Building A Clean Energy Portfolio; The Time Is At Hand

by: Henry Miles

The International Energy Agency continues to say that clean renewable energy is growing fast, faster than expected, and faster than dirty fossil fuels.

Reading left-to-right, supply-to-demand, the market is comprised of six basic segments – converters, distribution, storage, engineering, utilities, and appliances.

I’m investing on the supply-side where traditional hydrocarbon companies and newer “pure-play” clean energy firms are positioning for the growth ahead.

Clean energy no longer falls into the category, "...oh yeah, that". I refer you to the International Energy Agency, an intergovernmental organization whose history dates to the 1973 oil crisis. For those who prefer to cut to the chase, "Two-thirds of [the] world's new energy capacity in 2016 was renewable." Or, here's an IEA projection as reported by Oil and Gas Investor no less. Any time investors see a 43% five-year growth rate - that annually is being revised substantially upward - it's time to pay attention.

Our expectation is that (growth in) renewable electricity generation in the next five years will be higher than electricity generation from coal and natural gas times two [emphasis added]," IEA executive director Fatih Birol told journalists.

Six Basic Market Segments

Unfortunately, there are a lot of carnies out there barking this idea or that whether it be lithium mines, home battery units, solar shingles, the latest electric vehicle, you name it. I recently turned down the noise to segment the clean energy market before reevaluating where I want to invest. My training in economics and as an MBA led me to contort two ideas into a sort of value-chain / supply-demand continuum of six primary segments:

  1. Converters - the means to tap and turn the power of solar, wind, geothermal, hydro, tidal and other forms of clean fuel into electricity; generators, turbines, and photovoltaics.
  2. Distribution - grid solutions enabling the delivery of electricity; analogous to big oil's midstream system of pipes and downstream networks of gas stations.
  3. Storage - specifically, batteries (and capacitors), that enable the practical and economic retention and "buffering" of available electricity pending its final use.
  4. Engineering - the specialized services of experts that support governmental and commercial electric projects, conversions, upgrades, and ongoing maintenance.
  5. Utilities - those that bring together and operate the elements above (not unlike I/T integrators) to meet the ultimate needs of consumers for electricity.
  6. Appliances - broadly defined to mean all devices that plug-in and draw power for whatever their end purpose including lighting, heating, cleaning, BEV's, etc.

Now, let's flip the six segments above on their side before I stack the symbols of the stocks I own above one another in their respective column (alphabetical bottom-to-top). As you can see, we have the makings of histogram that, in my case, is skewed sharply to the supply-side on the left with a few companies occupying more than one segment:

Supply-Side Converters Distributors Storage Engineers Utilities Appliances Demand-Side

Little Interest in the Demand-Side

Let's start on the right side of this chart. As a rule, I am not a consumer product investor. I avoid gadget and toy manufacturers, apparel and shoe companies, grocers, and restaurants. For me, there is just too much competition for fickle market-share, with margins subject to never-ending compression. Other investors think about it differently but I am just not comfortable with the medium-to-long-run, alpha-odds in these kinds of businesses.

I feel the same with respect to clean energy. I understand that they are very important but my bias as an investor is to avoid energy-efficient plug-in's - toasters, dishwashers, dryers, light bulbs, water heaters, BEV's, you get the idea. Companies on the supply-side are also pushing away from the other end of the continuum. A couple of years ago, General Electric (GE) sold its appliance division to Sweden's Electrolux (OTCPK:ELUXY) and, as I was drafting this article, Siemens (OTCPK:SIEGY) took itself out of the consumer products business with the announced the sale of its stake is Orsam Licht.

I also shy away from utility companies because: a) They usually operate as national or regional monopolies under heavy rate regulation, and b) They are generally interest rate sensitive meaning that their share values face an uncertain future when the Fed reduces the size its balance sheet and the cost of money marches upward. No, these companies are not for me unless they are demonstrating exceptional leadership in "bending the curve" on energy use. The French giant ENGIE (OTCPK:ENGIY) satisfies this criterion and is the only utility company that rates a place in my clean energy portfolio.

A Lot of Interest in the Supply-Side

Okay, let's jump back to the left side of our histogram. Right off the bat, permit me to explain my positions in Total (TOT) in the converter column, and Royal Dutch Shell (RDS.A) (RDS.B) as a distributor. Look, I would love to see the whole world running renewably clean but, for the foreseeable future, it is not realistic because it's not an on-or-off proposition. So, I am looking for providers that are on-and-off. Total is very well-positioned with respect to cleaner natural gas but they are changing and I resonate to their 57% shareholding in SunPower (SPWR), a global force in solar energy. I'm particularly excited about their venture in Japan, a country that is looking for alternatives to imported oil and nuclear power.

As to Royal Dutch Shell, it is also very well positioned in natural gas as a transition fuel having stated that it is a strategic direction for them. At the same time, the company has sold their interests in Canadian oil sands and, as I was drafting this article, Royal Dutch announced their acquisition of NewMotion with 30,000 private electric charge points for homes and businesses in the Netherlands, Germany, France, and the UK. Could it be that fossil fuel giant Shell Oil is repositioning itself to also be a major distributor of vehicle electricity (and to sell more snacks, Slurpee's, and bill caps at their charging station stores:)?

This illustrates, importantly, that funding - big money - to bring about, and capitalize on, the growth in clean energy is being released from the wealth amassed by dirty energy. Moreover, as we are beginning to see, the transformation of fossil fuel extractors and refiners is driven by integration with innovative renewable energy firms; M&A. This screams investment both in the majors themselves as well as in pure play clean energy firms. Let that soak in.

In addition to Total and Royal Dutch Shell, in the converter and distributor columns I also have full positions in Siemens, General Electric, Ormat (ORA) and First Solar (FSLR). In order, Siemens is dominant both in electricity generation and grid technologies. For those who missed it, this German giant now owns a controlling interest in Spain's Gamesa having created the world's largest wind farm business. General Electric, of course, is the international competitor of Siemens. GE is active both in the converter and distribution segments although not as concentrated as Siemens in wind farming. That said, GE is arguably the global leader in turbines that are used to power all forms of clean energy. At the right price, this is reason enough to look past GE's current challenges.

In the pure play department, I am fully invested in Ormat the leader in geothermal energy and I recently established a full position in First Solar. Beyond the market and technological factors that primarily motivated me, in Ormat and First Solar we see evidence of companies that are very business-savvy. A few months ago, for example, Ormat cooperated in the sale of an early-stage investor's 22% holding to Orix, a Japanese financial conglomerate. This is significant for a variety of reasons most obviously for the access it gives Ormat to eastern markets and to financing to grow without unduly burdening its own balance sheet. Also, smartly, Ormat retains interests in the facilities they develop as a way of adding "annuity-type" income to their project management revenues. A case in point is the 12% share they have in Sarulla, Indonesia Sumatra's multiphase geothermal power plant.

As for First Solar, I'm impressed that they resisted the bright lights of the home panel market in favor of commercial / municipal collectors that actually deliver economies of scale. And while both companies are well capitalized, First Solar is especially so; adequate equity is extremely important to companies on steep growth arcs in a potentially uncertain interest rate environment. Ormat and First Solar are paying attention.

Moving Right on the Continuum

I admit it, I've had trouble getting my head around the storage of electricity; batteries (and capacitors). As to BEV's, the limiting factors of weight and distance bother me. As to home systems, their cost for a few hours of backup power seems prohibitive for all but the well-heeled, compared to that auxiliary generator you can buy for under $1K from the likes of Briggs & Stratton (BGG), Generac (GNRC), or Honda (HMC). If these issues were not enough to prevent me from putting some money on a battery stack, the capital structures of AES (AES) and Tesla (TSLA) are. So, I was sitting tight when, lo and behold, ABB (ABB) stepped up to partner in constructing the largest lithium-ion battery production facility in Europe. Since I already owned shares in ABB what for their grid (and robotic) technologies, I'm happy now to just watch pending additional advancements in the storage of electricity; my instincts tell me they will come.

And, finally, engineering services. It is almost too much for me to imagine the amount of design, engineering, and project management expertise required for the transformation from dirty to clean energy. There will be a lot of work well into the future never mind all the other governmental and industrial initiatives on stream or contemplated. Fluor (FLR) and Jacobs (JEC) fill the bill because they are diverse, transnational companies with deep roots already in related businesses. In my view, to think about clean energy without considering the key firms that will support the transformation is unwise.

A Few Comparative Numbers

All compared to the S&P 500, for each of the assets in my clean energy portfolio, as of market close on 10/13/2017, below we have their Price-to-Earnings, Forecasted Forward P/E, Price-to-Tangible-Book, Price-to-Sales, Price-to-Cash Flow, Dividend Coverage, Dividend Yield, and Total Debt-to-Capital ratios. As is often the case, depending on the metric, stocks look fully-priced in the moment and these are certainly no exception. However, as is equally true, one must consider the opportunities that lie ahead. The growth and dynamism in the business of clean energy compel me to move forward.

P/E F P/E P/B P/S P/CF D Cov. Yield D/C
S&P 500 22.0 20.1 3.3 2.2 - - 2.0% -
ENGIY - 10.3 2.5 0.5 7.7 - 4.8% -
TOT 18.5 13.8 1.5 1.0 7.5 112% 5.0% 33%
RDS.B 31.3 17.1 1.5 0.9 9.1 52% 6.2% 32%
SIEGY 16.8 16.7 44.2 1.2 12.2 204% 2.7% 46%
GE 26.3 14.9 - 1.7 12.8 95% 4.2% 63%
ORA 28.6 27.3 3.0 4.3 14.5 579% 0.7% 43%
FSLR - 21.5 1.0 1.9 - - - 6%
ABB 24.2 20.6 30.8 1.6 17.2 132% 3.0% 36%
FLR 53.8 28.0 2.3 0.3 10.8 95% 2.0% 33%
JEC 31.0 19.0 7.0 0.7 20.5 422% 1.0% 6%

I am not done building our clean energy portfolio. I may do a pure play in wind energy. I am also on the lookout for the right opportunity in tidal energy / ocean hydro electricity generators; please chime in with a comment, if you know of one. In other words, for me, there are a few gaps left to fill. Given fully-priced equity markets and considering what may be geometric growth ahead for clean energy, I fully intend to round out my supply-side holdings of dominant transnationals and believable pure play companies. The time is at hand.

Disclosure: I am/we are long ABB, ENGIY, FLR, FSLR, GE, JEC, ORA, RDS.B, SIEGY, TOT.

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.

Additional disclosure: Always do your own due diligence in consultation with a licensed and competent financial adviser who puts your interests ahead of their own. Remember, there are added considerations in owning foreign securities including those associated with ADR sponsorship, buying and selling the pinks, foreign withholding taxes on dividends, and fees. (All my proceeds from contributing to SA go to charity.)

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.