic electric power from coal fired plants and that percentage will decline very slowly, the only rational conclusion is that electric drive is unconscionable waste and pollution masquerading as conservation.

The Green Power Sophistry

EV advocates invariably paint an appealing picture of EVs being charged by wind or solar power and claim that the combination of the two is wondrous beyond reckoning. Beyond the impossibility of charging an EV from home solar panels and driving it to work at the same time, the reality is that the presumptive virtue of wind and solar power arises from generating green electrons, not using them. Once green electrons exist, it makes no difference whether they’re used to power an EV or a toaster oven. Since green electrons that are consumed in an EV can't be used to clean up a toaster oven, there can be no double counting of virtue. In fact, since wind and solar power impose their own burdens on materials supply chains there's a solid argument that the pretty picture is doubly wasteful.

The Fixed Cost Conundrum

In a conventional vehicle, the fixed vehicle cost is relatively low and the variable fuel cost per mile is relatively high. In electric drive the dynamic is reversed and the fixed vehicle cost is relatively high while the variable fuel cost per mile is relatively low. While few financial metrics are more shrouded in secrecy, intrigue and speculation than Li-ion battery manufacturing costs, A123 Systems (AONE) includes enough hard data in its quarterly and annual reports to the SEC to permit a reasonable estimate. The following graph compares A123’s reported quarterly revenue, their adjusted cost of goods sold (after backing out unabsorbed manufacturing costs) and their gross margin per kWh of batteries shipped.

8.8.11 A123 Graph.png

A123’s direct battery production costs have averaged over $1,000 per kWh for the last two years. By the time A123 adds a reasonable profit margin for its effort and an automaker adds another layer of markup, the only possible outcome is an end-user cost of $1,500 per kWh or more.

Since most advocates insist that battery costs will decline rapidly, I’ll assume end-user battery pack costs of $1,000 and $500 per kWh to keep the peace. I'll also use several other charitable assumptions including stable electricity costs of $0.12 per kWh, no loss of battery capacity over time, no cycle-life limitations and a 15% second-life value. The following graph presents alternative gas price scenarios of $3, $6 and $9 per gallon, and then overlays depreciation and charging cost curves for an EV with a 25 kWh battery pack priced at $1,000 and $500 per kWh. The solid red and green lines show current gas and battery prices. The dashed lines show possible futures that are uncertain as to both timing and magnitude.

6.19.10 Fuel Costs.png

The most striking feature of this graph is the shape of the curves. Where prevailing mythology holds that EVs will be wonderful for urbanites with short commutes that don't need much range flexibility, the curves show that high-mileage drivers who presumably need more flexibility will derive the most value. The reason is simple – spreading battery pack depreciation over 5,000 or even 10,000 miles a year results in a higher cost per mile than spreading that depreciation over 20,000 or 25,000 miles a year. Since the GM Volt has an effective electric range of 40 miles per charge and the Nissan Leaf has an effective range closer to 80 miles, it's clear that high mileage users will need to charge more than once a day to get the maximum benefit. Since nobody has claimed a useful life of more than about 100,000 miles for a battery pack, it seems likely that sustained and frequent recharging will impair the economics for high-mileage users who will need to replace their battery packs more frequently.

Moore’s Curse

The IT revolution set the stage for fatally flawed assumptions in cleantech because we all got accustomed to the phenomenon known as Moore’s Law, which describes exponential improvements in the speed and processing power of electronics. In the Moore’s Law world, electronic devices doubled their capacity every 18 to 24 months while requiring the same or smaller natural resource inputs. As a result, we’ve seen decades of falling prices for exponentially better products.

Unfortunately, Moore’s Law has no relevance to electric drive because the energy needed to move a given mass a given distance at a given speed is constrained by the laws of physics. Likewise, the number of electrons in a given mass of chemically active material is constrained by the laws of chemistry. These laws cannot be violated and in practice the theoretical limits can never be achieved. The best we can possibly hope for is highly efficient systems that take us most of the way there.

In the IT world of Moore’s Law the generational progression was 2, 4, 8, 16 etc.

In the cleantech world of Moore’s Curse the generational progression will be 50%, 75%, 87.5% etc.

The following graph is a bit dated, but it shows that current expectations respecting future advances in battery technology are completely out of touch with historical reality.

8.19.11 Batteries.png

When Edison was bitching about batteries specific energies of 25 wh/kg were common. A hundred and thirty years later specific energies of 150 wh/kg are pushing the envelope. A six-fold improvement over 130 years does not provide a rational basis for prevailing expectations.

Investment Conclusions

It's an Iron Law of Nature – things that can't happen won't happen. The world does not and cannot produce enough metals to permit the deployment of electric drive at a rate that approaches relevant scale. Chinese wind turbine producers are reeling from skyrocketing rare earth metal prices that are scuttling wind power deployment plans. Beijing is backing away from its aggressive vehicle electrification policies. If China can't make the numbers work in a command economy that produces over 95% of the world's rare earth metals, nobody can. The inescapable conclusion for investors is that resource dependent alternative energy and vehicle electrification schemes must fail.

Let's face it folks, it's time to kill the electric car, drive a stake through its heart and burn the corpse.

Companies like Tesla Motors (TSLA) are doomed because their vanity products can't possibly make a difference and have all the environmental and economic relevance of pet rocks. The only companies that stand a chance of long term survival are manufacturers of efficiency technologies that reduce aggregate resource consumption. If lithium-ion battery manufacturers like A123 Systems, Altair Nanotechnologies (ALTI) and Valence Technologies (VLNC) can stop chasing rainbows and focus on sensible applications like electric two-wheeled vehicles that reduce natural resource waste, they may have long and prosperous futures. Manufacturers of fundamentally cheap energy efficiency technologies like Johnson Controls (JCI) and Exide Technologies (XIDE) are certain to thrive in any event. The surprise winners in a resource constrained world will most likely be disruptive innovations like the PbC® battery from Axion Power International (AXPW.OB) which uses a third less metal while promising a ten-fold improvement in battery cycle life to optimize the performance of efficiency technologies like stop-start systems, stationary applications and hybrid drive for everything from passenger cars to freight trains.

This article provides a summary overview of several topics I’ve examined in detail over the last three years. A complete archive of my work is available on Seeking Alpha. Most of the resource materials I’ve relied on are available through the numerous hyperlinks I’ve embedded in my articles.

Given the nature of the investing process I don't expect anyone to accept my logic without independently verifying the facts. I sincerely hope that this article will give at least a few investors reason to question their own assumptions in a hopium free environment. Most of us grew up in a rare period of privilege, prosperity and plenty that has seriously distorted our worldview. If we don't accept the reality that our supply chain assumptions are fatally flawed, we can’t possibly identify realistic solutions that can be implemented at relevant scale.

My perspective is very different from the views held by many alternative energy and vehicle electrification analysts. Some readers will no doubt find my thinking reactionary if not heretical. But even the Catholic Church requires a Devil's Advocate to argue against the canonization of proposed saints and gives that advocate fair and equal consideration before making a decision.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

August 24, 2011

Rough Patch For Owners of Solar Stocks

Mark Henwood

This sector defines investment risk.   Not only has Evergreen Solar, Inc. [ESLR]  filed for bankruptcy, investors in another high visibility solar developer have been saddled with a 72% loss over the last week.   In a massive shift that has to shake confidence in the company, Germany’s Solar Millennium AG [S2M.DE] announced on Thursday said it will convert the first 500 megawatts of its 1,000 MW Blythe solar power plant in the Mojave desert to PV. It will decide what technology to use for the second half of the project at a later date.  Nor has it revealed the charge it will need to take due to the shift.

It’s not just these companies.  The two solar sector specific ETFs [KWT and TAN] have lost 36.8% and 33.2% respectively this year.  This is about double the loss broad-based market indices have suffered and lead the losses across all the clean energy ETFs and mutual funds.    In fact these losses have depressed the size of the sector specific ETFs for wind, solar, and smart grid to where only the Guggenheim Solar ETF  [TAN] has a market cap greater than $100 million.  The other four ETFs market caps are below a rule of thumb $70 million threshold required for the ETF sponsor to make money.   So I wouldn’t be surprised to see some of these ETFs shut down like the clean transportation ETF [PTRP] did last December.

That said, solar companies may be great technologists with good products.   With falling panel prices it looks like PV is on track to wipe out solar thermal projects and is making progress on being grid competitive.   Of course, in the US with natural gas prices constrained by the technological breakthrough that brought about shale gas, the bar for solar PV is being raised.  Whether solar can reach parity (and without the support of creative ratemaking that turns $4/mmBtu gas into 20 cents/kWh power in the summer) is still not answered.  But if so, solar companies with depressed stock prices may turn into good investments.

Disclosures:  none

Mark Henwood founded and directs New Energy View. This site grew out of the experience gained in developing Camino Energy and retains many of Camino Energy's functions.  Mark is the CEO of Henwood Associates (a Sustainable Energy Business), serves on the board of PLEXOS Solutions LLC., and manages a diversified portfolio of equities and fixed income. Mark was a board member and advisor to PowerLytix, LLC until April 2008 when it sold to Barclays Capital. He is also active in promoting sustainable energy businesses in Sacramento, CA through his involvement with CleanStart where he is Vice Chairman and with start-ups as a venture partner at Velocity Ventures LLC.

August 23, 2011

Trash Stocks Trashed: An Income Opportunity?

Tom Konrad CFA

Dumpster diving for high yielding gems.

An earlier version of this article was written at the end of July and published on my Forbes blog, before the August market implosion. I've updated it here to reflect the new stock prices and some recent company news.

Renewable energy has many advantages over fossil energy.  One of the most important is that it's renewable.  As supplies of Oil and other fossil fuels are used up, they become harder and more expensive to extract, while renewable energy is generally getting cheaper over time, due to improving technology.

Unfortunately, while there is no real limit to how expensive fossil fuels might become, as we start using more and more renewable energy, we will start running into resource constraints which will eventually end the decline in renewable energy prices.  Where fossil energy uses a small capital investment up front, followed by a long tail of fuel cost, renewable energy requires a large capital investment up front, followed by little or no fuel cost.  Unfortunately, that up-front capital investment is not just money: it's an investment in capital equipment such as solar panels or wind turbines using much more raw material than an equivalent fossil fuel plant.

Commodity prices are already high and rising higher because of buoyant demand in developing countries.  The transition to clean energy will only accelerate this trend, as old fossil fuel based generation is replaced with new renewable energy that require a far larger investment of industrial metals.  This is what Jeff Vail calls the Renewables Gap, and John Petersen calls the Alternative Energy Fallacy.  We cannot transition to clean energy without making other significant changes to our economic system: the resources in energy and raw materials are not there.  In reality, we must make those changes, because we simply do not have the resources to transition to clean energy while continuing business as usual.

Commodities and Trash

Rising commodity prices have recently been hurting waste haulers even as volumes fall during the recession.  On July 28, Waste Management (WM) missed Q2 Earnings expectations by $0.12, earning $0.50 per diluted share.  Waste Management's CEO, David Steiner, attributed a $0.04 earnings shortfall to increased operations and maintenance due to rising commodity prices in the earnings call, yet "[h]igher commodity prices, improved recycling volumes, acquisitions and year-over-year yield increases contributed to the [year over year] revenue growth."  Overall volumes dropped due to a slower economy, and management attributed a decline in revenues to this, in addition to increased competition. 

The other side of rising commodity prices is not a cost, but a revenue source.  This comes in two forms: Recycling and Waste-to-Energy.  Waste Management is expanding in both these areas, with significant waste to energy operations, which benefit from rising energy prices, and recycling operations, which benefit with rising prices for recycled paper, plastics, and metals. 

Stocks Trashed

While Waste Management has fallen from around $36 to below $30 (17%) because of the earnings miss and market decline, another waste and water purification stock I follow, Veolia Environnement SA (VE) has been much worse hit, falling from $26 to $15 (42%) because of lower guidance related to restructuring because of declining volumes, plans to downsize, and an accounting fraud in its US division.  Veolia has been hit by declining volumes and increased competition in the US, as well as European economic woes. 

Yet both Waste Management and Veolia are high yielding companies, and are beginning to look tempting to income investors as dividend yields are pushed up by declining stock prices. Unfortunately, Veolia's restructuring could easily lead to a dividend cut since the company already distributes most of its earnings to shareholders in the form of dividends, and this could lead to a further fall in the stock price, if it is not already priced in. 

Progressive Waste Solutions (BIN) also missed second quarter earnings, a shortfall the company blamed on bad weather.  The stock fell further than many others in the recent sell-off because much of it's revenue comes from Western Canada, where the economy is heavily dependent on the oil fields.  But I seriously doubt that oil price declines will come anywhere near the levels needed to seriously dent the oil sands boom, so investors' fears over oil seem to be providing a buying opportunity in this stock, as outlined in a recent Barron's article.

The downtrend in waste stocks has been industry-wide, with the Global X Waste Management ETF (WSTE) having declined 18% over the last three months, while the S&P 500 index has declined less than 15%.  This under-performance is surprising in an industry which is often considered a defensive play.


Safe Income From Trash?

While I'm tempted by the high current yields, I want to be sure that the companies can easily cover their rather high dividends with earnings going forward.  I'd like a stock with a high dividend yield, but with that dividend well covered by earnings and Free Cash Flow (FCF).  I'm also looking for a low leverage ratio (debt to equity,) so that the effects of any future decline in revenues will have only a moderate effect on earnings.  Below, I show dividend yield compared to three years of earnings yeilds and estimates as well as trailing FCF yield and debt to equity ratios for several waste management stocks.

As long as earnings and FCF yields are comfortably higher than the dividend yield, the company in question should be able to continue to pay (or even increase) the dividend.
Waste Co Stats.png

Per Share
Stock Price Dividend 2010 EPS 2011 Est 2012 Est FCF Debt/Equity
Waste Management (WM) $29.40 $1.36 $2.10 $2.14 $2.44 $2.04 1.38
Veolia (VE) $15.18 $1.47 $1.60 $1.85 $1.95 $0.85 1.94
Casella Waste (CWST) $4.81 $0.00 $0.24 -$0.50 $0.09 -$0.13 4.95
Republic Services (RSG) $27.50 $0.80 $1.71 $1.88 $2.13 $2.25 0.87
Progressive Waste (BIN) $20.91 $0.51 $0.94 $1.12 $1.30 $1.54 0.79
Waste Connections (WCN) $30.99 $0.30 $1.24 $1.48 $1.71 $1.74 0.83
Data Source: Yahoo! Finance

As I noted earlier, while Veolia has an attractive yield of almost 10%, but with earnings and Free Cash Flow yields only slightly higher, and FCF far below, Veolia will probably have trouble maintaining its dividend if the fierce competitive environment and low waste volumes persist or worsen, with 84 cents of every dollar earned being paid out as dividends.  With a Debt to Equity ratio of almost 200%, the company is quite vulnerable to further drops in revenue, although they may be able to pay off some of this debt by selling divisions as part of the downsizing. 

Waste Management's dividend payout is also higher than I would like at 64% of earnings and 67% of free cash flow, but the lower debt to equity ratio makes this more manageable, so I expect they will be able to maintain the current dividend.

Of the other companies listed, both Republic Services and Progressive Waste are beginning to look attractive because their lower dividends (at 3% and 2.5%) are very well covered by earnings and cash flow, and their low debt means that earnings will be more resilient in the face of a potential continued revenue decline.  On the other hand, if earnings continue to grow as projected, these two companies have plenty of room to increase dividends further.


The falling volumes and increased competition in the waste management industry, along with the last few week's market decline have made these stocks into attractive income investments.  Since the sector has a reputation for earnings stability, the recent earnings misses and revisions have hit investors particularly hard, leading to potential buying opportunities.  Nevertheless I feel there is still room on the downside, so it's probably better to dip a toe into the trash bin rather than engaging in full scale dumpster diving. 

The most attractive names right now are Waste Management and Republic Services, while Veolia's gigantic dividend will tempt braver investors, and Progressive Waste is probably worth including in a portfolio for additional diversification.  I have a bias toward Waste Management and Veolia because they have stronger focuses on recycling and waste-to-energy, which I believe will serve them well if commodity and energy prices continue to rise due to growth in emerging economies. 


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

August 21, 2011

Four Bargain-Priced Stocks in the Energy Storage Sector

John Petersen

The last couple weeks remind me of the adage that history never repeats itself, but it frequently rhymes. As I watched the awesome market volatility my mind drifted back to October 1987 when I cleared SEC comments on a client’s registration statement a week before Black Monday. As a result of the market break, the planned IPO didn’t happen, the client and its underwriter both went broke and I didn’t get paid. It was an expensive education that’s paid for itself many times over.

The market is always fickle, often brutal and sometimes downright vindictive. But it’s times of maximum ugliness, volatility and fear that give rise to the greatest opportunities. Barron Rothschild is credited with saying, "buy when there's blood in the streets, even if the blood is your own." A similar line of reasoning from Warren Buffet says investors "should try to be fearful when others are greedy and greedy when others are fearful."

While I usually avoid specific stock picks and focus on groups of companies that are likely to outperform or underperform the broader market, sometimes prices get far enough out of line with reality that I have to prepare a short list of specific companies that I think energy storage investors should seriously consider.

Exide Technologies (XIDE) is an easy double if not a triple over the next 12 months. The stock trades at 11.7 times trailing twelve-month earnings of $30.3 million. What the market fails to recognize is that Exide has finished a major restructuring that savaged its historic earnings and is not expected to impact future earnings. If you adjust Exide's historical net income to eliminate restructuring costs, you'll find it earned $69,098 in FY 2011 and $68,782 in FY 2010. On a go-forward basis, Exide is trading at 5 times earnings and 12% of revenue. With $3 billion in annual revenue and a heavy focus on the replacement battery market, Exide is well positioned to thrive even if the economy slows.

Enersys (ENS) is not as undervalued as Exide, but its current price represents 8.1 times earnings and 48% of revenue. The stock is down 42% from its June 30th close in spite of a strong quarter and favorable outlook. The stock is 50% down from its 52-week high while the broader markets are down about 15%. It all adds up to opportunity for investors who want to position themselves in an established company with solid fundamentals, a good chance for short-term appreciation and a likely double over the next year.

A123 Systems (AONE) doesn't have the immediate upside potential of Exide and Enersys, but the stock is trading at a 33% discount to the $6 per share A123 received in a public offering earlier this year. I was a critic when A123's stock was trading in the $20s, but now that the stock is trading at $4 it's a different story. My opinion on electric cars hasn't changed because the application is a foolish waste batteries and can never be economic. I have a different outlook, however, when it comes to electric two-wheeled vehicles, electric drive for buses and commercial vehicles and grid-based storage to smooth minute-to-minute variations in the power output of wind turbines and solar panels. A123 makes a fine battery and there are several substantial markets for products from its new plant. Given its solid financial foundation, fine products and modest premium over book value, I think A123 is the best bet by far in the lithium-ion battery space.

Axion Power International (AXPW.OB) is the most speculative stock on the list, but it also has the most potential. Axion has a very ugly price chart, but the last 18 months of trading have been dominated by huge supply and demand imbalances.

For calendar 2009, Axion's reported trading volume was 7 million shares and in December of that year it sold 45 million new shares (over 6 years of trading at historic volumes) in a private placement and agreed to promptly register the shares for resale. When the resale registration went effective in April 2010, the price plunged as investors who bought with short time horizons started selling. During calendar year 2010, reported volume ramped to 22 million shares and the price languished. The price started to recover in February and March of this year, which kicked off another round of selling from the 2009 investors. Total volume for 2012 now stands at 53 million shares.

After adjusting for the OTCBB double-count, the total number of shares that have moved from willing sellers to new buyers since April 2010 is just a hair over 36 million. Since Axion's stock is not volatile enough to attract day-traders, the only rational conclusion is that most of the shares sold in the 2009 private placement have been resold into the market. The one nice thing about investors who buy with short time horizons is that they eventually become small stockholders and then they become irrelevant when they run out of stock to sell.

I've been to this rodeo before and I've learned that the only stockholders that really matter are the buyers because they'll be around until their investment goals are met or they get tired of waiting. Based on trading patterns over the last 18 months I believe the 36 million shares of buying came from thousands of retail investors who have been educated by my blog, view Axion as a speculative investment and are willing to give the company time to mature and flower. Based on the available information, I think Axion is within weeks or even days of an inflection point where the price will begin a transition from undervalued to overvalued. I don't think many of the retail investors who bought over the last 18 months are likely to sell for 25%, 50% or even 100% gains. Instead I think most will wait for multi-bag returns on their investment. Then the question becomes "How far and how fast is up?" I can't even venture a guess.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

August 19, 2011

EVs, Lithium-ion Batteries and Liars Poker

John Petersen

Last week I stumbled across a link that led to a 2010 report from the National Research Council titled "Hidden Costs of Energy, Unpriced Consequences of Energy Production and Use." This free 506-page book takes a life-cycle approach – from fuel extraction to energy production, distribution, and use to disposal of waste products – and attempts to quantify the health, climate and other unpriced damages that arise from the use of various energy sources for electricity, transportation and heat. After studying the NRC's discussion of the unpriced health effects, other nonclimate damages and greenhouse gas emissions of various transportation alternatives, and thinking about what the numbers really mean, I've come to the conclusion that the electric vehicle advocates are playing liars poker with their cost and benefit numbers – emphasizing a couple areas where electric drive is superior and de-emphasizing or completely ignoring a far larger number of areas where electric drive is clearly inferior. The result, of course, is unfounded and wildly optimistic claims of superiority based on four sevens in a ten digit serial number that don't mean a thing if your goal is to evaluate the entire serial number.

The first graph from the introduction summarizes the unpriced health and other nonclimate damages arising from the use of thirteen different vehicle fueling technologies over the entire cycle life of an automobile and quantifies the unpriced mine to junkyard cost per vehicle mile traveled, including well or mine to wheels costs of manufacturing the vehicle and fueling it over its operational life.

8.19.11 Health Damages.png

The thing I found most surprising was the relative consistency of the numbers across all thirteen classes, both for today and for the future, and the fact that many advanced drive train technologies score lower than their conventional cousins because the unpriced costs of manufacturing the vehicle or processing the fuel exceed the claimed operating benefits. When you look at the realities from a cradle to grave perspective there are no clearly superior choices and the values are all clustered within ±15% of a $1.25 average. While I derive some personal satisfaction from the idea that the low cost winners are a Prius-class HEV or an internal combustion engine with a CNG fuel system, and that electric drive is just a smidgen cleaner than a diesel engine burning fuel produced from Fischer Tropsch coal liquifaction, the reality is that none of the advanced technologies are inherently better. They're just more expensive.

The game is simply not worth the candle. It’s certainly not worth the enormous expenditures of public funds that governments worldwide don't have. There’s nothing electric drive can accomplish that CNG and fuel efficiency can’t accomplish cleaner, faster and cheaper.

The second graph from the introduction summarizes the unpriced greenhouse gas damages arising from the use of the thirteen different vehicle fueling technologies over the cycle life of an automobile. While the range of variation around a current average of about 450 grams of CO2 per vehicle mile traveled is a little wider at ±25%, once again it's just not worth getting worked up over inconsequential differences that entail substantial incremental costs.

8.19.11 GHG Damages.png

One of the most intriguing take aways from these two graphs is the inescapable conclusion that the differences today are modest and as technologies mature and improve the differences will become less important, not more. By 2030, plug-ins will have no advantage over internal combustion when it comes to greenhouse gasses and be significantly worse than internal combustion when it comes to health and other nonclimate costs.

Over the years I've suffered endless abuse from commenters who decry my appalling lack of vision when it comes to lithium-ion superstars like Ener1 (HEV), A123 Systems (AONE), Altair Nanotechnologies (ALTI) and Valence Technologies (VLNC) that are certain to drive battery performance to new highs while driving manufacturing costs to new lows and enabling a paradigm shift to electric cars from Tesla Motors (TSLA), Nissan (NSANY.PK), General Motors (GM) and a veritable host of newcomers that are positioning for future IPOs and certain to change the world. While the following graph is a little dated, it shows why the electric pipe dream can’t happen unless some genius in a garage comes up with an entirely new way to store electricity.

8.19.11 Batteries.png

Liars poker can be a fun way to fritter away the hours in Wall Street watering holes like Fraunces Tavern, but it creates enormous risk for investors who hear about four sevens but never hear about the other six characters in the serial number. I've seen this melodrama before. For the period from 2000 through 2003 fuel cell developers like Ballard Power (BLPD) and FuelCell Energy (FCEL) carried nosebleed market capitalizations based solely on dreams. From 2005 through 2007, it was the age of corn ethanol kings like Pacific Ethanol (PEIX). Lithium-ion battery developers have already taken it on the chin and there's no question in my mind that Tesla will be the next domino to fall. Its demise is every bit as predictable and certain as Ener1's was.

It's frequently said that those who do not learn from history are condemned to repeat it. There isn't much I can add.

Disclosure: None. | | Comments (12)

August 18, 2011

Should We Worry About Beacon's Flywheels?

Tom Konrad CFA

How material is the failure of one of Beacon Power's (BCON) flywheels on July 27?

Last week, I published an article Four Clean Energy Value Stocks I'm Buying Now, including Beacon Power as one of the four.  My rationale for including Beacon was:
Beacon has been operating their first commercial scale 20MW flywheel energy storage plant  since early this year without mishap, achieving full capacity in June.  They are set to begin construction of their second 20MW plant later this year, 54% of the $53 million cost of which will be covered by state and federal grants, making the funding of the plant practical even for a company with a high cost of capital like Beacon.  If both plants continue the relatively trouble-free operation seen so far, that experience will pave the way for less capital-intensive turn-key sales for flywheel energy storage plants worldwide.
I was quickly contacted after my article by two disgruntled Beacon shareholders who informed me that there was indeed a "mishap" at Beacon's Stephentown plant in late July.  I had missed this incident in my research, which had consisted of a news search, reading management's discussion and analysis and the financial statements in the quarterly report, and a discussion with a Beacon employee in early July.

I generally prefer not to invest in immature technologies, but was drawn to Beacon because they seemed to have a track record with their flywheels sufficient to mostly eliminate technology risk, given Beacon's massively depressed price (currently around $1), and the fact that the company is reaching the point of significant revenue ramp, which has the potential of giving the brave investors who buy now returns of many multiples in just a few months or a year. 

Technology risk once again loomed large in my mind.  Given the information I had, I could not decide if the failure represented an isolated incident, or was a harbinger of more to come.  Was this the failure of "one out of 200 flywheels" as management prefers to characterize it, or was it the failure of one of 200 flywheels over the average 3-4 months the flywheels had been in operation?

If we only expect a failure of 1-2 flywheels (0.5% to 1%) over the life of the plant, that should not radically change the economics of the technology.  However, if we expect a failure rate of 1 flywheel every six months or so, that will make a significant difference to the operating costs of a plant that was supposed to be nearly maintenance free. 

Given this unresolved question, and the unpleasant surprise of not hearing about the potential bad news until after the fact (which made me wonder what other bad news I had not heard about) I decided to sell first and ask questions later.  Since it was the day after my article was published, I updated my article discussing the decision.

In Beacon's defense

Beacon's position on the failure of the flywheel was that it simply was not material.  The flywheel failed as designed, did not damage the rest of the facility, and its repair was "consistent with the reserves" set aside for operations and maintenance at the Stephentown plant, as Beacon CEO William Capp told me in a phone conversation this week. 

I was never worried about Beacon's technology being dangerous.  Certainly, you would not want to be standing next to a flywheel when it failed, but such failures are rare even in the most pessimistic scenario I can come up with, and people do not stand around Beacon's plants for the very good reason that they operate with extremely high voltage electricity.

My question is then, how many more flywheels are likely to fail?  Unlike some commenters, I do not immediately assume that once a flywheel is through a period of "infant mortality" they can be assumed to be safe.  I see two possible sorts of failures: failures due to manufacturing defects and failures due to wear and tear during operation. 

Beacon's engineers believe that this failure was infant mortality, so if we are to determine how much more infant mortality we are likely to have, we need some idea how long it takes this sort of defect to manifest.  Capp told me on the phone that the particular flywheel in question had been in operation for a "number of months" and that he did not know exactly how long that was.  I'll assume it was four months, to make math simpler.

Doing the math

It's very difficult to calculate failure rates from one data point, but with a Bayesian approach we can get some idea of what the failure rate looks like.  I think it's a fairly safe assumption that a flywheel with a defect is most likely to fail early on, so an exponential distribution is an appropriate probability model.  Since we only have one incident to go by, the best guess for the average lifespan of defective flywheels is the lifespan of the one that broke.  That means that the rate parameter λ will be the inverse of the lifetime of the defective flywheel, and any defective flywheel will have a 63% chance of failing in the first four months, a 86% chance of failure in the first eight months, and 95% chance of failure in the first year.

We also know that the first 30 flywheels which were in operation for one to three years at Tyngsboro are unlikely to have any defects, since any one of those which was defective would have more than a 95% chance of failure by now.  Since the 170 relatively new flywheels at Stephentown have been in service for about 4 months on average, more than half of those with manufacturing defects should have failed by now, meaning that it would be very surprising to see more than one more failure from initial defects, and not seeing any more failures is the more likely possibility.

Hence, if this failure was caused by a manufacturing defect as management believes, they are right that the total failure rate of flywheels from manufacturing defects is immaterial because it is less than 1%.

The other possibility is that the failure was due to wear and tear.  In this case, we would expect the failure rate to be fairly constant over time.  Given the average of two years of operation for the 30 flywheels at Tyngsboro, and the average four months operation of the 170 new flywheels at Stephentown, Beacon has about 120 flywheel-years of experience, during which they have experienced one failure.  So if this was a wear-and-tear malfunction, we would expect 0.6% of flywheels to fail each year, or 12% over the plant's expected 20 year lifetime.  This was the possibility that scared me into selling shortly after I wrote the article. (At the time, I did not have the numbers I do now, and my off-the-cuff estimate for the failure rate was considerably higher.)

However, we don't know that the failure arose from wear and tear, and Beacon's engineers believe that the failure was due to a manufacturing defect.  Given that information, I will assign a 2/3 probability that this was a manufacturing defect, and a 1/3 probability that this was wear-and-tear. 

Given all these assumptions, my estimate of the likely failure rate of flywheels at Stephentown over the plant's 20 year planned life will be 4%, which is probably low enough to be manageable with the plant's planned operations and maintenance reserves.


Although my estimates contain more uncertainty than hard data, I now feel that, Beacon management is likely correct that the failure of one or two flywheels in the first year of operation at the Stephentown plant is not material.  Any flywheel failures after the first year of operation would be a much greater cause of concern, as that would lend credence to the possibility that flywheels sometimes fail due to wear and tear, something that would have much greater impact on the cost of operating a flywheel plant.

Hence, I return to my original position that Beacon Power (BCON) is a compelling if highly speculative stock pick at the current $1 price.


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

August 10, 2011

Four Clean Energy Value Stocks I'm Buying Now

Tom Konrad CFA

Corrected version 8/11/2011

Apologies to readers who have been missing my articles recently.  I've had little time to write as I have been too busy trading.  Long-time readers know that I've been bearish since the summer of 2009, and it has been a painful two years as I maintained my short positions and puts in the face of a generally rising market. 

Market Outlook

In my opinion, we are still a good distance from the bottom.  The rise of the stock market over the last two years has been predicated on stimulus spending at the Federal level and Quantitative Easing (QE) from the Federal Reserve (Fed).  Today, not only has stimulus spending ended, the recent debt limit deal sets the Federal government on a decidedly contractionary path.  While reducing government spending is prudent in the long term, it is bound to have negative effects in the short term. 

On the monetary side, rumors were circulating that the Fed  might announce a third round of QE at their meeting on Tuesday, but instead the chose to keep interest rates at record low levels into 2013.  As Chris Gaffney, CFA wrote in the Daily Pfennig, "the Fed was basically admitting the US economy will be stuck in a rut for the foreseeable future."  While low interest rates generally do provide a stimulus to the economy, that stimulus acts by stimulating borrowing.  But both taxpayers and governments are borrowing less in an attempt to get out of debt, meaning the stimulative effect of continued low interest rates is likely to be muted.

With that backdrop, and business confidence undermined by the current decline in the stock market, a double-dip recession seems likely, assuming you believe we ever left the recession.  This should lead to further market declines over the coming quarters, so I don't think that we have reached a bottom by any means. 

Buying Opportunities

On the other hand, the rapid declines over the last two weeks have lead to a combination of panic selling and forced selling due to margin calls, which is pushing many stocks out of their fair value range.  Further clean energy stocks had already been pummeled by significant declines over the last two years, even as the broad market was rising.

I now believe that selected clean energy stocks are trading at prices that we are unlikely to see again because of indiscriminate selling to meet margin calls.  What follows is a list of stocks I've purchased over the last couple weeks, and why I think they represent good values now.

New Flyer Industries (NFYIF.PK/NFI.TO)

New Flyer is currently going through a conversion from its former unusual stapled security structure to a more traditional structure (see here and here.) After conversion, management says that the stock will pay a dividend of approximately half the current level, or about C$0.48 annually.  With the stock trading at C$6.59 as I write, that's an annual dividend yield of 7.3%, which should be well covered by earnings.   I most recently bought shares for US$6.66 on Wednesday.

Note: If you plan to buy before the conversion deadline of Aug 18th, make sure that your broker has not set an earlier deadline.  Unconverted IDS's will be worth less than the exchanged shares.  However, if you can buy IDS's for C$6.50 or less, I think they will still be a excellent value even after the dilution caused when other New Flyer IDS shareholders exchange their notes for additional shares.

Beacon Power Corporation (BCON)
Beacon has been operating their first commercial scale 20MW flywheel energy storage plant  since early this year without mishap, achieving full capacity in June.  They are set to begin construction of their second 20MW plant later this year, 54% of the $53 million cost of which will be covered by state and federal grants, making the funding of the plant practical even for a company with a high cost of capital like Beacon.  If both plants continue the relatively trouble-free operation seen so far, that experience will pave the way for less capital-intensive turn-key sales for flywheel energy storage plants worldwide.  I most recently bought shares of BCON for $0.85 on Tuesday.

CORRECTION: There was a "mishap" at Beacon's Stephentown plant on July 27.  Since this undermines my thesis for buying the stock, and there are many other opportunities, I have sold my positions.  The fact that this was not mentioned in management's discussion and analysis section of the most recent quarterly report is troubling, in that it shows a lack of commitment to full transparency.  I did find it in Item 1A. Risk factors: "In July 2011, one of the 200 flywheels in Stephentown failed.  We are currently investigating the root cause and the appropriate corrective action for this failure. Our system operated as designed, and no other equipment was damaged.  However, over the life of the plant, if we incur significantly higher than anticipated repair and maintenance costs, it could have a materially adverse effect on our business."

Thanks to the commenter who brought this to my attention.

UPDATE 8/18/11: An in-depth look at the implications of the Stephentown "mishap."

Great Lakes Dredge and Dock (GLDD)
When I wrote about GLDD last year as part of my Peak Oil investments series, I said it seemed like a bargain at $4.50.  The combination of disappointing second quarter results due to equipment downtime and the general market decline dropped the stock back below $4.50 on Aug 8th, when I made my most recent purchase.  I'm not sure where the bottom for this stock lies, so that was a small purchase which I expect to add to if the stock continues to decline. 

Waste Management (WM)
Last week, I wrote about trash stocks as possible income investments on Forbes, just as the market was beginning the current downward leg of its decline.  My top pick at the time was WM due to a low debt to equity ratio and a relatively high dividend reasonably well covered by cash flow and income.  I bought some at $29.60 on August 8th, and plan to buy more if the stock declines further.


Market panics are always a good time to pick up solid income investments at discounted prices, a description which applies to both New Flyer and Waste Management.  Great Lakes Dredge recently raised their dividend to $0.08 annually, for a 2% yield at $4.50, and the dividend is very well covered by last year's earnings of $0.59 and even this year's expected earnings of $0.35, which does not make it an income stock, but does make it look like a good value bet.

The sole speculative company is Beacon, which is currently trading well below its book value of $1.19, and is in the process of rapidly increasing revenues, which give it significant upside potential.

In the current market climate, any of these stocks could fall significantly lower: panic selling and margin calls pay no attention to valuation.  But if they do fall farther, I will be buying more, at even better values than today.


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

August 07, 2011

Lithium-ion Batteries and 8-Track Tapes

John Petersen

In three years of writing about investing in energy storage, I’ve learned that most public relations nightmares encountered by battery companies are self-inflicted wounds. They do an appalling job of managing the expectations of investors and potential customers. Then, when the inevitable delays, disappointments and cost overruns arise, everybody suffers. It may not be their fault, but it is most certainly their problem.

Most of my long term readers have seen this timeless and blistering 1883 Thomas Edison quote:

“The storage battery is one of those peculiar things which appeals to the imagination, and no more perfect thing could be desired by stock swindlers than that very selfsame thing. Just as soon as a man gets working on the secondary battery it brings out his latent capacity for lying.”

Edison understood innovation problems well, but he didn’t understand innovation problems in the battery industry until he tried to develop a better battery for use in electric cars and failed to win the hearts and minds of a grateful nation.

The essential truth most battery developers fail to recognize is that the problem isn’t their products or even their development plans; it’s the fertile imaginations of investors and potential users who read about gee-whiz discoveries in research laboratories, overestimate the importance of the developments and make wildly optimistic leaps from the possible to the absurd. Battery developers don’t lie to investors and potential users; but the investors and potential users lie to themselves and then blame the industry for failing to meet their patently unreasonable expectations.

My first job after law school was in the Houston office of a Big-8 public accounting firm that had a substantial oil and gas tax practice. On my first day at work, the partner in charge of our group hauled me into his office and explained that every oil project in history could be explained with a simple Venn diagram.

8.8.11 Target.png

Over the last 30 years I’ve learned to my chagrin that this Venn diagram is not just an overview of the oil industry, it’s a fundamental truth that applies to every form of human interaction and endeavor from sex to science to business to politics, especially politics. Over the years I’ve worked with some of the finest minds on the planet, but I’ve never been involved in a project that didn’t take twice as long, cost twice as much and deliver half the expected result – and that’s when everything went right.

A truly bizarre twist that I’ve only encountered in the energy storage industry is that developers report modest results, but a hyper-imaginative public adds a couple layers of expectations, eliminates all time and materials constraints, assumes a roll-out speed that would make Steve Jobs jealous and fabricates outlandish promises developers didn't make and can’t possibly keep.

I think it all boils down to the fact the world desperately wants better batteries but doesn’t understand the magnitude of the challenge and isn't really willing to pay the price. At last year’s ELBC I spoke with an executive from India, who described batteries as “a grudge purchase.” The sad part is he’s right. We don't buy batteries because we want them. We buy them because we need them. In most cases, we don't even think about batteries unless they need to be recharged or replaced. Is it any wonder that the adjective most commonly associated with batteries is “damned?”

The finest examples of horrible expectations management are found in the advanced battery space where Secretary Chu of the US Department of Energy frequently says things like this:

"And what would it take to be competitive? It will take a battery, first that can last for fifteen years of deep discharges. You need about five as a minimum, but really six- or seven-times higher storage capacity and you need to bring the price down by about a factor of three. …

Now, how soon will that be? Well, we don't know, but the Department of Energy is supporting a number of very innovative approaches to batteries and it’s not like it’s ten years off in the future, in my opinion, it might be five years off in the future. It's soon.”

This is a fair statement of the DOE’s goals. They’re pushing very hard to develop new technologies that will leapfrog the state of the art in the battery business. What the DOE never explains, however, is that any major advance will make all of today’s spiral-wound batteries obsolete before their developers have a chance to become profitable.

The data in the following graph was taken from quarterly and annual reports that A123 Systems (AONE) has filed with the SEC over the last 30 months. It compares their quarterly revenue per kWh of batteries shipped with their adjusted cost of goods sold (after backing out unabsorbed manufacturing costs) and their gross margin per kWh.

8.8.11 A123 Graph.png

The purchase prices paid by A123's customers have been gradually declining, but their manufacturing costs have climbed and their gross margins have turned sharply negative. Without gross income, net income isn't even a pipe dream. I expect the dynamic to change when A123's new factory is brought on line, debugged, optimized and ramped to reasonable capacity utilization rates. But that transition is not going to happen quickly and until it occurs A123's stock price will continue to languish.

My next graph comes from the current issue of Science and shows why the spiral-wound lithium-ion battery can never be a viable long-term solution.

7.17.11 Science Graph.png

It doesn’t take a rocket scientist or electrochemist to see that lithium-ion batteries can’t ever meet Secretary Chu’s goals of six or seven times more energy at a third of the cost. That will require a different kind of battery and a different kind of battery manufacturing infrastructure. No matter what you believe the next big thing will be, it’s clear that today's lithium-ion batteries are a dead end – the 8-Track tapes of the battery world and little more than a transition technology from what we have to what we need. This Jan Darasz cartoon from the current issue of Batteries International Magazine is too true to be funny.

8.8.11 Darasz.png

Readers frequently assume I’m a Luddite who can’t or won’t see the future. The fact is I see the future all too clearly and know to a certainty that lithium-ion batteries are the barest of beginnings, not the Holy Grail. The true Luddites are the EVangelicals who are so enthralled with the EV dream that they refuse to see that our very best batteries are not good enough for the short term and can never be good enough for the long term.

The global fleet of 800 million cars and light trucks all depend on lead-acid batteries for starting, lighting and ignition functions. Within a few years, all new cars will come with stop-start idle elimination systems as standard equipment. No matter what happens in the sexy battery space over the next five to ten years, that fleet will need replacement batteries for decades to come. Established lead-acid battery manufacturers like Johnson Controls (JCI), Enersys (ENS) and Exide Technologies (XIDE), together with advanced lead-acid battery innovators like Axion Power International (AXPW.OB), will have a long and profitable run regardless of what happens in the sexy space.

While I can’t make any predictions about timing, it is only a matter of time before one of the scientists in one of the labs that are working on better batteries has a Eureka! moment. When that moment arrives, the new technology will become the darling of EVangelicals, automakers and maybe even utilities, and the market potential of lithium-ion batteries will be capped forever at the number of vehicles that are made between now and then using a bridge technology.

As a broker friend of mine once observed, a bridge that only connects with land at one end is more properly called a pier.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

August 04, 2011

New Flyer: An Offer You Can't Refuse

Tom Konrad CFA

A couple readers have asked me if they should accept the New Flyer (NFI-UN.TO/NFYIF.PK) Rights offering to exchange their C$5.53 principal 14% subordinated notes for nine shares of New Flyer common stock.  The answer is most emphatically YES.

When I last wrote about New Flyer, I knew that they were planning to convert from their unusual stapled security structure to a more conventional share structure, but I was not certain how they could entice IDS holders to go along with the swap. 

Now, it's clear.  The New Flyer IDS is the combination of the C$5.53 note and one common share of New Flyer, and currently trades for C$7.66.  The subordinated note is worth more than the face value because of the high interest rate, but is callable for C$5.80 next year, and hence is worth no more than about C$6.40 (call price plus interest) if not exchanged.  That means New Flyer common shares are currently worth at least C$7.66-C$6.40 = C$1.26.

The Tender offer gives you the right to exchange the IDS for 10 common shares (one that you already own, 9 in exchange for the subordinated note).  This is worth at least C$12.26, 60% more than the current IDS price.

When New Flyer issues all these new common shares in exchange for subordinated notes, note holders who make the exchange will have an instant gain, but the value of all shares will be diluted.  Since only the company structure is being changed, not its net value, if everyone exchanges their notes for common shares, the whole exchange will be a wash in terms of the value to IDS holders.  But any IDS holder who chooses not to make the exchange will not participate in the gain, yet they will still be diluted by all the new shares issued, and hence will suffer a net loss. If some IDS holders choose not to exercise the Rights, those who do make the exchange will benefit at the expense of any IDS holders who do not exercise their Rights.

In other words, although this exchange is voluntary, any IDS holder who chooses not to participate will suffer immediate dilution and a net loss in the value of their share large enough to more than offset any benefit from holding on to the high-interest subordinated note until it is called.

If you're a New Flyer IDS holder, you've been made an offer you can't refuse.  Don't.


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

August 03, 2011

Climate Bond Standard to be Released This Week

Tom Konrad CFA

Conserving the planet for conservative investors.

Investing in clean energy stocks has an (often well-deserved) reputation for risk.  Although energy efficiency and more inclusive progressive energy indexes have held up fairly well over the last few years, the performance of narrower clean energy sectors has been dismal, and some industry observers feel that the declines in wind and solar are structural (and hence permanent) as opposed to cyclical (and therefor temporary.)

This presents a conundrum for investors with long time horizons who not only need their investments to earn a steady return and meet long term financial obligations, but also care about the long term health of the planet.  Individuals saving for retirement, as well as many pension funds and insurers match this profile. 

Why should such long term investors care about the environment?  Because runaway climate change has the potential to undermine the goals which they are saving to achieve.  If a property insurer doubles its money by investing in businesses that increase the frequency of floods, droughts, and hurricanes, the financial gains will be undermined by an increase in claims.  A retired couple will be happier and healthier on any given amount of money if the Florida condo where they planned to retire is not inundated by sea level rise, ocean acidification has not destroyed the coral reefs where they want to take their grand kids snorkeling, and they can feel optimistic about those same grand kids' future health and economic well-being not being undermined by environmental toxins and energy insecurity.

Funding Clean Energy

There is a temptation to compare investing in clean energy to investing in information technology (IT), since both are rapidly advancing technologies that are disrupting old, inefficient ways of doing things.  But clean energy is fundamentally different from IT in that it is very capital intensive.  Lists of the most successful college drop-outs in history are dominated by IT moguls who started companies in their garages or with minimal capital: Bill Gates, Larry Ellison, Larry Page, Micheal Dell, Paul Allen, and Steve Jobs, are six of the top ten on one list I found.

It's unlikely that the same list will be filled with clean energy entrepreneurs thirty years from now, because clean energy start-ups are capital-hungry, and college drop-outs have a harder time convincing investors to part with a few million dollars than businessmen with degrees and successful careers behind them.  Clean energy projects are typically even more capital-intensive than traditional energy projects (with the exception of nuclear,) because the low fuel and operating expenses come at the cost of higher up-front costs. 

According to an IEA 2010 report, between $600 billion and $1 trillion will be required every year until 2030 above existing infrastructure requirements in order to transition to a clean energy economy.  The Stern report places the economic costs of avoiding dangerous climate change at approximately 2% of global GDP.  Only the global bond market has the necessary amount of capital to deploy, but nearly all fixed income investments in low carbon technologies have very short maturities, and do not match the investment needs of the conservative institutions that would prefer green investments over brown ones, if they only had the option.

Climate Bond Initiative

The Climate Bond Initiative was founded in late 2009 to bridge the gap between the needs of fixed income investors and the needs of clean energy developers.  The initiative's goal is to catalyze the issuance of Climate Bonds to finance the global transition at speed and scale.  To do this, the Initiative is developing the financial infrastructure necessary for the new class of Climate Bonds to emerge with the speed and scale necessary for the task at hand.  Large pension funds such as the California State Teachers’ Retirement System, investor groups such as the Ceres Investor Network on Climate Risk,  governments like the California State Treasurers’ Office, and nonprofits such as the Natural Resources Defense Council worked together to create a Climate Bond Standard which will be suitable for the broadest possible range of investors and projects, while still giving investors an assurance that the underlying projects are indeed helping to mitigate climate change.

The Climate Bond Standard was initially scheduled to be released at the end of July, but it was expanded to include a broader range of bond types, and so the release is now scheduled for this week.

For the Small Investor

The limited number of Climate Bonds issued to date have mostly been sold in the commercial market, but we can hope that the new Standard will catalyze the issuance of Climate bonds available to the retail investor as well.  While retail investors are unlikely to provide a large fraction of the funding needed for the clean energy transition, retail investors can play important roles in helping to engage the public in the effort to tackle global warming, and help draw attention to the efforts of participating institutions. 

In my opinion, retail Climate Bond offerings cannot come soon enough.  When small investors see that green energy investing can not only be the right thing to do for the planet and our grandchildren, they are more likely to give political support to government initiatives that remove the barriers and confront the vested interests that are holding back the transition to a clean energy future.

Not to mention I'd like to buy a few Climate Bonds for my own IRA.


August 02, 2011

Modern Energy Forum: Denver, CO – Sep. 13-15, 2011

The fifth annual Modern Energy Forum is the premier conference in 2011 for investors who want to have one-on-one conversations with some of the brightest stars and leading investors and experts in emerging clean tech companies. Please consider this your invitation to attend.

Some of this year’s highlights include:

  • Keynote speaker Dick Rutan, on the 25th anniversary of his pioneering Voyager non-stop flight around the world.
  • Test drives for registered attendees of a Tesla roadster on the streets of downtown Denver.
  • Experts and investors will share wisdoms about batteries, electric vehicles, PV, wind, water, nuclear, biomass, biofuels, geothermal, and energy.

The Modern Energy Forum is a private, exclusive event that showcases premier modern energy companies presenting their stories to an elite list of institutional, private and buy-side investors and customers. We take the time to match all attendees for private one-on-one meetings that are pre-arranged to optimize the conference experience and create a foundation for continuing successful business relationships. If your company is interesting at presenting at the conference, please visit this link.

For 25 years, we have specialized in putting investors and businesses together in a comfortable, personalized atmosphere. Attendees keep coming back year after year because of these three reasons:

1. We accept only the most qualified companies that meet certain criteria designed to make them attractive to investors.
2. We maintain a pre-specified ratio of investors to businesses, which allows investors to spend their time getting to know executives from good companies.
3. We make time for 1:1 meetings.

For more information on this year’s conference, or to register to attend, please visit our website or contact Alexis Bogart at 303-377-6463 or alexis@minellc.com.

Michele Ashby

The preceding post is a Special Information Supplement by our Featured Company MiNELLC.

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