By David Sterman
The global energy picture is changing so fast that it's getting hard to keep up. In just the last five years, we've seen:
- Crude oil briefly spike above $140 a barrel in 2008
- A number of governments - especially in Europe and China - subsequently rush to deploy solar and wind power
- The United States find ways to tap into vast reservoirs of natural gas
- The Chinese, Indian and Brazilian economies grow so fast, that their energy needs threaten to alter the current global balance between energy supply and demand.
If there's one thing for sure, it's that more neck-snapping moves in the global energy market will take place anew in the next few years. And investors will need to be prepared to act accordingly.
The rush to embrace wind and solar power now seems to have been a bit hasty. Key countries such as Germany and Italy have radically cut spending in this area, and for investors, solar- and wind-power stocks have been duds anyway because supply overwhelmed demand and pricing plunged.
Yet it's abundantly clear that in the future, the world will have to do more with less. Demand for energy will only rise, and the supply of energy may not keep pace. We'll have no choice but to make more judicious use of the power we have. Electric utilities are just now starting to take steps to enhance the efficiency of their networks, looking at ways to serve more customers without building more power plants.
This, in a nutshell, is the premise behind a "smart grid." By adding a degree of intelligence to their systems, utilities can more effectively monitor and control power consumption patterns. And though a number of companies seek ways to profit from this niche, only one has a longstanding track record and the products that can help utilities "get smart."
I'm talking about Echelon (ELON), which has been around for more than 20 years and has already seen several spurts of growth on the heels of major utility contracts. Right now, its stock is near 10-year lows, as growth has slowed in a constrained global economy. But the steps are in place for a solid rebound in sales - and the lagging share price.
The long hard slog to current lows
Shares of Echelon, which currently trade below $5, changed hands for $80 back in 2000. At the time, the company was in the midst of completing a huge contract with Italy's electric utility Eni (E).
Millions of Italian homes were re-wired to use Echelon's electric meters, which contained controls that enabled the meter to wirelessly transmit information back to the utility. The system was known as advanced meter reading (AMR), which as I'll note in a moment, has been radically upgraded. The company hoped to quickly secure additional major contracts, and as they failed to materialize, shares started to grind lower.
Shares had fallen to just $10 by 2007, but quickly spiked to $30 that year as sales were rising at a few key clients, and a range of pilot programs with other utilities looked quite promising as well. Management expected those programs to become full-fledged rollouts within a few years, but the economic downturn led utilities to slash many discretionary investments. Shares have been on a downward drift ever since.
Though sales shot up 40% in 2011 to $156 million, management now concedes that ongoing delays will keep sales from rising sharply again in 2012. Analysts expect sales to grow just 8% this year to around $170 million, and even that forecast may prove to be optimistic.
Many investors in this stock have simply had enough. Yet behind the scenes, the seeds of a rebound have been planted, and over the next 12-18 months, Echelon appears poised to land another big fish or two. This time, it won't be from a major utility in the United States. or Europe. These two regions appear paralyzed at the moment, making few major bold moves to address the changing global energy picture. Only Duke Energy (DUK) and Finland's Fortum are actively working on rollouts with Echelon right now.
Instead, China and Brazil appear to hold the keys to an upturn. These countries aren't simply looking to deploy the AMR's noted above that Italy's Eni used. They aim to do much more, with a system developed by Echelon that entails advanced meter infrastructure (AMI).
So what's an AMI? It's a communications and control system that can help utilities save energy, reduce power when needed and improve reliability. Let me provide an example. There is an increasing number of electric cars hitting the road, and each one needs to be plugged in at night to recharge the batteries. Utilities have grown concerned that too many cars being charged at once will overwhelm the system. So they want to be able to know what is being charged, and they want to have the ability to cut the juice to specific devices when demand peaks.
The car charging could be delayed if needed until consumers are done with washing machines, dishwashers and other appliances. We are starting to see this happen in places such as California, where utilities have signed up many homes to have their power cut voluntarily when the risk of summer blackouts can occur.
The interest from Brazil and China is different. These countries also aim to better identify when electricity is being pilfered, and need an AMI to truly control all the juice that flows.
In November 2009, Echelon announced plans to partner Brazil's ELO Sistemas Electronicos. The company supplies meters and other equipment to the top 40 utilities throughout the country (representing 55 million homes). Not only does the Brazilian government seek to push utilities to become more efficient, but the utilities themselves lose an estimated $350 million to electricity theft every year. Echelon's technology is being tested throughout Brazil this year, with an eye toward possible major rollouts in 2013. ELO also has relationships with other utilities outside of Brazil.
Echelon is partnering with China's Holley Metering to tackle the country's mandate to connect 300 million homes and businesses to smart-grid technology over the next five years. As is the case with ELO in Brazil, Holley has relationships with most of China's major utilities. Both of these deals are unlikely to impact results in 2012, but could represent a significant growth driver in 2013 and beyond. The Brazilian opportunity is a little further along and could be the first driver to help boost the stock.
The fact that 2012 will likely represent minimal growth for Echelon is why this stock is now scraping fresh lows. Investors had been anticipating that 2012 would finally be the year when Echelon sees a sustained build-up in sales.
As a final note, Echelon also has a base of industrial customers that use the company's "Lonworks" technology in process-control environments. Lonworks is a suite of hardware and software that allows for the remote management of factory machinery. This is a solid segment of the business, but not key to upside for the stock. I'll be touching on Lonworks in the future if the segment becomes more relevant to the stock's potential upside.
Downside Support: This stock appears fully washed out, and it's hard to see how it can move much lower. I see a floor at $4, which would value this company at $170 million. Consider that Echelon has spent $260 million on research and development during the past eight years. Current investors can buy that knowledge base at a 25% discount to that value. (The current market value is $200 million and the enterprise value is just $160 million.)
Said another way, Echelon's technology base and customer relationships - though they may be nascent in their development potential - makes Echelon quite valuable to any larger technology firms that want to enter into the smart-grid space. That $4 mark may also be the point where chatter would likely build around the company being acquired. Besides, Echelon has $59 million in cash and no debt so there is minimal financial risk.
Upside Triggers: This is no longer a timely investment, so many investors have given up on Echelon for now. But they will pour back into this stock once the makings of an upturn begin to take shape. Management's upcoming comments could help to refocus investors on what is still a tremendous long-term opportunity.
Echelon has also held discussions with dozens of other utilities around the globe, and you can look for new customer wins later his year as well. As a final catalyst, the United States and Europe have been paralyzed by their economic woes, but as these two major economies start to stabilize, the willingness to make upfront investments with long-term payoffs may soon be back in vogue. On its most recent conference call, management noted that Echelon's pipeline of new business leads is three times larger than a year ago. Converting these leads into contracts could be a solid catalyst for shares.
I will buy 1,000 shares (roughly worth $4,700). I suggest investors put in a stop-loss at $4.00, in the event that a market rout sucks this stock down with the pack. Shares can be bought under $7.
(Editor's note: the stop-loss for this trade has been revised.)
Disclosure: David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of E in one or more if its "real money" portfolios.