The Energy Report: A large number of photovoltaic (PV) manufacturing firms went bankrupt during the past year. What is the outlook for solar energy firms?
Pavel Molchanov: Most of the solar bankruptcies that took place in the U.S., Europe and China have occurred among companies that manufacture solar modules. But it's important to note that a bankrupt company does not necessarily shut down production. About 75% of these companies, as measured by production capacity, have continued to operate, either on a stand-alone basis during bankruptcy or following an acquisition by a strategic partner.
Take, for example, China's Suntech Power Holdings (STP:NYSE). It was the largest solar manufacturer in the world as recently as 2011. It declared bankruptcy in March, and continues to operate and generate revenue. Solyndra, of course, has been wiped off the face of the earth. But such liquidation is a very rare outcome for large solar companies that take temporary refuge in bankruptcy.
TER: Are bankrupt, producing solar companies attractive investments?
PM: Rule of thumb: Do not invest in a bankrupt company! The broader point is that bankrupt solar companies are continuing to contribute to the overcapacity that plagues parts of the industry. A year ago, the amount of production capacity exceeded demand by a ratio of 2:1. In other words, the industry had twice as much production capacity as there was global demand. Obviously, that is an absolute nightmare. Since 2012, though, overcapacity has been reduced a bit as certain bankrupt firms were liquidated. Meanwhile, demand for solar modules has picked up. My best guesstimate of the overcapacity in the solar industry is about 60%--which is still a challenging situation for any manufacturing industry, but not as bad as it had been.
TER: Please explain what you mean by the term "clean tech."
PM: Clean tech is an investment theme that comprises a broad set of industries, including solar, wind, biofuels, natural gas fuels, fuel cells, electric vehicles and smart grid. The overarching theme is production and distribution of energy using technologies that are more environmentally sustainable than conventional methods
TER: What are solar inverters?
PM: Inverters transform DC current to AC current and connect a solar system with the grid. Modern inverters are very sophisticated pieces of electrical equipment. The competitive landscape for inverters is much more manageable than for solar panels.
TER: What firms are hot in the solar inverter space?
PM: Advanced Energy Industries Inc. (AEIS:NGS; AEIS:BSX) is the third biggest inverter company in the world behind SMA Solar Technology AG (S92:Xetra) from Germany and ABB Ltd. (ADR:NYSE) from Switzerland. It is the biggest U.S.-based manufacturer of inverters. On average, inverter gross margins are in the 20–30% range, double the margins for panel manufacturers.
TER: Is Advanced Energy a start-up?
PM: Advanced Energy has an interesting history. Until about five years ago, it was barely involved in the solar industry. It was primarily a semiconductor capital equipment provider selling to customers such as Applied Materials Inc. (AMAT:NASDAQ). Through acquisitions and organic growth, Advanced Energy has morphed into much more of a solar company; this year more than half of its revenue comes from the sale of solar inverters.
TER: What other promising clean tech firms do you follow?
PM: EnerNOC Inc. (ENOC:NASDAQ) is a one-of-a-kind company. It provides demand response services to utilities and energy management services to enterprises. About 90% of its revenue comes from utilities and 10% from enterprise customers. For utilities, demand response aims to prevent blackouts in times when power demand exceeds supply. Traditionally, utilities compensated for excess demand by building peak-power plants, which are capital-intensive investments that mostly just sit there and depreciate. By contrast, EnerNOC connects electric utilities with commercial and industrial power consumers, reducing the need to build peak-power plants. It prevents blackouts—most recently in the mid-Atlantic region in September—by carefully controlling and curtailing power consumption, spreading the pain across a broad base.
TER: What happens when a utility signs up with EnerNOC?
PM: The utility assigns EnerNOC a quota of megawatts that EnerNOC's sales force needs to fill. Commercial and industrial power users in that utility's region sign up to enter EnerNOC's network. When the grid is stressed and demand is at the risk of exceeding supply, the utility automatically signals EnerNOC's computers. The machines take over and reduce power consumption by the commercial and industrial consumers. In an office building, for example, thermostats will go from 72 degrees to 74 degrees in the summer. Most people will not even feel that increase. Or if there are 10 production lines in a factory, one line might be turned off. It is much more controlled and manageable than rolling blackouts.
TER: How does this affect the price of electricity?
PM: The utility pays EnerNOC a fee for having the megawatts available, even if the energy is never utilized. In other words, if the utility does not end up needing any of this demand response, then EnerNOC gets paid anyway. And, best of all, when there are demand response events, and EnerNOC is called upon to activate its network, it is paid extra. About half of EnerNOC's revenue is transferred to the commercial and industrial power users as their compensation for simply being in the network.
TER: Are EnerNOC's financial fundamentals sound?
PM: One reason that I like EnerNOC as a stock is it has a high free-cash-flow yield, not just by clean tech standards, but by anyone's standards. This year, we estimate that EnerNOC's free cash flow yield will exceed 12%. Next year, it could exceed 16%. These are very high numbers. Because its business model is based on recurring revenue, there is a certain similarity between EnerNOC and the software-as-service platform, which is justifiably popular among investors.
TER: Are you following any natural gas companies involved in exporting liquefied natural gas (LNG)?
PM: Exporting LNG—whether from North America or Australia or Qatar—is an interesting theme, but it is not part of clean tech. What does fall in the clean tech category is the production of liquefied and compressed natural gas for powering fleets of trucks and buses.
"Clean tech is an investment theme that comprises a broad set of industries, including solar, wind, biofuels, natural gas fuels, fuel cells, electric vehicles and smart grid."
There are several companies that participate in this market. They are not all buys, but I am very positive on Chart Industries Inc. (GTLS:NGS; GTLS:BSX). Among other things, it makes the equipment that is installed at fuel stations to convert natural gas into LNG for trucking transport. Chart Industries is a diversified business. It has leverage to many other types of gas consumption, not just LNG. It is a profitable company with positive free cash flow. And it has nice leverage to various international markets, especially China, not just North America.
I watch some other companies in the natural gas transportation theme. Clean Energy Fuels Corp. (CLNE:NASDAQ) is a fuel distributor for both compressed natural gas and LNG, but the stock is overvalued right now. If investors are looking for a good trade, I suggest go long Chart Industries and short Clean Energy Fuels. Both companies are connected to the same theme—but one is very well positioned, and the other not so much.
A Canadian company with leverage to this theme is Westport Innovations Inc. (WPT:TSX; WPRT:NASDAQ). It makes engines for natural gas vehicles. It is an interesting company with a differentiated technology, but it is also a very expensive stock and not worth chasing at current levels. I am neutral on Westport for the time being.
TER: What about clean tech consumer products?
PM: There are some public companies that use renewable feedstocks, especially sugar cane, to produce materials that can be turned into cosmetics or nutrition products. Solazyme, Inc. (SZYM:NASDAQ) uses an algae technology platform. It is going into commercial production in the U.S. and Brazil to make oils that can be turned into nutrition and cosmetics products. In the long run, I anticipate that Solazyme will focus more on chemicals and fuels—but for now, it has good traction in the consumer arena.
TER: Are clean tech industries as a whole responsive to political crises like the oil and gas industry is?
PM: One of the nice things about clean tech companies is that they do not have to worry about wars in the Middle East. They do not have to worry about nationalizations. They do not have to worry about oil spills: You cannot spill solar power or wind power. You could spill some ethanol, but that would hardly be the end of the world.
"One of the nice things about clean tech companies is that they do not have to worry about wars in the Middle East. They do not have to worry about nationalizations."
Political risk for these companies does exist, but that is related to governments suddenly changing policies that support the adoption and deployment of renewable energy. For example, in Europe, solar subsidies have been cut, and that has slowed down solar installations in Europe. Conversely, in China, the solar market went gangbusters this year because the government is pushing very aggressively for it.
In the U.S., renewable fuels have historically been politically popular in Washington on a bipartisan basis. The Renewable Fuels Standard, a set of regulations developed by the Environmental Protection Agency, requires the industry to use increasing amounts of biofuels through 2022. Meeting the standards will require increased production of advanced biofuels and cellulosic biofuels, both of which are early-stage industries. Corn ethanol has lately caused some political controversy, but the newer kinds of biofuels have not.
Advanced biofuels can be manufactured from different types of biomass, including sugars, vegetable oils and corn, whereas cellulosic biofuels are made from non-food materials. That means no sugar cane or soybean oil resources are used—nothing that would compete with food production. Cellulosic fuels are based upon switchgrass, miscanthus, wood chips or municipal solid waste, all of which have the advantage of lower input costs.
We also like a company called KiOR, Inc. (KIOR:NASDAQ), which is the only public pure play on cellulosic biofuels. It makes gasoline and diesel, not ethanol, from wood chips. KiOR's first commercial plant, in Mississippi, began producing earlier this year and is currently in the process of ramping up.
TER: Any final thoughts to share with investors?
PM: Political leaders the world over have almost unanimously concluded that cleaner, lower-carbon, renewable energy should be supported by governments. Europe has historically led the way in solar and wind adoption. Biofuels are much more prevalent in the U.S. and Brazil. China is now becoming a major driver of demand for renewable energy. In markets that some people may not normally associate with renewable energy, such as Thailand, South Africa and Chile, the clean tech sectors are starting to get traction at the political level. All that is encouraging for clean tech investment in the long run. It's worth keeping in mind that some of these companies are earlier-stage businesses that are a ways off from profitability, so the risk profile of clean tech tends to be on the high side.
TER: Thanks for your time, Pavel.
PM: Cheers, Peter.
Pavel Molchanov joined Raymond James & Associates in June 2003 and has worked as part of the exploration and production research team since that time. He also initiated coverage on the alternative energy sector in fall 2006. Molchanov became an analyst in January 2006. He graduated cum laude from Duke University in 2003 with a Bachelor of Science degree in economics with high distinction.
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1) Peter Byrne conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
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3) Pavel Molchanov: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Chart Industries Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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