Cleantech, an outperformer in the energy space since 2012, experienced a major expansion phase in 2013 that is still unfolding. In this interview with The Energy Report,Raymond James Energy Analyst Pavel Molchanov points to companies with innovative technologies, strong balance sheets and financial flexibility as examples of low risk with high-flying rewards. Find out about his strongest Buy recommendation, as well as a special situation in big oil.
The Energy Report: Let's talk about growth in the energy sector. How well is the cleantech investment sector positioned during the next six to eight quarters?
Pavel Molchanov: The cleantech index has been the best performer of the energy indexes over the past two years. Since the beginning of 2012, cleantech has outperformed oil services, E&P companies and MLPs, and has dramatically outperformed coal. 2012 was a tough year for the cleantech space. But 2013 was fantastic, and year-to-date cleantech is outperforming again, despite the choppy market. I doubt that cleantech will continue to perform at this pace during the next two years, but there are many opportunities. In 2013 the cleantech index was up 58%, but there were plenty of stocks that doubled and even tripled. There were also stocks that were cut in half. This is a stock picker's market.
TER: Do you categorize cleantech stocks as intrinsically high risk?
PM: There are a number of cleantech companies at the low end of the risk spectrum, so we have to look at them case by case. As a matter of investor perception, the cleantech space appears to have a fair amount of volatility, and in some cases it does have a very high beta. But generally speaking, cleantech stocks, like most tech stocks, will outperform in a bull market and underperform when the Dow is under pressure.
TER: What cleantech companies do you like right now?
PM: EnerNOC Inc. (ENOC:NASDAQ) is currently my strongest Buy recommendation in cleantech. It is at the lower end of the risk spectrum, and it has done quite well for two years. It is still not priced for perfection, currently trading at about six times EBITDA. The company has no debt, and it has been throwing off free cash flow year after year.
TER: What is EnerNOC's business?
PM: EnerNOC is an energy software company that fits nicely into the cleantech category because it enables energy efficiency solutions using proprietary technology. In other words, it is not weatherizing windows, or building diesel generators. It uses advanced software to improve stability on the grid. EnerNOC connects utilities to commercial and industrial power users and enables demand-side energy efficiency solutions, particularly when the grid is in crisis. Imagine a hot summer day when the grid is overburdened. Normally, there could be rolling blackouts. EnerNOC prevents blackouts with its automated demand-response software. It is essentially a service company with regularly recurring revenue, and it earns extra revenue during times of crisis on the grid.
It has created a nicely diversified revenue mix. In 2010, it only operated in the U.S. Last year, 20% of its revenue came from Australia and New Zealand. And in the last 90 days, it has expanded into Japan, Germany, Austria and Ireland. Demand response is an effective strategy for countries such as Germany that generate a high amount of renewable power. Renewables can be intermittent on the grid; demand response reduces this intermittency by filling in the gaps.
TER: Is EnerNOC's software proprietary?
PM: Absolutely proprietary. A secret sauce, so to speak.
TER: Does it have competitors?
PM: EnerNOC has competitors in all its markets, but it is the largest demand-response provider in the world. In the U.S., it enjoys a 30% market share. There are other demand-response companies out there, but they are either not public, or they are not pure plays. Johnson Controls Inc., for example, runs a demand-response business, but it is a small part of a very big company.
TER: Does EnerNOC pay dividends?
PM: No dividends, though it throws off so much free cash that it could. The firm does have a very acquisitive track record, and most recently it has been implementing a share buyback program.
TER: Do you have a target price for EnerNOC?
PM: EnerNOC's share price has doubled in the past year. Right now it is at $21/share and we have a $26/share target price on it.
TER: What is new in solar power?
PM: 2013 was a good year for the solar industry. It was a year of recovery after the tough years in 2011 and 2012. Two big swing factors in 2013 were China and Japan. China became the largest solar market in the world because the government dramatically ramped up domestic installation of solar. Japan became the second biggest market because it also prioritized solar adoption.
There are various dynamics informing these new pro-solar policies by both of these nations. China wants to provide a backdoor bailout to its troubled solar manufacturers, but there is also an environmental element at work amid the epic pollution. Japan, on the other hand, is literally running out of power. After the Fukushima disaster and the shutdown of the country's nuclear industry, it needs every watt it can generate, and solar is a big part of that. In 2013, global solar installations totaled approximately 35 gigawatts. That may not be dramatic, but it was up 12% compared to 2012 levels.
TER: Do you have any picks in the solar power sector?
PM: We like a billion-dollar company called Advanced Energy Industries Inc. (AEIS:NGS; AEIS:BSX). It makes inverters, the cash registers of solar energy systems. Inverters connect the generating system to the grid. Inverter manufacturing is a competitive market; there are a lot of players, including some new entrants. But it is experiencing a more benign form of competition compared to companies that make cells and modules. The gross margin structure for inverter companies is around 25% to 30%, which is double the typical margin for module makers.
Advanced Energy is not 100% solar, though. It has a legacy semiconductor capital equipment business that makes up half of its revenue. The solar inverter business is the other half of revenue, but the solar part of the sales mix is growing much faster than the semi. We are looking for earnings of over $2 in 2014. The stock is in the mid-twenties and trading at a relatively moderate multiple. The firm is debt-free and throwing off a lot of free cash flow. Like EnerNOC, Advanced Energy is using some of that cash to make creative acquisitions.
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