Editors' Note: This article cover stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
Over the past year, the renewable energy sector experienced mixed returns. In this article, I will break down eight renewable energy industries (from worst to best performance last year) and examine their future potential. For my analysis, I will be using ETFs or ETNs, when possible, and averaging only companies with a price over 1 for industries without an ETF or ETN.
1. Synthetic Fuel
Synthetic fuel is a clean burning fuel produced from traditional fossil fuels. Synthetic fuel is unique because it produces a transparent fluid, lacking sulfur and aromatics. The companies involved in synthetic fuel production are Rentech (NYSEMKT:RTK), Sasol (NYSE:SSL), Synthesis Energy Systems (NASDAQ:SYMX), Syntroleum (NASDAQ:SYNM), and Velocys (traded on the London Stock Exchange as VLS). Currently, there are two different ways to produce or use synthetic fuel. The first way, the indirect method, is illustrated below.
As seen above, traditional fossil fuels are converted to gasoline, diesel, and jet fuel, but a clean burning synthetic fuel is produced in between. The second method of production, known as gasification, stops at the production of synthetic fuel. The past year was lackluster for synthetic fuel stocks. Sasol, the largest synthetic fuels company, was the only one in the group to end the year positive. Sasol currently produces over 150,000 bpd in South Africa and is the most attractive investment of the group for several reasons. Firstly, Sasol is the most established of the group with a market cap just shy of 30 billion dollars. Secondly, Sasol trades at 9 times forward earnings and will expand EPS 11% this year with a 35% profit margin. Rentech, at first glance, appears attractive with 170% growth next year. Unfortunately, Rentech has a debt/equity ratio of 2.5 and a forward P/E of 70, both metrics should scare investors away.
Biofuel is a type of fuel produced from living organisms. Biofuel can be broken down into two major types of liquid fuel, bioalcohol and biodiesel. Bioalcohol, the first of the two, is produced through fermentation (when yeast converts a sugar into an alcohol in the absence of oxygen) and is commonly known as ethanol. Sugar, corn, and all starch crops can be converted into bioalcohol and sold at a gas station alongside gasoline. In the United States, the EPA mandates that gasoline contain 10% ethanol. Reports on future action by the EPA range from the agency raising the "blend wall" to 15% to the abolishment of the blend wall. EPA action that increases the blend wall will benefit the ELEMENTS MLCX Biofuels Index TR ETN (NYSEARCA:FUE) (seen above) and hurt big name refiners such as Phillips 66 (NYSE:PSX) and Valero (NYSE:VLO). Given the extremely data sensitive nature of an ethanol trade, I recommend that investors avoid the ETN and refiners altogether. Biodiesel, the second of the two biofuels, is made from vegetable oils and animal fats. Biodiesel can be used in pure form or as a diesel additive. Biodiesel is also data sensitive and EPA action should be factored into any investment. Biodiesel companies, however, have had a mixed year so far. Renewable Energy Group (NASDAQ:REGI) gained 62% while Methes Energies International (NASDAQ:MEIL) shed 3%. This past month, Renewable Energy Group purchased Syntroleum's assets making Renewable Energy Group a player in both the synthetic fuels and biodiesel industries. Renewable Energy Group should only be bought by investors looking to speculate on future EPA action as biodiesel remains the majority of the company's business. Methes should also be strongly avoided by investors at 6 times book value with an EPS contraction of -346% next year.
3. Ocean Energy
Ocean Power (NASDAQ:OPTT), the major player and pure play in the ocean energy space, transforms wave energy into electrical energy. The process is detailed below.
Though Ocean Power has a market cap of 22.9 million dollars, the company is already an international brand. Currently, Ocean Power operates projects in Oceania, North America, and Europe. Also, Ocean Power's major product is the PowerBouy (seen above). Ocean Power sells three types of PowerBuoys, the most advanced is known as the Mark 4 PowerBuoy. Ocean Power cites several great uses for their buoys including use at naval bases, creating hydrogen energy from seawater, creating drinking water from seawater, and use at oil and gas rigs. While each use sounds tantalizing, Ocean Power has yet to report a positive quarter and will continue to report negative quarters for, at least, the next two quarters. While I do not advise an investment in Ocean Power until the company turns a profit, Ocean Power holds incredible promise 2-3 years down the road.
4. Nuclear Power
Nuclear power is a controversial energy source which converts the immense power of the atom into electrical energy. In a nutshell, nuclear energy from Uranium is converted to mechanical energy in turbines and then to electrical energy for consumption. Nuclear power has existed for a long period of time and experienced a boom period following World War II, when the U.S. Government subsidized nuclear plants. Until 2012, no nuclear power plants had been built in the United States since the late 70's. The main reason is that the plants are incredibly expensive and come under severe pressure after a nuclear accident (such as the recent Fukushima incident). Even worse, the cost of closing a nuclear plant is up to 50% the cost of building it in the first place and nuclear waste must be buried deep in a mountain. That being said, the future of nuclear energy in the United States is important to consider given that US production is equivalent to the production of the next four nations combined. The above chart shows last year's performance of the Market Vectors Uranium + Nuclear Energy ETF (NYSEARCA:NLR). The fund's top US holding, Exelon (NYSE:EXC) is detailed below.
Exelon produces 20% of the United States' nuclear energy with 10 power plants and 17 reactors. Though Exelon is cheap on a forward P/E basis, it is a terrible investment. Exelon will contract on an EPS basis in the next 5 years and long-term debt is 85% of current equity. I advise investors to profit from Exelon's shrinkage by buying January 2016 put options at the 25 strike for 2.7 per contract. The profit model and probability for that options trade is shown below if 100 contracts are bought.
5. Geothermal Energy
Geothermal power plants convert thermal energy in the Earth's crust to electrical energy for consumers. Currently, the United States is the world's leading producer of geothermal energy with 29% of global production. The major players in the geothermal space are Calpine Corporation (NYSE:CPN), LSB Industries (NYSE:LXU), Ormat Technologies (NYSE:ORA), Ormat Industries (traded on the Tel Aviv Stock Exchange as ORMT), and Waterfurnace Renewable Energy (traded on Toronto Stock Exchange as WFI). The best investment in the group is an easy choice, LSB Industries. As the world's largest producer of geothermal heat pumps, LSB has a market cap of 809 million dollars. A table comparing the three companies from the US highlights LSB's superiority below.
Currently, LSB sells its geothermal pumps to the residential and commercial markets. LSB's geothermal operations include four different companies. The companies are ClimateMaster, Trison Construction, Thermaclime Technologies, and Koax Corporation. A noteworthy aspect of LSB's geothermal operations is that the subsidiaries complement each other very well. ClimateMaster makes and sells geothermal pumps while Koax and Thermaclime make parts for the pumps. Then, Trison Construction installs the pumps. ClimateMaster's latest geothermal pump, part of the Trilogy 40 Series, is patent pending. I advise investors looking to profit from LSB by purchasing shares of common stock. LSB is currently 15.8% away from its last 52 week high, therefore, now is a great time to invest.
6. Wind Power
Though wind power has existed for hundreds of years, only 2.5% of the world's energy is generated from wind power. Better yet, wind power is growing at 25% per year. The United States currently leads the world in production and produces more than the next three countries combined. After falling over 500% from its debut in the summer of 2008 to the summer of 2012, the First Trust ISE Global Wind Energy ETF (NYSEARCA:FAN) has rebounded over 100% from its 2012 lows. The top US holding in the fund, British Petroleum (NYSE:BP), is hardly a pure play on US wind production. Unfortunately for investors seeking a US wind energy pure play, options are limited. Broadwind Energy (NASDAQ:BWEN), with 100% of 2009 revenue from the sale of its wind towers and other wind related services, is the best US play in the wind energy space. I am using 2009 numbers because Broadwind has yet to post an updated annual report since 2009. Broadwind is the largest producer of steel wind energy towers in North America and the largest producer of precision gears used in wind towers. To service its own and other towers, Broadwind offers technical services across the country and a hauling fleet of heavy-load trucks. Even though Broadwind is an industry leader in the US, investors need to be wary of its rich valuation. Today, Broadwind trades at 1024 times forward earnings with a disappointing -6.7% profit margin. Therefore, for investors seeking a place in the wind energy industry, the First Trust ETF is the best investment. For investors seeking a US wind energy pure play, Broadwind Energy is the obvious choice.
7. Solar Energy
Solar power, a heavily traded renewable industry, deserves the attention it receives. Solar has grown roughly 40% per year since 2000 and constitutes less than 0.5% of global energy production. Presently, the US operates the two largest solar facilities in the world. The Guggenheim Solar ETF (NYSEARCA:TAN), weighted 31.3% to the US, contains plenty of great solar plays. The top five US holdings in the fund are SolarCity Corporation (SCTY), First Solar Inc. (NASDAQ:FSLR), SunEdison (SUNE), GT Advanced Technologies (GTAT), and SunPower Corporation (NASDAQ:SPWR). SolarCity, at 18 times book value with a -46% profit margin, can easily be ruled out. While SolarCity is not a good investment now, I certainly do not recommend shorting a stock strongly fueled by speculation. A table below shows that none of the solar companies make good individual investments.
With each solar company, there are at least two statistics that rule it out as a sound investment. These "killer stats" have been highlighted in red. While none of the major US players can be justified as solid investments, it would be unwise to avoid the solar sector altogether at its terrific annual growth rate. Therefore, my recommendation is no different from my recommendation for wind energy. I suggest that investors purchase the Guggenheim ETF, and if holding an individual name is necessary, I recommend SunPower as the best of an ugly group.
8. Hydrogen Fuel
Without question, the past year was a triumphant year for hydrogen fuel cell companies. The diagram below explains the hydrogen fuel process.
Out of the seven major players, five doubled last year. The seven major players are Air Products and Chemicals (NYSE:APD), Plug Power (NASDAQ:PLUG), Hydrogenics Corporation (NASDAQ:HYGS), Ballard Power System (NASDAQ:BLDP), Quantum Fuel Systems Technologies Worldwide (NASDAQ:QTWW), Proton Power (traded on the London Stock Exchange as PPS), and AFC Energy (traded on the London Stock Exchange as AFC). Most of the above companies are highly volatile and yet to turn a profit. Therefore, while it is too early to invest in many of the smaller companies, I believe that Air Products and Chemicals serves as a good investment. Air Products and Chemicals, a diversified 22.4 billion dollar company, stands to gain greatly from its hydrogen energy division. Today, Air Products and Chemicals' hydrogen operations can be divided into three main parts. The first of the three parts, material handling, refers to the hydrogen powered forklifts that the company sells. The forklifts are preferable to conventional lead battery forklifts because they only require one to two refuels per day. Better yet, a refuel takes only three to five minutes. Air Products and Chemicals' second hydrogen division, power generation, consists of the company's hydrogen fuel cell plant operations. The diagram below illustrates how a hydrogen plant functions (CNG stands for compressed natural gas and H2 stands for hydrogen gas, both are transportation fuels).
Air Products and Chemicals' final hydrogen division, transportation, refers to the company's hydrogen stations for commercial automobile or bus usage. While it is unlikely many people have seen a hydrogen station, Air Products and Chemicals believes that hydrogen is, "the perfect fuel." Investors seeking to profit from Air Products and Chemicals can purchase both options and common stock. Right now, I advise investors to purchase common stock instead of call options. I suggest investors do so as a different part of Air Products and Chemicals' business could drag it lower, even if the hydrogen division is performing well.
While some renewable energy companies and industry ETFs are ready to move higher, others are still in the very early stages of development. As mentioned in the above paragraphs, my top picks are Sasol, LSB, First Trust ISE Global Wind Energy, and Guggenheim Solar. Exelon makes a great short though put options. Lastly, I hope that I have distinguished the dominance of the United States and the importance of the regulatory environment as crucial factors to consider before making any investment in renewable energy.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.