Last August I published a short list of pure play energy storage stocks and promised to track them over time. Since then I’ve modified the list to add two companies [i] and delete three others [ii], but the core remains stable. Tradition holds that New Year’s Day is a wonderful time to reflect on the past and plan for the future. While 2008 is not a year that most investors will remember with fondness, I will honor tradition by returning to my list, summarizing market performance since August, noting current market capitalization values and offering my unvarnished opinions about likely performance in 2009. My December 31, 2008 review and outlook list follows.
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The five primary drivers that I relied on in formulating my 2009 outlook are:
- The ongoing recession of uncertain depth and duration;
- The capital cost per kWh of storage capacity for various energy storage technologies;
- The potential end-user markets for products based on various energy storage technologies
- The relative market capitalizations of companies in comparable stages of development; and
- The time-proven wisdom that last year’s top performers are not likely to be next year’s top performers.
On my first pass through the list I considered whether a company had substantial revenue from product sales or had a clear path to substantial revenue over the next 12 months. Recessions are hard on everybody because demand for consumer products dries up and commercial buying decisions are frequently deferred. While increased spending on maintenance typically offsets part of the contraction in demand, everybody suffers. Recessions are particularly unkind to development stage companies that don’t have revenues or a clear short-term path to revenues. In connection with the preparation of my 2009 outlook, I assigned negative marks to companies that do not currently have a product that can be manufactured by them and sold into an existing market in the next 12 months.
On my second pass through the list I considered the relative capital cost per kWh of storage capacity. In making that assessment, I used the capital cost hierarchy that I built from recent cost estimates published by Sandia National Laboratories that I’ve annotated to highlight the principal potential market segments for each of the technologies. For a more exhaustive presentation of the advantages, disadvantages, commercial status, current R&D and potential applications of the various technologies, please see pages 18 and 19 of the Sandia report. Since recessions tend to favor the best affordable technology over the best available technology, I assigned negative marks to companies that are focusing on the development and commercialization of objectively expensive products unless the primary users of those products are relatively insensitive to battery costs.
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On my third pass through the list, I considered the relative size of the potential primary and secondary markets for various energy storage products based on the companies’ stated goals. Since potential market size is a long-term rather than short-term factor, I did not limit my analysis to a one-year time horizon and focused instead on long-term potential assuming successful development of technologies that are still in the demonstration stages. While that analysis was necessarily subjective, technologies that have limited scope of application received lower marks than technologies that have significant potential in a wide variety of substantial markets.
On my fourth pass through the list, I considered the relative market capitalizations of companies in comparable stages of development. There are substantial disparities between the relative valuations of the development stage companies and there are also substantial disparities between the relative valuations of the companies that are already manufacturing and selling comparable products. I assigned negative marks to companies that have unduly high market capitalizations when compared to a sub-group of peer companies in a comparable stage of development.
On my final pass through the list, I considered the recent market performance of the various companies compared with their long-term historical performance. In the absence of specific objective reasons for price increases or declines, I assigned higher marks to companies that are underperforming when compared to their peer group and lower marks to companies that are significantly outperforming their peer group.
Since my 2009 outlook is particularly unkind to Ener1, Valence, Altair and Beacon, I think a fuller discussion of my reasoning is probably in order.
Ener1 (HEV) is a development stage company that lost its potential first mover advantage when Toshiba introduced its SCiB lithium-titanate product line last September. It then lost its principal customer when Th!nk was forced into public administration. As a result Ener1 has turned to its principal stockholder, the privately held Ener1 Group, for a $30 million credit lifeline. Despite uncertainty about whether Ener1 will ever manufacture or sell a product beyond the “me-too” lithium-polymer devices that its recently acquired Korean subsidiary manufactures, it carries a market capitalization that’s only 13% less than the combined market capitalizations of Exide and Enersys. To put things in perspective, these two companies collectively sell about $6 billion of products per year and have combined annual earnings that are about 150% of Ener1’s pro forma stockholders equity. Ener1’s gravity defying performance over the last year was impressive, but I don’t see any way that it will be able to maintain an $800 million market capitalization while comparable transition-stage companies are valued in the $40 to $100 million range.
Valence (VLNC) sells Li-ion batteries that it manufactures through Chinese subsidiaries. Despite the fact that its competitors including Hong Kong Highpower (HPJ), Advanced Battery Technologies (ABAT) and China BAK (CBAK) all have solid technologies, far stronger balance sheets and significantly higher annual revenues, Valence carries a market capitalization that is two to five times greater than its peers. I don’t see how Valence can maintain a disproportionately high price in a recessionary environment when both A123 Systems and China BAK manufacture comparable products using the same basic chemistry.
Altair Nanotechnologies (ALTI) and Beacon (BCON) are both pursuing opportunities in an exotic utility support niche known as frequency regulation. For several months I’ve been trying to get a handle on what frequency regulation services are worth without much success. Last week I received an inquiry from a potential client who told me that frequency regulation services in California had an annual revenue potential of approximately $250,000 per megawatt, but pending regulatory changes would probably increase that number. If comparable values prevail for the Altair and Beacon projects, they’re looking at a relatively uninspiring four-year payback on capital investment without accounting for operating and maintenance costs. Since Altair is also testing a battery solution for hybrid transit bus applications that may prove to be a cost effective use of its technology, I think its business model carries less risk than Beacon’s approach which puts all the eggs in a single basket. On the other hand I think Altair’s higher market capitalization largely offsets the business model risk.
Some commenters will undoubtedly suggest that my favorable outlook for Axion Power International (AXPW.OB) is biased because of my prior relationships with Axion. But that doesn’t change the fact that I’ve watched Axion’s technology develop over the last five years and have spent enough time working in the energy storage sector to understand that an inexpensive general purpose product with broad usefulness across a variety of applications has much greater short term potential than a more-expensive product that’s designed to satisfy the highest performance requirements of a particular market niche. It all goes back to my basic belief that customers will gravitate to the best affordable technology before they decide to pay a substantial premium for the best available technology. When my fundamental view of market dynamics is combined with the fact that Axion is presently trading within a few cents of its all time low, I can’t help but have high expectations for 2009.
I’ll revisit this list at least quarterly over the next year and either gloat or eat crow as appropriate. In the meantime I would like to wish everyone a Happy New Year and the optimistic thought that 2009 has to be better than 2008.
Disclosure: Author holds a large long position in Axion Power International (AXPW.OB) and small long positions in Exide (XIDE) Enersys (ENS) and Active Power (ACPW).
[i] Hong Kong Highpower and Active Power have been added to the list.
[ii] VRB Power Systems [VRB.V] and Electro Energy (EEEI) have encountered significant business difficulties and I’ve stopped reporting on their stock performance. I’ve also stopped reporting on SAFT Batteries SA (SGPEF.PK) because of the difficulty in providing data on foreign companies without complex exchange rate conversions.