Another Alternative
Energy was one key focal point of the president’s State of the Union address last night. Among other points, Bush sought to promote the dramatic expansion of alternative energies and biofuels like ethanol. He even proposed increasing the target amount of ethanol and other biofuels mixed into US gasoline to 35 billion gallons in 2017; that represents a significant increase in the prior target of 7.5 billion gallons by 2012.
And the president isn’t alone in promoting alternative energies. Whether it’s windmills, solar panels or biofuels, governments the world over are using subsidies, tax breaks and mandates to promote greater use of nontraditional fuels.
And polls consistently show broad public support for such initiatives; right or wrong, politicians will continue using alternative energy as a means of currying favor with the populace. This is powering a bull market in alternatives that has little relation to the price of oil or natural gas.
In This Issue
As long-time subscribers are well aware, I believe that the potential contributions of biofuels, wind power and solar panels are all-too-often overstated. But whether these technologies ever reach their potential or not, there’s no denying that there will be rapid growth. And rapid growth spells massive opportunity for investors.
We’re already playing many of these key themes in The Energy Strategist. Uranium and nuclear power remain my No. 1 long-term growth play; this is the only clean “alternative” energy technology that could truly make a massive contribution to the globe’s electric grid.
The world is finally starting to catch on to that potential, and nuclear plants are being constructed all over the globe. Our uranium field bet, reviewed below, has produced some nice gains for the model Portfolio to date, and I still see more upside.
We also introduced a biofuels field bet in 2006 (reviewed and explained below) that’s done very well. In this issue, I’m adding yet another play on biofuels to my field bet.
But one area I haven’t yet covered to its full extent is other alternatives, such as wind power and solar panels; both technologies have drawbacks but are seeing huge investment. In this issue, I’ll inaugurate a field bet to play the bull market in these technologies as well.
Although alternative energies won’t take the place of staples such as natural gas or oil, they will play a part in the overall energy issue worldwide. I’m initiating a new field bet for diversified portfolio coverage. See Talking Alternatives.
At the forefront of alternative energies are hydroelectric, wind and solar powers. As noted above, they won’t be enough to replace other sources, but each as its pros and cons. See Where We Are.
Many countries are trying to promote the increased use of alternative energies through the use of subsidies and systems such as feed-in tariffs. Although their production targets may be a bit lofty, the potential for growth and investment gain is right on track. See Growth And Policy.
As with previous recommendations regarding nuclear power and biofuels, I’m recommending a field bet for alternative energies to cast a wide net over the sector and decrease risk. I detail my picks for this bet here. See How To Play It.
Nuclear power and biofuels are still two of my favorite sectors. Biofuels especially continue to enjoy rising prices. I update my field bets on these two areas here, as well as detail a new addition for biofuels that captures commodities contracts as opposed to actual stocks. See Nuclear And Biofuels.
In this issue, I’m recommending or reiterating my recommendation on the following stocks:
Talking Alternatives
Alternative energy has an almost intoxicating allure. After all, most would agree that electricity is a necessity, not a luxury.
However, generating that power produces some unintended, harmful environmental side effects. Technologies such as wind and solar seem to offer an easy way out, a means of generating power with minimal environmental impact.
In addition, most countries are dependent to at least some degree on oil and natural gas imports for their energy needs. For example, Europe’s dependence on Russia for both oil and natural gas supplies has recently become a major bone of contention on the continent.
Twice over the past two years, Russia has cut off supplies temporarily because of pricing disputes with former Soviet satellite states. Although there was never any real danger of running out of supply, these events did serve as a reminder of just how energy dependent the region is. Even the United Kingdom (UK), traditionally a net exporter of oil and gas, is planning to import Russian commodities as the country’s vast reserves in the North Sea are depleted.
Similarly, the US depends on imported oil for roughly two-thirds of its daily consumption; dependence has grown markedly since US oil production peaked in the early 1970s. By the middle of the next decade, America will also become one of the world’s larger importers of liquefied natural gas (LNG). And with China, India and other fast-growing countries also stepping up imports, America will be competing with all these countries for energy supplies.
Alternative energy appears to offer a chance for the world to have its cake and eat it, too. Wind and solar power produce no direct emissions of pollutants such as sulphur dioxide, mercury or nitrous oxides.
Countries are increasingly moving to control emissions of greenhouse gases such as carbon dioxide; such gases aren’t an issue with alternative energy facilities. In addition, sunlight and wind aren’t resources that we have to import; there’s no dependence on foreign supplies.
Sadly, this dream doesn’t represent reality. All too often, alternative energy gets pitched to investors as some sort of panacea to cure the world’s energy problems; as I detail later in this issue, these claims just don’t add up.
The simple fact is that alternative energy technologies such as solar and wind power will never be able to replace coal, natural gas and nuclear power in either the developed or developing world. The idea that any country can achieve full energy independence by spending more money on such technologies is naïve at best.
However, just because alternatives aren’t a cure-all for pollution and energy independence doesn’t mean that we can’t make money investing in the sector. It also doesn’t mean that such technologies have no place in the global energy puzzle. The truth is there’s no single golden solution for the world’s energy shortages–a wide variety of technologies will play a role.
Undoubtedly, modern clean coal plants will vastly ameliorate the environmental reputation of this cheap, abundant fuel. And my favorite solution of all, nuclear power, is increasingly enjoying a global Renaissance: Nuclear power generates no dangerous emissions of any pollutant. And although we can’t rely solely on alternative technologies, wind and solar power will play a supporting role in this environment.
Even more important, alternative energy stocks are unique in the energy industry; the performance of these stocks has little to do with the price of oil, natural gas or any other commodity because the primary driver of these stocks isn’t the market, but politics.
Countries the world over promote alternative technologies with subsidies, direct generation targets and mandates. As long as these subsidies persist, alternative energy technologies can grow regardless of what happens to oil, natural gas prices and electricity prices.
And if recent history is any guide, these subsidies are likely to grow, not decline, in the coming years. Although alternative energy technologies are limited, the public is broadly supportive of such technologies and so are politicians.
In the US, for example, congressional Republicans and Democrats are currently debating over tax breaks for oil and gas companies, but both parties are supporting various renewable fuel initiatives. European countries have a long history of supporting green renewable technologies–new European Union (EU) initiatives set out earlier this month place a good deal of weight on furthering alternative energies.
I’m not here to comment on whether this type of subsidy makes sense; the only important point is subsidies for alternative energy are present worldwide and are powering strong growth for the group. That means that alternative energy isn’t just a leveraged bet on commodity prices or growing energy demand.
Bottom line: The market for wind and solar power globally is tiny when compared with that of oil, natural gas or even uranium. However, these technologies are seeing rapid growth from that low base, helped along by generous government subsidies.
And constant, incremental technological improvements are dramatically cutting costs and widening the applications for such fuels. That rapid growth coupled with little commodity price exposure is a recipe for strong stock market performance.
To take advantage of that potential, I’m initiating an alternative power field bet as I’ve already recommended with biofuels and nuclear power. Every portfolio can benefit from some diversified exposure to alternative energy.
Back To In This Issue
Where We Are
I define alternative energy to encompass any energy technology that doesn’t involve hydrocarbons such as oil, coal or natural gas. As such, both nuclear power and biofuels fit into this category. I’ve already recommended myriad ways to play these two markets and review my top picks at the end of this issue. For now, however, I’ll focus my attention on other alternative technologies.
Check out the chart below for a closer look at where the world derives its energy.
Source: Energy Information Administration (EIA)
This chart covers global primary energy use. This measure doesn’t differentiate between uses for energy; in other words, this chart doesn’t make a distinction between energy products used for transportation fuel and energy used for electricity generation.
Instead, it’s based on total global energy use in quadrillions of British Thermal Units (Btus) commonly called “quads.” For those unfamiliar with the term, a Btu is the amount of heat needed to raise the temperature of a pound of water by 1 degree Fahrenheit. This is roughly equivalent to the energy released by burning one common kitchen match. A quadrillion is a 1 followed by 15 zeroes; it’s a big number to say the least.
On that basis, it’s clear that the three most-important fuels globally are oil, natural gas and coal, together accounting for more than 85 percent of the energy consumed annually. These power sources are followed by nuclear and hydroelectric power with about a 12 percent share combined. The other alternatives–including geothermal, wind and solar–account for less that 1 percent of the primary energy consumed worldwide.
Because both solar and wind are typically used to produce electricity, check out the chart of US renewable electric capacity by energy source. (Note that I excluded nuclear power from this chart to focus on just non-nuclear alternatives.)
Source: EIA
Of the alternative energies used in the US (and worldwide), hydroelectric power is far and away the most important. Hydropower is clean and efficient, but it’s not a fast-growing technology in most markets. The reason is there’s a physical limit as to how many dams you can place on a given river system; in the US, there just aren’t many rivers left that are suitable for such projects.
And many parts of the world are experiencing a water shortage; China and parts of the western US are two examples. Dam projects have to be carefully planned with an eye toward maintaining sufficient water supplies and flow. Droughts can also mean that hydroelectric plants have to scale back energy output.
Recent massive hydroelectric power projects in markets such as China and India have been an important source of power capacity growth in recent years. But these countries are also reaching the limit in terms of potential hydroelectric capacity.
China’s Three Gorges hydroelectric power plant is the largest in the world, around five times the size of the famed Hoover Dam near Las Vegas. Building this project required relocating nearly 2 million people. The project has already been underway for a decade and isn’t likely to come online until 2009.
It’s unlikely there are any other rivers in China that would be suitable for a similar-sized project. Even if there were, bringing a project of that scale online takes more than a decade. China will need to look elsewhere for its rapidly growing power needs.
Outside of hydropower, wind power is the most-important technology. Wind power has grown rapidly in recent years and can be economical in some markets with no subsidies.
The efficiency of wind turbines has improved dramatically in just the past 10 years, making them a far-more-viable alternative. As an example, consider that a modern wind turbine produces more than 150 times the electricity at less than half the cost of an equivalent-sized turbine in the late ’80s.
Some countries and regions have been more successful with wind power than others. The most-obvious reason is the wide availability of steady wind.
For example, Denmark gets about 20 percent of its power from wind, thanks to strong breezes near the coast. And Spain believes that it can boost the contribution of wind power to 15 percent by 2010, roughly double the 8 percent it gets from wind today. The US, Canada and several Asian countries are also pursuing wind power.
Of course, there are issues with wind power; prime among them is that the wind doesn’t blow at a constant rate in all areas. Without turning this issue into a physics lesson, consider the relationship between wind speed and power generated by a windmill: It isn’t a one-for-one relationship. If wind speed rises by 10 percent, the power generated does not rise by 10 percent.
Rather, the output from a wind power plant is related to the density of the air, the size of the rotors and the cube of wind speed. What this means is that if wind speed doubles, the power generated by the wind turbine rises by a factor of eight. Therefore, small changes in wind speed can have outsized effects on power output.
Multiply that by hundreds (or thousands) of turbines on a wind farm and you can see the scope for rapid, sudden rises and falls in power output in regions without constant wind.
In modern electric grid networks, power isn’t stored; the amount of power generated must equal the power being used by consumers at any given time. Generators have to build what’s known as shadow capacity—coal and gas-fired facilities–that can fill the gaps when wind power farms aren’t generating sufficient power. In addition, generators must build out relatively expensive systems for controlling surges of power from wind farms.
Often the best locations for installing wind farms are a long way from population centers. That would include wind farms that are installed offshore to take advantage of more-stable maritime breezes.
Unfortunately, when electricity is transported, some is lost; the further the distance traveled, the less efficient it is to transport electricity. Therefore, countries must install more wind capacity to account for transmission loses.
Geothermal power uses the natural heat from the Earth to generate steam and power. This power source is important in some markets but is limited in terms of application. Some countries, such as Iceland, get most of their power this way, but it requires very specific geological conditions to be cost-effective.
Then there’s solar. Although there’s obviously no charge for sunlight, power from solar cells is expensive and there are significant shortages of components needed to manufacture solar cells. This is particularly the case with the raw material known as polysilicon.
In addition, because grid power can’t be stored, solar power only offers power during daylight hours. Weather conditions and seasonal factors can also alter the amount of power produced from solar cells.
However, solar cells are finding a niche. Solar power companies have made impressive technological advances that continue to make the technology more cost-effective. Because many governments subsidize solar, it’s a rapidly growing technology.
Solar cells are also finding applications as supplemental sources of power for individual residences and office buildings. New cells are low profile and can be installed on roofs, supplementing power from the grid itself.
In this week’s issue, I focus my attention on wind and solar power because this is where I see the most-investable opportunities at this time. I will look to add coverage of other markets and companies over time.
Back To In This Issue
Growth And Policy
Although wind and solar power are small markets, they’re growing much faster than the market for energy and electricity at large. Consider the chart below.
Source: Global Wind Energy Council
Global wind power capacity has grown from 4,800 megawatts in 1995 to more than 59,000 in 2005. According to the Global Wind Energy Council, total wind power capacity could top 150,000 by 2010 and 350,000 megawatts by 2030. That represents annualized growth of more than 17 percent.
For comparison, consider that global electric demand is increasing by just 2 to 2.5 percent annually. Wind power is growing far faster globally than general electricity demand.
A total of 50 countries now have some sort of wind power industry. And alternative energy is no longer the province of developed markets: Both China and India are aggressively adding capacity.
Solar power is a smaller market with a less-established track record of growth. However, at the end of 2004, there were roughly 2 gigawatts of installed grid-connected solar power. By the end of 2005, there were more than 3.1 gigawatts of installed capacity–a growth rate of more than 50 percent. By the end of 2006, installed global solar capacity likely topped 4.6 gigawatts, another increase of roughly 50 percent.
Although I’d be surprised if that didn’t slow, solar is likely to continue growing faster than wind over the next five to 10 years, albeit from a much smaller base. Current projections are for annualized growth of 20 to 30 percent through the middle of the next decade.
And the market for solar also goes beyond the developed world: India is the world’s fourth-largest market for installed solar capacity at this time, while China ranks eighth. Still, Germany and Japan together currently account for roughly 80 percent of the global solar power market.
As noted earlier, the primary driver of growth for both wind and solar power has been government policy and subsidy. Although wind power is arguably competitive with natural gas in some markets, the technology still benefits from subsidy and environmental credits.
There are several ways that governments promote alternative energies. One of the most common and most favorable to the industry is a so-called feed-in tariff.
With a feed-in tariff, the government mandates that electric power utilities allow renewable energy generators to connect to the grid. Further, the utilities must purchase any power produced at certain fixed minimum prices. These prices are generally set above the normal market price for power. This strategy is very common in the EU; Germany, Spain, Greece and several other countries use feed-in systems.
Germany is a world leader when it comes to promoting alternative energy. The country set forth feed-in tariffs for solar and wind power in the renewable Energy Sources Act, updated in 2004. Each year, the premium renewables tariffs are gradually reduced; the idea is that as wind and solar become more competitive, less subsidy is needed.
The prevalence of generous feed-in tariff systems accounts for rapid growth of alternative energy in Europe. In fact, the region’s wind power capacity accounts for roughly 70 percent of the global total.
Several countries and regions have also established targets for renewable energy and other subsidies. Earlier this month, the EU set forth a target of boosting the region’s use of renewables to 12 percent of primary energy supply by 2012. By 2020, the EU hopes to boost renewables to close to a fifth of total primary energy supply.
Individual EU countries have further established targets—some mandatory and some indicative—to boost renewable energy use over the next 20 years. France, for example, announced a plan to boost renewables to 21 percent of electricity capacity by 2010. That’s up from around 17 percent today.
And it’s not just Europe. In the US, California recently enacted its Solar Initiative. This plan would subsidize the purchase of solar panels for home and business owners–the goal is to have 3 gigawatts of solar power by 2017. The initial subsidy is roughly a third of the purchase price; that subsidy would decline over time.
China is looking at a target of 16 percent of primary energy use by 2020 and has plans to build out 30 gigawatts of wind power and 1.8 gigawatts of solar. India, too, has proposed a target of 10 percent of all new power capacity by 2012 and 15 percent of total electricity capacity by 2032.
I won’t bore readers with a detailed rundown of government policies in every market. Suffice it to say that a total of 49 countries worldwide have policy targets for renewables and 41 states, provinces and countries have enacted some form of feed-in tariff to promote technologies like wind and solar.
I have serious doubts about some of these policies and targets. Some of the targets set forth in the EU framework look to be highly ambitious at best. However, whether all these regions ultimately meet their targets or not, the effect has been a major boost in renewable energy spending.
Although I firmly believe that countries like Germany should refocus some of their energies and subsidies toward a more-aggressive promotion of nuclear power, current policy is unlikely to change markedly with respect to renewables. That spells strong growth, and investors are well advised to take advantage.
Back To In This Issue
How To Play It
Alternative energy is a rapidly developing but still-immature niche of the energy market. These companies offer lots of growth and promise; along with that comes higher volatility and risk.
To play the sector most effectively, I’m recommending a broadly diversified approach that I call a field bet. I’ve recommended similar plays for both nuclear power and biofuels.
The concept is simple. For the best chance at big returns, I recommend casting a wide net. Instead of just buying one or two high-risk names, I recommend placing a smaller amount in five to 10 such companies.
My plan is to periodically review these companies and add or subtract names as conditions change. I’ll continually track the field bet in my aggressive Gushers Portfolio. As noted above, I’m also looking to eventually expand the field bet to include other renewable technologies such as geothermal power.
My current alternatives field bet is listed in the table below. Below the table, you’ll find a description of each stock and my rationale for adding it to the list. For return calculations, I’ll place 20 percent of a normal position size in each stock: If you normally put $10,000 in a Gushers recommendation, I’ll assume a $2,000 position size.
Please note that many of these stocks are traded in markets outside the US. Where applicable, I have included a US over-the-counter (OTC) symbol. Some brokers can also buy and sell the stocks directly off the overseas exchange; this is normally preferable if possible.
I don’t make a habit of recommending or endorsing brokers, but direct access broker Interactive Brokers allows you to purchase stocks from Canada and most of the big European exchanges online for a small commission. The broker is aimed at professional users and active traders, so the trading platform can take some time to get used to. But if you plan on doing any trading on these exchanges, Interactive Brokers is worth investigating.
Vestas Wind Systems
Vestas Wind Systems is the world’s largest producer of wind turbines; the company has a more than one-third share of the global wind turbine market. As noted above, the global wind market has continued to grow rapidly, which has spelt solid revenue growth for Vestas over time. In fact, revenues have grown at an average annualized pace of close to 33 percent for the past five years.
But just because Vesta has seen significant growth doesn’t mean the company hasn’t had its share of growing pains. In 2005, the company announced a major profits warning caused by three basic factors: improper contract pricing, component issues and high warranty provisions.
First, Vestas priced a number of contracts in the US market at unprofitable levels; the company appeared to price these contracts cheaply to grab market share. Not only did the company lose money on those contracts, but it was forced to use up valuable manufacturing capacity that could have been better employed on other higher-margin projects.
Second, component suppliers had trouble meeting demand and there were major delays in production. Furthermore, these delays often meant that components had to be shipped separately, adding significantly to cost.
Finally, manufacturing defects meant that the company had higher-than-expected warranty expenses to repair damaged turbines.
But these problems have been addressed at Vestas. Management set a goal of boosting profitability and addressing quality and components issues. In its late-November conference call, management highlighted significant progress in these areas. The company now believes that it will exceed its previously announced margin targets for 2007; it raised guidance for earnings before interest and tax (EBIT) margins from 10 percent to 10 to 12 percent.
Although the company left its warranty provisions unchanged, there was some hint during the call that this could ultimately prove conservative. Vestas seems to have addressed many of the quality issues that caused the original jump in warranty expenses, and there were no more extraordinary warranty provisions in the first nine months of 2006.
Finally, the company seems to have used its dominant market share to negotiate more-fluid supply arrangements for components. Management clearly stated that it’s starting to make headway in encouraging suppliers to invest in capacity to ease supply bottlenecks in the fast-growing wind industry.
And Vestas itself is investing in new manufacturing capacity for key components. The company recently invested in windmill blade manufacturing facilities in the US and Spain as well as a control system factory in Denmark.
Meanwhile, Vestas continues to announce major new orders; management expects to be able to, at a minimum, maintain its 35 percent market share. The list includes new orders in China, Europe and the US. The company remains the premiere pure-play on global wind power; its third quarter report adds to my confidence in the turnaround plan.
Even more interesting, consider that France’s AREVA recently offered to pay close to $800 million for a 70 percent stake in German wind-turbine supplier REpower Systems. AREVA is a global power plant construction giant; the company already owned 30 percent of REpower.
The valuation paid surprised most analysts. AREVA’s bid signals confidence in the continued growth of wind power. That’s bullish for Vestas.
EDF Energies Nouvelles
EDF Energies Nouvelles (EDF New Energies) was spun off from France’s Electricite de France (EDF) late in 2006. Wildcatters Portfolio holding EDF owns half of the outstanding shares of Energies Nouvelles. In addition, the company’s founder, Paris Mouratoglou owns just shy of 24 percent of the shares.
EDF New Energies is a pure-play on the generation of electricity from renewable and alternative sources. Currently, the company owns 746 megawatts of generating capacity and is the No. 1 renewable power company in France and No. 3 in Portugal.
EDF New Energies also has significant positions in the UK, Spain and Italy, as well as the US. In fact, it’s the eighth-largest wind power generator in the US.
Roughly 78 percent of the power that EDF New Energies generates comes from wind turbines. However, the company also has installed hydropower, biomass and solar generation facilities.
In a major expansion plan announced in the middle of last year, EDF New Energies earmarked 3 billion euros to boost its total generation capacity to 3,000 megawatts by 2011. Much of that investment is going toward wind energy. In addition to actual generation, the company is also involved in power plant construction and management of alternative energy assets for third-party generators.
EDF New Energies will benefit from subsidies provided to alternative energy generators. And with considerable experience installing and operating alternative energy assets, it’s well placed to leverage that competency, expanding more aggressively outside Europe.
SunPower Corp
SunPower designs and manufactures photovoltaic (PV) solar cells; PV cells simply convert solar energy into electric power. The company manufactures PV cells aimed at both the commercial and residential markets.
What I like about SunPower is that it’s the technological leader in the solar market. The key metric to look at is what’s known as conversion efficiency–a measure of how efficiently a company’s solar cells turn solar energy into electricity. This number is typically expressed as a percentage; the higher the conversion efficiency, the more efficient the cells.
The standard solar cell shipped globally has a conversion efficiency of 14 to 16 percent. This is considerably better than what was possible five years ago but is well shy of what SunPower is currently manufacturing. The company’s current least-efficient cells are around 20 percent conversion efficiency, while its state-of-the-art cells manage closer to 22 percent. And I’m not just talking about averages here–this is the highest efficiency ratio of any company in the solar industry.
SunPower’s cells can generate the same amount of energy as the competition with a far smaller cell. The benefits of a more-efficient cell are clear.
On the residential front, no one wants a gigantic, shimmering solar panel bolted to their roof when they can have a smaller, less-obtrusive and lower-profile model. Heavy solar panels may even require expensive mountings and shoring up of roof strength. And roof space is always limited; smaller is definitely better. This is precisely why SunPower’s products typically command a premium price.
The second key point is polysilicon use. Polysilicon is the raw material for both semiconductors (used in every imaginable electronic product) and solar power cells. The industry has quite literally grown itself into a problem: Surging solar power demand has meant rapidly rising demand for polysilicon. The world’s manufacturing capacity just hasn’t been able to keep pace; polysilicon prices have soared, and it’s often tough to get supplies at any price.
But because of SunPower’s design and technology, its cells use less polysilicon than the competition. Currently, the company’s average solar cell has 7.5 grams of polysilicon (a little more than a quarter ounce) per watt of power produced. The next-generation cells SunPower now produces have pushed that down to about 7 grams per watt.
The industry average, according to SunPower, is more like 10 grams per watt. This means that SunPower has to buy less-expensive polysilicon than the competition, a major advantage in a supply-constrained market. Patents covering most of the company’s industry leading technologies aren’t due to expire until after 2013; this competitive advantage is here to stay.
A few additional points are worth noting. First, in the company’s third quarter call, management stated there was some slight buildup of solar panel inventory mainly in the German market. But that inventory was confined to lower-tech products; SunPower’s top-end products remain in demand.
And finally, SunPower acquired PowerLight Corp in mid-November. This company specializes in the installation of commercial solar cells; it’s a market leader in key US states such as California.
The company also operates solar power plants in Germany. This acquisition helps expand SunPower into the installation and power plant markets; SunPower has traditionally focused its attention mainly on cells for residential homes.
Note SunPower reports earnings on January 25. The stock can be volatile around such announcements. More-conservative investors should consider taking on half their position ahead of the release and half after the company reports.
MEMC Electronic Materials
As highlighted above, polysilicon is the key raw material used to make solar cells. Raw polysilicon is used to manufacture wafers; wafers are, in turn, the key building block for both solar cells and semiconductors.
MEMC Materials is the world’s third-largest supplier of wafers to the semiconductor industry. It’s also one of the world’s largest suppliers of wafers for the solar power industry.
In the past, the company’s fortunes have tended to rise and fall alongside the semi industry; still, close to 90 percent of MEMC’s sales comes from this market. But that figure understates the importance of solar power: Demand from the solar industry is a key driver that’s been propping up the pricing for wafers and polysilicon.
The semiconductor industry is currently in the midst of an inventory correction–these firms overproduced and now have to cut prices to move inventory. Inventory corrections are part of the normal cyclicality of the semi industry.
Normally, this would be expected to impact demand and prices for MEMC’s wafers. But because of polysilicon shortages for the solar industry, average selling prices for MEMC remain firm.
The company has signed long-term wafer supply agreements with two major solar firms, Suntech Power Holdings and Gintech Energy Corp. This will help lock in solid prices for some of the company’s production going forward.
Note MEMC is also scheduled to announce earnings January 25. Conservative investors should consider buying half ahead of the announcement and half afterward.
SolarWorld
SolarWorld is a fully integrated solar power company. The firm has established joint ventures with other German firms to procure polysilicon; SolarWorld also produces its own wafers.
In addition, the company has one of the most-advanced polysilicon recycling plants in the world; by recycling the key material, SolarWorld cuts down on its need to purchase raw material. The company makes solar cells and modules and even designs and constructs actual solar systems for customers.
Last summer, SolarWorld purchased the operations of Shell Solar. Shell was particularly strong in the US market; SolarWorld subsequently reported that it was able to maintain many of Shell’s existing customers.
Fully integrated solar players such as SolarWorld have a few advantages, including easier access to raw materials and the ability to offer a turn-key solution to customers.
Back To In This Issue
Nuclear And Biofuels
My two favorite long-term growth themes in The Energy Strategist are nuclear power and biofuels. Although we’ve seen some big gains from recommended stocks in these groups, I don’t believe the run is over yet; both groups are locked in longer-term secular bull markets.
What’s more, I see both themes as insulated from volatility in oil and natural gas prices–both nuclear power and biofuels-related issues have outperformed traditional oil and gas stocks during the past six months.
I offered a detailed rundown of my rationale for recommending both biofuels and nuclear power stocks in the Dec. 20, 2006, issue of TES, Oil And Gas. My basic outlook for both groups is unchanged; I recommend that all new subscribers unfamiliar with these markets review the December 20 issue, along with the July 26, 2006, issue of TES, The Nuclear Option and the Sept. 20, 2006, issue, Fueled By Food.
In the two tables below, I list my nuclear and biofuels field bet recommendations, with updated returns for each stock since my original recommendation.
Source: The Energy Strategist
My basic outlook for all of these stocks is unchanged since my last update in late December. Although pullbacks of 10 to 15 percent are possible for all of these stocks from time to time, I regard such selloffs as outstanding buying opportunities.
In addition to these existing selections, I’m adding PowerShares Deutsche Bank Agricultural Fund (AMEX: DBA) to the biofuels field bet table. The DB Agricultural Fund is a relatively new exchange traded fund (ETF).
Typically, I’m not a fan of ETFs as long-term holdings; all too often, they are nothing more than proxies for a particular industry or general market index. In most cases, it’s possible to outperform through careful selection of individual stocks.
In this case, however, the DB Agricultural Fund doesn’t hold any stocks at all. This fund instead buys commodity futures contracts, a market where the majority of stock investors have little or no exposure.
The fund holds a quarter of its assets in corn futures, a quarter in wheat, a quarter in soybeans and a final quarter in sugar. These are the most-important traded agricultural commodities. Therefore, the fund is a good play on the overall bull market in agricultural commodities I see developing in coming years.
There are several drivers for the agriculture boom. Two of the most important are rising consumption in emerging markets such as Asia and rising demand for biofuels. To the first point, the simple fact is that as countries grow wealthier, consumers eat more; even more important, consumers eat more meat.
It’s true that the average daily caloric intake of consumers in the poorest countries is lower than for developed countries like the US or UK. For example, according to the United Nations, the average Bangladeshi consumed about 2,200 calories per day in 2003 compared to 3,750 per day in the US.
But what’s even more striking than overall calories consumed is where those calories come from–the phenomenon of food upgrading. If you look at the diet of consumers in the poorest countries, you will find that the majority of their diet comes from basic cereals and grains; this includes primarily wheat and rice.
For example, more than 80 percent of the Bangladeshi diet comes from cereals; direct consumption of meat is less than 70 calories per day. In the US, meat and animal products consumption accounts for around 30 percent of total caloric consumption. Meanwhile, direct consumption of cereals is relatively unimportant.
In China, meat consumption is growing very rapidly. Total daily average calorie intake grew nearly 80 percent in China between 1961 and 2003. But meat consumption grew by more than 11 times over the same period.
While animal products accounted for barely 5 percent of daily consumption as recently as 1970, by 2003, meat was already more than 20 percent of the diet.
It takes 8 to 10 pounds of grain and feed to produce 1 pound of meat. Of course, these figures vary depending upon the type of meat produced, but 8-to-1 is a decent rule of thumb.
As meat consumption rises, the effect on grain and feed demand rises at an even faster pace. With literally billions of consumers in the emerging markets now starting to demand more processed, meat-based foods, there’s an every expanding wall of demand for products like soybeans, corn and wheat.
These same crops are being used to produce biofuels. Check out the chart below.
Source: BP
Ethanol production is soaring globally. From less than 9,000 tonnes of oil equivalent a decade ago, ethanol production shot up to more than 16,000 tonnes in 2005. And in 2005, biodiesel production rose more than 85 percent to 3.9 billion liters. With generous government subsidies and technological improvements, production of these fuels will rise regardless of oil and gas prices.
Corn is the primary feedstock for ethanol in the US, while Brazil uses mainly sugar. Meanwhile, soybeans are a key source of biodiesel fuel in some countries.
It’s improper to think of each commodity in a vacuum. For example, if corn prices rise because of strong ethanol demand, farmers will divert some of their soybean or wheat acreage to produce more corn. The effect is, of course, lower supplies of the displaced crops and higher prices.
The powerful wave of demand for food upgrading coupled with rising biofuels consumption is behind the powerful bull market in agricultural commodities. The PowerShares Deutsche Bank Agricultural Fund is a solid overall play on this trend
And the president isn’t alone in promoting alternative energies. Whether it’s windmills, solar panels or biofuels, governments the world over are using subsidies, tax breaks and mandates to promote greater use of nontraditional fuels.
And polls consistently show broad public support for such initiatives; right or wrong, politicians will continue using alternative energy as a means of currying favor with the populace. This is powering a bull market in alternatives that has little relation to the price of oil or natural gas.
In This Issue
As long-time subscribers are well aware, I believe that the potential contributions of biofuels, wind power and solar panels are all-too-often overstated. But whether these technologies ever reach their potential or not, there’s no denying that there will be rapid growth. And rapid growth spells massive opportunity for investors.
We’re already playing many of these key themes in The Energy Strategist. Uranium and nuclear power remain my No. 1 long-term growth play; this is the only clean “alternative” energy technology that could truly make a massive contribution to the globe’s electric grid.
The world is finally starting to catch on to that potential, and nuclear plants are being constructed all over the globe. Our uranium field bet, reviewed below, has produced some nice gains for the model Portfolio to date, and I still see more upside.
We also introduced a biofuels field bet in 2006 (reviewed and explained below) that’s done very well. In this issue, I’m adding yet another play on biofuels to my field bet.
But one area I haven’t yet covered to its full extent is other alternatives, such as wind power and solar panels; both technologies have drawbacks but are seeing huge investment. In this issue, I’ll inaugurate a field bet to play the bull market in these technologies as well.
Although alternative energies won’t take the place of staples such as natural gas or oil, they will play a part in the overall energy issue worldwide. I’m initiating a new field bet for diversified portfolio coverage. See Talking Alternatives.
At the forefront of alternative energies are hydroelectric, wind and solar powers. As noted above, they won’t be enough to replace other sources, but each as its pros and cons. See Where We Are.
Many countries are trying to promote the increased use of alternative energies through the use of subsidies and systems such as feed-in tariffs. Although their production targets may be a bit lofty, the potential for growth and investment gain is right on track. See Growth And Policy.
As with previous recommendations regarding nuclear power and biofuels, I’m recommending a field bet for alternative energies to cast a wide net over the sector and decrease risk. I detail my picks for this bet here. See How To Play It.
Nuclear power and biofuels are still two of my favorite sectors. Biofuels especially continue to enjoy rising prices. I update my field bets on these two areas here, as well as detail a new addition for biofuels that captures commodities contracts as opposed to actual stocks. See Nuclear And Biofuels.
In this issue, I’m recommending or reiterating my recommendation on the following stocks:
- EDF Energies Nouvelles (France: EEN, OTC: EDFEF)
- MEMC Electronic Materials (NYSE: WFR)
- PowerShares DB Agriculture Fund (AMEX: DBA)
- SolarWorld (Germany: SWV, OTC: SRWRF)
- SunPower Corp (NSDQ: SPWR)
- Vestas Wind Systems (Denmark: VWS, OTC: VWSYF)
Talking Alternatives
Alternative energy has an almost intoxicating allure. After all, most would agree that electricity is a necessity, not a luxury.
However, generating that power produces some unintended, harmful environmental side effects. Technologies such as wind and solar seem to offer an easy way out, a means of generating power with minimal environmental impact.
In addition, most countries are dependent to at least some degree on oil and natural gas imports for their energy needs. For example, Europe’s dependence on Russia for both oil and natural gas supplies has recently become a major bone of contention on the continent.
Twice over the past two years, Russia has cut off supplies temporarily because of pricing disputes with former Soviet satellite states. Although there was never any real danger of running out of supply, these events did serve as a reminder of just how energy dependent the region is. Even the United Kingdom (UK), traditionally a net exporter of oil and gas, is planning to import Russian commodities as the country’s vast reserves in the North Sea are depleted.
Similarly, the US depends on imported oil for roughly two-thirds of its daily consumption; dependence has grown markedly since US oil production peaked in the early 1970s. By the middle of the next decade, America will also become one of the world’s larger importers of liquefied natural gas (LNG). And with China, India and other fast-growing countries also stepping up imports, America will be competing with all these countries for energy supplies.
Alternative energy appears to offer a chance for the world to have its cake and eat it, too. Wind and solar power produce no direct emissions of pollutants such as sulphur dioxide, mercury or nitrous oxides.
Countries are increasingly moving to control emissions of greenhouse gases such as carbon dioxide; such gases aren’t an issue with alternative energy facilities. In addition, sunlight and wind aren’t resources that we have to import; there’s no dependence on foreign supplies.
Sadly, this dream doesn’t represent reality. All too often, alternative energy gets pitched to investors as some sort of panacea to cure the world’s energy problems; as I detail later in this issue, these claims just don’t add up.
The simple fact is that alternative energy technologies such as solar and wind power will never be able to replace coal, natural gas and nuclear power in either the developed or developing world. The idea that any country can achieve full energy independence by spending more money on such technologies is naïve at best.
However, just because alternatives aren’t a cure-all for pollution and energy independence doesn’t mean that we can’t make money investing in the sector. It also doesn’t mean that such technologies have no place in the global energy puzzle. The truth is there’s no single golden solution for the world’s energy shortages–a wide variety of technologies will play a role.
Undoubtedly, modern clean coal plants will vastly ameliorate the environmental reputation of this cheap, abundant fuel. And my favorite solution of all, nuclear power, is increasingly enjoying a global Renaissance: Nuclear power generates no dangerous emissions of any pollutant. And although we can’t rely solely on alternative technologies, wind and solar power will play a supporting role in this environment.
Even more important, alternative energy stocks are unique in the energy industry; the performance of these stocks has little to do with the price of oil, natural gas or any other commodity because the primary driver of these stocks isn’t the market, but politics.
Countries the world over promote alternative technologies with subsidies, direct generation targets and mandates. As long as these subsidies persist, alternative energy technologies can grow regardless of what happens to oil, natural gas prices and electricity prices.
And if recent history is any guide, these subsidies are likely to grow, not decline, in the coming years. Although alternative energy technologies are limited, the public is broadly supportive of such technologies and so are politicians.
In the US, for example, congressional Republicans and Democrats are currently debating over tax breaks for oil and gas companies, but both parties are supporting various renewable fuel initiatives. European countries have a long history of supporting green renewable technologies–new European Union (EU) initiatives set out earlier this month place a good deal of weight on furthering alternative energies.
I’m not here to comment on whether this type of subsidy makes sense; the only important point is subsidies for alternative energy are present worldwide and are powering strong growth for the group. That means that alternative energy isn’t just a leveraged bet on commodity prices or growing energy demand.
Bottom line: The market for wind and solar power globally is tiny when compared with that of oil, natural gas or even uranium. However, these technologies are seeing rapid growth from that low base, helped along by generous government subsidies.
And constant, incremental technological improvements are dramatically cutting costs and widening the applications for such fuels. That rapid growth coupled with little commodity price exposure is a recipe for strong stock market performance.
To take advantage of that potential, I’m initiating an alternative power field bet as I’ve already recommended with biofuels and nuclear power. Every portfolio can benefit from some diversified exposure to alternative energy.
Back To In This Issue
Where We Are
I define alternative energy to encompass any energy technology that doesn’t involve hydrocarbons such as oil, coal or natural gas. As such, both nuclear power and biofuels fit into this category. I’ve already recommended myriad ways to play these two markets and review my top picks at the end of this issue. For now, however, I’ll focus my attention on other alternative technologies.
Check out the chart below for a closer look at where the world derives its energy.
Source: Energy Information Administration (EIA)
This chart covers global primary energy use. This measure doesn’t differentiate between uses for energy; in other words, this chart doesn’t make a distinction between energy products used for transportation fuel and energy used for electricity generation.
Instead, it’s based on total global energy use in quadrillions of British Thermal Units (Btus) commonly called “quads.” For those unfamiliar with the term, a Btu is the amount of heat needed to raise the temperature of a pound of water by 1 degree Fahrenheit. This is roughly equivalent to the energy released by burning one common kitchen match. A quadrillion is a 1 followed by 15 zeroes; it’s a big number to say the least.
On that basis, it’s clear that the three most-important fuels globally are oil, natural gas and coal, together accounting for more than 85 percent of the energy consumed annually. These power sources are followed by nuclear and hydroelectric power with about a 12 percent share combined. The other alternatives–including geothermal, wind and solar–account for less that 1 percent of the primary energy consumed worldwide.
Because both solar and wind are typically used to produce electricity, check out the chart of US renewable electric capacity by energy source. (Note that I excluded nuclear power from this chart to focus on just non-nuclear alternatives.)
Source: EIA
Of the alternative energies used in the US (and worldwide), hydroelectric power is far and away the most important. Hydropower is clean and efficient, but it’s not a fast-growing technology in most markets. The reason is there’s a physical limit as to how many dams you can place on a given river system; in the US, there just aren’t many rivers left that are suitable for such projects.
And many parts of the world are experiencing a water shortage; China and parts of the western US are two examples. Dam projects have to be carefully planned with an eye toward maintaining sufficient water supplies and flow. Droughts can also mean that hydroelectric plants have to scale back energy output.
Recent massive hydroelectric power projects in markets such as China and India have been an important source of power capacity growth in recent years. But these countries are also reaching the limit in terms of potential hydroelectric capacity.
China’s Three Gorges hydroelectric power plant is the largest in the world, around five times the size of the famed Hoover Dam near Las Vegas. Building this project required relocating nearly 2 million people. The project has already been underway for a decade and isn’t likely to come online until 2009.
It’s unlikely there are any other rivers in China that would be suitable for a similar-sized project. Even if there were, bringing a project of that scale online takes more than a decade. China will need to look elsewhere for its rapidly growing power needs.
Outside of hydropower, wind power is the most-important technology. Wind power has grown rapidly in recent years and can be economical in some markets with no subsidies.
The efficiency of wind turbines has improved dramatically in just the past 10 years, making them a far-more-viable alternative. As an example, consider that a modern wind turbine produces more than 150 times the electricity at less than half the cost of an equivalent-sized turbine in the late ’80s.
Some countries and regions have been more successful with wind power than others. The most-obvious reason is the wide availability of steady wind.
For example, Denmark gets about 20 percent of its power from wind, thanks to strong breezes near the coast. And Spain believes that it can boost the contribution of wind power to 15 percent by 2010, roughly double the 8 percent it gets from wind today. The US, Canada and several Asian countries are also pursuing wind power.
Of course, there are issues with wind power; prime among them is that the wind doesn’t blow at a constant rate in all areas. Without turning this issue into a physics lesson, consider the relationship between wind speed and power generated by a windmill: It isn’t a one-for-one relationship. If wind speed rises by 10 percent, the power generated does not rise by 10 percent.
Rather, the output from a wind power plant is related to the density of the air, the size of the rotors and the cube of wind speed. What this means is that if wind speed doubles, the power generated by the wind turbine rises by a factor of eight. Therefore, small changes in wind speed can have outsized effects on power output.
Multiply that by hundreds (or thousands) of turbines on a wind farm and you can see the scope for rapid, sudden rises and falls in power output in regions without constant wind.
In modern electric grid networks, power isn’t stored; the amount of power generated must equal the power being used by consumers at any given time. Generators have to build what’s known as shadow capacity—coal and gas-fired facilities–that can fill the gaps when wind power farms aren’t generating sufficient power. In addition, generators must build out relatively expensive systems for controlling surges of power from wind farms.
Often the best locations for installing wind farms are a long way from population centers. That would include wind farms that are installed offshore to take advantage of more-stable maritime breezes.
Unfortunately, when electricity is transported, some is lost; the further the distance traveled, the less efficient it is to transport electricity. Therefore, countries must install more wind capacity to account for transmission loses.
Geothermal power uses the natural heat from the Earth to generate steam and power. This power source is important in some markets but is limited in terms of application. Some countries, such as Iceland, get most of their power this way, but it requires very specific geological conditions to be cost-effective.
Then there’s solar. Although there’s obviously no charge for sunlight, power from solar cells is expensive and there are significant shortages of components needed to manufacture solar cells. This is particularly the case with the raw material known as polysilicon.
In addition, because grid power can’t be stored, solar power only offers power during daylight hours. Weather conditions and seasonal factors can also alter the amount of power produced from solar cells.
However, solar cells are finding a niche. Solar power companies have made impressive technological advances that continue to make the technology more cost-effective. Because many governments subsidize solar, it’s a rapidly growing technology.
Solar cells are also finding applications as supplemental sources of power for individual residences and office buildings. New cells are low profile and can be installed on roofs, supplementing power from the grid itself.
In this week’s issue, I focus my attention on wind and solar power because this is where I see the most-investable opportunities at this time. I will look to add coverage of other markets and companies over time.
Back To In This Issue
Growth And Policy
Although wind and solar power are small markets, they’re growing much faster than the market for energy and electricity at large. Consider the chart below.
Source: Global Wind Energy Council
Global wind power capacity has grown from 4,800 megawatts in 1995 to more than 59,000 in 2005. According to the Global Wind Energy Council, total wind power capacity could top 150,000 by 2010 and 350,000 megawatts by 2030. That represents annualized growth of more than 17 percent.
For comparison, consider that global electric demand is increasing by just 2 to 2.5 percent annually. Wind power is growing far faster globally than general electricity demand.
A total of 50 countries now have some sort of wind power industry. And alternative energy is no longer the province of developed markets: Both China and India are aggressively adding capacity.
Solar power is a smaller market with a less-established track record of growth. However, at the end of 2004, there were roughly 2 gigawatts of installed grid-connected solar power. By the end of 2005, there were more than 3.1 gigawatts of installed capacity–a growth rate of more than 50 percent. By the end of 2006, installed global solar capacity likely topped 4.6 gigawatts, another increase of roughly 50 percent.
Although I’d be surprised if that didn’t slow, solar is likely to continue growing faster than wind over the next five to 10 years, albeit from a much smaller base. Current projections are for annualized growth of 20 to 30 percent through the middle of the next decade.
And the market for solar also goes beyond the developed world: India is the world’s fourth-largest market for installed solar capacity at this time, while China ranks eighth. Still, Germany and Japan together currently account for roughly 80 percent of the global solar power market.
As noted earlier, the primary driver of growth for both wind and solar power has been government policy and subsidy. Although wind power is arguably competitive with natural gas in some markets, the technology still benefits from subsidy and environmental credits.
There are several ways that governments promote alternative energies. One of the most common and most favorable to the industry is a so-called feed-in tariff.
With a feed-in tariff, the government mandates that electric power utilities allow renewable energy generators to connect to the grid. Further, the utilities must purchase any power produced at certain fixed minimum prices. These prices are generally set above the normal market price for power. This strategy is very common in the EU; Germany, Spain, Greece and several other countries use feed-in systems.
Germany is a world leader when it comes to promoting alternative energy. The country set forth feed-in tariffs for solar and wind power in the renewable Energy Sources Act, updated in 2004. Each year, the premium renewables tariffs are gradually reduced; the idea is that as wind and solar become more competitive, less subsidy is needed.
The prevalence of generous feed-in tariff systems accounts for rapid growth of alternative energy in Europe. In fact, the region’s wind power capacity accounts for roughly 70 percent of the global total.
Several countries and regions have also established targets for renewable energy and other subsidies. Earlier this month, the EU set forth a target of boosting the region’s use of renewables to 12 percent of primary energy supply by 2012. By 2020, the EU hopes to boost renewables to close to a fifth of total primary energy supply.
Individual EU countries have further established targets—some mandatory and some indicative—to boost renewable energy use over the next 20 years. France, for example, announced a plan to boost renewables to 21 percent of electricity capacity by 2010. That’s up from around 17 percent today.
And it’s not just Europe. In the US, California recently enacted its Solar Initiative. This plan would subsidize the purchase of solar panels for home and business owners–the goal is to have 3 gigawatts of solar power by 2017. The initial subsidy is roughly a third of the purchase price; that subsidy would decline over time.
China is looking at a target of 16 percent of primary energy use by 2020 and has plans to build out 30 gigawatts of wind power and 1.8 gigawatts of solar. India, too, has proposed a target of 10 percent of all new power capacity by 2012 and 15 percent of total electricity capacity by 2032.
I won’t bore readers with a detailed rundown of government policies in every market. Suffice it to say that a total of 49 countries worldwide have policy targets for renewables and 41 states, provinces and countries have enacted some form of feed-in tariff to promote technologies like wind and solar.
I have serious doubts about some of these policies and targets. Some of the targets set forth in the EU framework look to be highly ambitious at best. However, whether all these regions ultimately meet their targets or not, the effect has been a major boost in renewable energy spending.
Although I firmly believe that countries like Germany should refocus some of their energies and subsidies toward a more-aggressive promotion of nuclear power, current policy is unlikely to change markedly with respect to renewables. That spells strong growth, and investors are well advised to take advantage.
Back To In This Issue
How To Play It
Alternative energy is a rapidly developing but still-immature niche of the energy market. These companies offer lots of growth and promise; along with that comes higher volatility and risk.
To play the sector most effectively, I’m recommending a broadly diversified approach that I call a field bet. I’ve recommended similar plays for both nuclear power and biofuels.
The concept is simple. For the best chance at big returns, I recommend casting a wide net. Instead of just buying one or two high-risk names, I recommend placing a smaller amount in five to 10 such companies.
My plan is to periodically review these companies and add or subtract names as conditions change. I’ll continually track the field bet in my aggressive Gushers Portfolio. As noted above, I’m also looking to eventually expand the field bet to include other renewable technologies such as geothermal power.
My current alternatives field bet is listed in the table below. Below the table, you’ll find a description of each stock and my rationale for adding it to the list. For return calculations, I’ll place 20 percent of a normal position size in each stock: If you normally put $10,000 in a Gushers recommendation, I’ll assume a $2,000 position size.
Please note that many of these stocks are traded in markets outside the US. Where applicable, I have included a US over-the-counter (OTC) symbol. Some brokers can also buy and sell the stocks directly off the overseas exchange; this is normally preferable if possible.
I don’t make a habit of recommending or endorsing brokers, but direct access broker Interactive Brokers allows you to purchase stocks from Canada and most of the big European exchanges online for a small commission. The broker is aimed at professional users and active traders, so the trading platform can take some time to get used to. But if you plan on doing any trading on these exchanges, Interactive Brokers is worth investigating.
|
Alternatives Field Bet
|
||
|
Company Name (Exchange: Symbol)
|
Recent Price
|
Advice
|
| Vestas Wind Systems (Denmark: VWS, OTC:VWSYF) | $44.80 | Buy |
| EDF Energies Nouvelles (France: EEN, OTC: EDFEF) | EUR38.73 | Buy |
| SunPower Corp (NSDQ: SPWR) | 42.75 | Buy |
| MEMC Materials (NYSE: WFR) | 45.87 | Buy |
| SolarWorld (Germany: SWV, OTC: SRWRF) | 71.05 | Buy |
Vestas Wind Systems
Vestas Wind Systems is the world’s largest producer of wind turbines; the company has a more than one-third share of the global wind turbine market. As noted above, the global wind market has continued to grow rapidly, which has spelt solid revenue growth for Vestas over time. In fact, revenues have grown at an average annualized pace of close to 33 percent for the past five years.
But just because Vesta has seen significant growth doesn’t mean the company hasn’t had its share of growing pains. In 2005, the company announced a major profits warning caused by three basic factors: improper contract pricing, component issues and high warranty provisions.
First, Vestas priced a number of contracts in the US market at unprofitable levels; the company appeared to price these contracts cheaply to grab market share. Not only did the company lose money on those contracts, but it was forced to use up valuable manufacturing capacity that could have been better employed on other higher-margin projects.
Second, component suppliers had trouble meeting demand and there were major delays in production. Furthermore, these delays often meant that components had to be shipped separately, adding significantly to cost.
Finally, manufacturing defects meant that the company had higher-than-expected warranty expenses to repair damaged turbines.
But these problems have been addressed at Vestas. Management set a goal of boosting profitability and addressing quality and components issues. In its late-November conference call, management highlighted significant progress in these areas. The company now believes that it will exceed its previously announced margin targets for 2007; it raised guidance for earnings before interest and tax (EBIT) margins from 10 percent to 10 to 12 percent.
Although the company left its warranty provisions unchanged, there was some hint during the call that this could ultimately prove conservative. Vestas seems to have addressed many of the quality issues that caused the original jump in warranty expenses, and there were no more extraordinary warranty provisions in the first nine months of 2006.
Finally, the company seems to have used its dominant market share to negotiate more-fluid supply arrangements for components. Management clearly stated that it’s starting to make headway in encouraging suppliers to invest in capacity to ease supply bottlenecks in the fast-growing wind industry.
And Vestas itself is investing in new manufacturing capacity for key components. The company recently invested in windmill blade manufacturing facilities in the US and Spain as well as a control system factory in Denmark.
Meanwhile, Vestas continues to announce major new orders; management expects to be able to, at a minimum, maintain its 35 percent market share. The list includes new orders in China, Europe and the US. The company remains the premiere pure-play on global wind power; its third quarter report adds to my confidence in the turnaround plan.
Even more interesting, consider that France’s AREVA recently offered to pay close to $800 million for a 70 percent stake in German wind-turbine supplier REpower Systems. AREVA is a global power plant construction giant; the company already owned 30 percent of REpower.
The valuation paid surprised most analysts. AREVA’s bid signals confidence in the continued growth of wind power. That’s bullish for Vestas.
EDF Energies Nouvelles
EDF Energies Nouvelles (EDF New Energies) was spun off from France’s Electricite de France (EDF) late in 2006. Wildcatters Portfolio holding EDF owns half of the outstanding shares of Energies Nouvelles. In addition, the company’s founder, Paris Mouratoglou owns just shy of 24 percent of the shares.
EDF New Energies is a pure-play on the generation of electricity from renewable and alternative sources. Currently, the company owns 746 megawatts of generating capacity and is the No. 1 renewable power company in France and No. 3 in Portugal.
EDF New Energies also has significant positions in the UK, Spain and Italy, as well as the US. In fact, it’s the eighth-largest wind power generator in the US.
Roughly 78 percent of the power that EDF New Energies generates comes from wind turbines. However, the company also has installed hydropower, biomass and solar generation facilities.
In a major expansion plan announced in the middle of last year, EDF New Energies earmarked 3 billion euros to boost its total generation capacity to 3,000 megawatts by 2011. Much of that investment is going toward wind energy. In addition to actual generation, the company is also involved in power plant construction and management of alternative energy assets for third-party generators.
EDF New Energies will benefit from subsidies provided to alternative energy generators. And with considerable experience installing and operating alternative energy assets, it’s well placed to leverage that competency, expanding more aggressively outside Europe.
SunPower Corp
SunPower designs and manufactures photovoltaic (PV) solar cells; PV cells simply convert solar energy into electric power. The company manufactures PV cells aimed at both the commercial and residential markets.
What I like about SunPower is that it’s the technological leader in the solar market. The key metric to look at is what’s known as conversion efficiency–a measure of how efficiently a company’s solar cells turn solar energy into electricity. This number is typically expressed as a percentage; the higher the conversion efficiency, the more efficient the cells.
The standard solar cell shipped globally has a conversion efficiency of 14 to 16 percent. This is considerably better than what was possible five years ago but is well shy of what SunPower is currently manufacturing. The company’s current least-efficient cells are around 20 percent conversion efficiency, while its state-of-the-art cells manage closer to 22 percent. And I’m not just talking about averages here–this is the highest efficiency ratio of any company in the solar industry.
SunPower’s cells can generate the same amount of energy as the competition with a far smaller cell. The benefits of a more-efficient cell are clear.
On the residential front, no one wants a gigantic, shimmering solar panel bolted to their roof when they can have a smaller, less-obtrusive and lower-profile model. Heavy solar panels may even require expensive mountings and shoring up of roof strength. And roof space is always limited; smaller is definitely better. This is precisely why SunPower’s products typically command a premium price.
The second key point is polysilicon use. Polysilicon is the raw material for both semiconductors (used in every imaginable electronic product) and solar power cells. The industry has quite literally grown itself into a problem: Surging solar power demand has meant rapidly rising demand for polysilicon. The world’s manufacturing capacity just hasn’t been able to keep pace; polysilicon prices have soared, and it’s often tough to get supplies at any price.
But because of SunPower’s design and technology, its cells use less polysilicon than the competition. Currently, the company’s average solar cell has 7.5 grams of polysilicon (a little more than a quarter ounce) per watt of power produced. The next-generation cells SunPower now produces have pushed that down to about 7 grams per watt.
The industry average, according to SunPower, is more like 10 grams per watt. This means that SunPower has to buy less-expensive polysilicon than the competition, a major advantage in a supply-constrained market. Patents covering most of the company’s industry leading technologies aren’t due to expire until after 2013; this competitive advantage is here to stay.
A few additional points are worth noting. First, in the company’s third quarter call, management stated there was some slight buildup of solar panel inventory mainly in the German market. But that inventory was confined to lower-tech products; SunPower’s top-end products remain in demand.
And finally, SunPower acquired PowerLight Corp in mid-November. This company specializes in the installation of commercial solar cells; it’s a market leader in key US states such as California.
The company also operates solar power plants in Germany. This acquisition helps expand SunPower into the installation and power plant markets; SunPower has traditionally focused its attention mainly on cells for residential homes.
Note SunPower reports earnings on January 25. The stock can be volatile around such announcements. More-conservative investors should consider taking on half their position ahead of the release and half after the company reports.
MEMC Electronic Materials
As highlighted above, polysilicon is the key raw material used to make solar cells. Raw polysilicon is used to manufacture wafers; wafers are, in turn, the key building block for both solar cells and semiconductors.
MEMC Materials is the world’s third-largest supplier of wafers to the semiconductor industry. It’s also one of the world’s largest suppliers of wafers for the solar power industry.
In the past, the company’s fortunes have tended to rise and fall alongside the semi industry; still, close to 90 percent of MEMC’s sales comes from this market. But that figure understates the importance of solar power: Demand from the solar industry is a key driver that’s been propping up the pricing for wafers and polysilicon.
The semiconductor industry is currently in the midst of an inventory correction–these firms overproduced and now have to cut prices to move inventory. Inventory corrections are part of the normal cyclicality of the semi industry.
Normally, this would be expected to impact demand and prices for MEMC’s wafers. But because of polysilicon shortages for the solar industry, average selling prices for MEMC remain firm.
The company has signed long-term wafer supply agreements with two major solar firms, Suntech Power Holdings and Gintech Energy Corp. This will help lock in solid prices for some of the company’s production going forward.
Note MEMC is also scheduled to announce earnings January 25. Conservative investors should consider buying half ahead of the announcement and half afterward.
SolarWorld
SolarWorld is a fully integrated solar power company. The firm has established joint ventures with other German firms to procure polysilicon; SolarWorld also produces its own wafers.
In addition, the company has one of the most-advanced polysilicon recycling plants in the world; by recycling the key material, SolarWorld cuts down on its need to purchase raw material. The company makes solar cells and modules and even designs and constructs actual solar systems for customers.
Last summer, SolarWorld purchased the operations of Shell Solar. Shell was particularly strong in the US market; SolarWorld subsequently reported that it was able to maintain many of Shell’s existing customers.
Fully integrated solar players such as SolarWorld have a few advantages, including easier access to raw materials and the ability to offer a turn-key solution to customers.
Back To In This Issue
Nuclear And Biofuels
My two favorite long-term growth themes in The Energy Strategist are nuclear power and biofuels. Although we’ve seen some big gains from recommended stocks in these groups, I don’t believe the run is over yet; both groups are locked in longer-term secular bull markets.
What’s more, I see both themes as insulated from volatility in oil and natural gas prices–both nuclear power and biofuels-related issues have outperformed traditional oil and gas stocks during the past six months.
I offered a detailed rundown of my rationale for recommending both biofuels and nuclear power stocks in the Dec. 20, 2006, issue of TES, Oil And Gas. My basic outlook for both groups is unchanged; I recommend that all new subscribers unfamiliar with these markets review the December 20 issue, along with the July 26, 2006, issue of TES, The Nuclear Option and the Sept. 20, 2006, issue, Fueled By Food.
In the two tables below, I list my nuclear and biofuels field bet recommendations, with updated returns for each stock since my original recommendation.
|
Biofuels Field Bet
|
|||
|
Company Name (Exchange: Symbol)
|
Recent Price
|
Change From Recommendation
|
Advice
|
| Potash Corp (NYSE: POT) | $144.75 | 44.4% | Buy |
| Mosaic (NYSE: MOS) | 21.60 | 29.7 | Buy |
| Syngenta (NYSE: SYT) | 37.60 | 29.0 | Buy |
| MP Evans (London: MPE) | GBP2.99 | 6.0 | Buy |
| Anglo-Eastern Pl. (London: AEP) | GBP3.25 | 7.4 | Buy |
| Monsanto (NYSE: MON) | 55.28 | 17.2 | Buy |
| Sipef (Belgium: SIP) | EUR245 | 31.1 | Buy |
| Earth Biofuels (OTC: EBOF) | 0.80 | -63.1 | Buy |
| PowerShares DB Agriculture (AMEX: DBA) | 26.22 | NEW | Buy |
|
Uranium Field Bet
|
|||
|
Company Name (Exchange: Symbol)
|
Recent Price
|
Change From Recommendation
|
Current Advice
|
| Paladin Resources (Australia: PDN, Toronto: PDN, OTC: PALAF) | CD8.15 | 117.82% | Buy |
| SXR Uranium One (Toronto: SXR; OTC: SXRFF) | CD16.00 | 67.2 | Buy |
| Energy Metals (Toronto: EMC, NYSE: EMU) | CD10.04 | 69.6 | Buy |
| Pitchstone Exp. (Toronto V: PXP, OTC: PEXPF) | CD3.22 | 98.8 | Buy |
| UNOR (Toronto V: UNI, OTC: ONOFF) | CD0.64 | 18.5 | Buy |
| Uranium Part. (Toronto: U, OTC: URPTF) | CD13.30 | 58.0 | Buy |
| Uranium Resources (OTC: URRE) | USD5.01 | 1.0 | Buy |
Source: The Energy Strategist
My basic outlook for all of these stocks is unchanged since my last update in late December. Although pullbacks of 10 to 15 percent are possible for all of these stocks from time to time, I regard such selloffs as outstanding buying opportunities.
In addition to these existing selections, I’m adding PowerShares Deutsche Bank Agricultural Fund (AMEX: DBA) to the biofuels field bet table. The DB Agricultural Fund is a relatively new exchange traded fund (ETF).
Typically, I’m not a fan of ETFs as long-term holdings; all too often, they are nothing more than proxies for a particular industry or general market index. In most cases, it’s possible to outperform through careful selection of individual stocks.
In this case, however, the DB Agricultural Fund doesn’t hold any stocks at all. This fund instead buys commodity futures contracts, a market where the majority of stock investors have little or no exposure.
The fund holds a quarter of its assets in corn futures, a quarter in wheat, a quarter in soybeans and a final quarter in sugar. These are the most-important traded agricultural commodities. Therefore, the fund is a good play on the overall bull market in agricultural commodities I see developing in coming years.
There are several drivers for the agriculture boom. Two of the most important are rising consumption in emerging markets such as Asia and rising demand for biofuels. To the first point, the simple fact is that as countries grow wealthier, consumers eat more; even more important, consumers eat more meat.
It’s true that the average daily caloric intake of consumers in the poorest countries is lower than for developed countries like the US or UK. For example, according to the United Nations, the average Bangladeshi consumed about 2,200 calories per day in 2003 compared to 3,750 per day in the US.
But what’s even more striking than overall calories consumed is where those calories come from–the phenomenon of food upgrading. If you look at the diet of consumers in the poorest countries, you will find that the majority of their diet comes from basic cereals and grains; this includes primarily wheat and rice.
For example, more than 80 percent of the Bangladeshi diet comes from cereals; direct consumption of meat is less than 70 calories per day. In the US, meat and animal products consumption accounts for around 30 percent of total caloric consumption. Meanwhile, direct consumption of cereals is relatively unimportant.
In China, meat consumption is growing very rapidly. Total daily average calorie intake grew nearly 80 percent in China between 1961 and 2003. But meat consumption grew by more than 11 times over the same period.
While animal products accounted for barely 5 percent of daily consumption as recently as 1970, by 2003, meat was already more than 20 percent of the diet.
It takes 8 to 10 pounds of grain and feed to produce 1 pound of meat. Of course, these figures vary depending upon the type of meat produced, but 8-to-1 is a decent rule of thumb.
As meat consumption rises, the effect on grain and feed demand rises at an even faster pace. With literally billions of consumers in the emerging markets now starting to demand more processed, meat-based foods, there’s an every expanding wall of demand for products like soybeans, corn and wheat.
These same crops are being used to produce biofuels. Check out the chart below.
Source: BP
Ethanol production is soaring globally. From less than 9,000 tonnes of oil equivalent a decade ago, ethanol production shot up to more than 16,000 tonnes in 2005. And in 2005, biodiesel production rose more than 85 percent to 3.9 billion liters. With generous government subsidies and technological improvements, production of these fuels will rise regardless of oil and gas prices.
Corn is the primary feedstock for ethanol in the US, while Brazil uses mainly sugar. Meanwhile, soybeans are a key source of biodiesel fuel in some countries.
It’s improper to think of each commodity in a vacuum. For example, if corn prices rise because of strong ethanol demand, farmers will divert some of their soybean or wheat acreage to produce more corn. The effect is, of course, lower supplies of the displaced crops and higher prices.
The powerful wave of demand for food upgrading coupled with rising biofuels consumption is behind the powerful bull market in agricultural commodities. The PowerShares Deutsche Bank Agricultural Fund is a solid overall play on this trend
Stock Talk
Add New Comments
You must be logged in to post to Stock Talk OR create an account