Source: Tom Armistead of The Energy Report (7/16/13)
"Regulation" is a dirty word among most investors, but for speculators like Rodney Stevens, portfolio manager at Wolverton Securities Ltd. and author of The Disciplined Speculator newsletter, state-mandated emissions caps and renewable energy goals present an extraordinary opportunity for growth. In this interview with The Energy Report, Stevens makes a bullish case for solar stocks and offers several names for traders playing offense or defense. But whatever your strategy, Stevens says get the heck out of bonds and into equities.
The Energy Report: What can retail investors learn from the speculator's perspective and methods?
Rodney Stevens: "Investing" is one of the most misused terms in finance. When you're an investor, the typical strategy would be to buy cash-cow businesses at low prices and hold them forever, like the Warren Buffett strategy. Most of us don't have that time horizon. Very few companies actually fit that particular definition of an investment. Our main strategy is to buy speculative companies, but if you apply the Warren Buffett strategy to speculative stocks, that scenario is fraught with danger. But you can speculate with a process that puts the odds in your favor. The first thing to determine is whether you are indeed speculating.
Another approach to stock speculation is to integrate short selling into your strategy. A lot of people view short selling as more risky, but when you combine a long and short portfolio, it actually serves to reduce the overall portfolio risk.
TER: Why do you advise getting out of bonds and into equities?
"A rising interest rate is going to negatively impact bonds."
RS: The U.S. bond market-the treasuries-has recently turned bearish. The cause is the perception of growth in the U.S. economy combined with the potential for Federal Reserve Chairman Ben Bernanke to begin reducing his stimulus. If he does reduce his stimulus, interest rates should rise. A rising interest rate is going to negatively impact bonds. We certainly view those as underperformers going forward.
TER: What conditions would justify a Fed decision to reduce stimulus?
RS: Ben Bernanke has always said that he would reduce stimulus if the economic growth in the U.S. could support that. His key metrics are the unemployment rate and, more important, the inflation rate. So long as Bernanke is supporting U.S. growth, U.S. stocks are the most favorable place to be right now.
TER: Why do you think "offensive" stocks and sectors that include energy will outperform utilities and other "defensive" stocks?
RS: Defensive stocks refer to the bond-like stocks, such as utilities, which might have consistent dividends and marginal growth, but essentially trade like bonds. In the face of rising interest rates, these assets should underperform. The more offensive stocks, which are more impacted by growth in the U.S. economy, can support low rates or small increases in rates, but also have the growth potential to outperform.
TER: How will President Obama's climate change program affect the solar energy industry?
RS: The key takeaway is that Obama would like to double renewable electricity generation by 2020. This could be beneficial for nuclear energy, which doesn't have carbon emissions, but I think the prime beneficiary would be the solar space, because right now solar is the cheapest form of green energy to install and maintain. Solar energy, with its lower upfront cost and low energy rates, is positioned to be one of the prime beneficiaries.
TER: You say it has lower costs. Is that in the materials? The construction?
"Right now solar is the cheapest form of green energy to install and maintain."
RS: That's the upfront cost for materials and installation, and those costs are much lower compared to wind power or geothermal. In terms of upfront costs and ongoing costs, solar is in the position to benefit most for political incentives towards clean energy or renewable energy.
TER: Is the solar industry threatened by the low price of natural gas?
RS: Typically, in the past, solar companies' equities would trade inversely to natural gas, but it's becoming less of an impact now because the technology in the solar space has improved so significantly that it's almost economic without government subsidies. The natural gas price, if it declines, can of course result in lower utility costs assuming the utility companies transfer that reduction to the customers.
TER: Can solar thrive if it's not installed for utility-scale generation?
RS: Yes, it already is thriving. Right now they're actually competing with the utilities, whereas previously there was no real competition for these companies. Yes, it can and it is happening in a large way now.
TER: What solar companies could thrive in this environment?
RS: The main companies that we're interested in are SunPower Corp. (SPWR:NASDAQ), SolarCity Corp. (SCTY:NASDAQ) and Real Goods Solar Inc. (RSOL:NASDAQ). SunPower we like because not only does it manufacture the solar panels, but it also has a leasing program for the retail space, similar to SolarCity. SunPower has one of the best products available on the market and it should benefit from the incentives utility companies have to add renewable sources of energy to their business. SunPower could play a big role in the utility space, but also grab the retail markets. It should benefit from the growth in solar and also it has an international base, although its operations are primarily in the U.S.
SolarCity, for example, leases electricity to both retail and institutional customers, but it is focusing on the more profitable retail segment. Its strategy is to provide solar panels at no upfront costs to the customer. It's a business proposal of, "let us save you money right now at no cost." The company has put together a maximum market-penetration strategy. It is definitely the most aggressive strategy in the industry and the company is positioned to capture a large market share. Of course, its leasing strategy is fraught with default risk and interest rate risk as it is financing sales, but so far, the company's business plan has been working and the company is set to grow considerably.
Real Goods Solar simply installs the panels, but it doesn't finance, as SolarCity does. However, it recently hired new management and has a very competitive product as well. It has been around for a long time and is now on the cusp of turning to profitability and growing sales considerably. I think these three companies are well positioned to benefit from the growth in the solar space, which is probably one of the largest growing sectors in the energy sector.
TER: Why has Real Goods Solar's stock been so volatile recently?
RS: It's been volatile recently because it has good liquidity, but not a very large float. The recent move to $7/share was basically due to a positive article on the company. Right now the price has settled down into a more reasonable range of 0.9 times sales and we expect profitability and sales to grow over the next 12 months, which should result in fairly decent performance of the share price.
TER: And SunPower Corp. has rallied from $5/share to $20/share since the beginning of this year. What's driving that?
RS: I think decent quarterly results drove the stock. Its revenues beat expectations and its losses have narrowed. Going forward, SunPower is staged for further growth and profitability. I think that's been the main catalyst driving the share price. We expect that revenue growth to continue.
TER: I understand you like the energy service industry. What are some examples of good service plays?
RS: I'm looking at businesses peripheral to the E&Ps (exploration and production companies) and less related to the commodity price. The midstream segment-services, storage and transportation-should benefit from low interest rates. These companies don't have the same growth potential, but the ones I look for are those that have support, a sustained dividend and the potential to grow those dividends. They're not quite like bond companies, although they do provide a good balance in a portfolio with less risk, but still have that growth aspect to them. Some of the companies that I like in the sector are Canadian Pacific Railway Ltd. (CP:NYSE), Martin Midstream Partners L.P. (MMLP:NASDAQ) and Targa Resources Partners L.P. (NGLS:NYSE). They've all got good growth potential. Targa and Martin Midstream Partners have great dividend-growth potential.
TER: Canadian Pacific Rail's stock has tripled in four years. What part has the energy industry played in that growth?
RS: Canadian Pacific Rail and the rails in general are great, very simple business models. They are like toll bridges. They have the position where, if you don't use their services, you potentially have to pay a higher price for the alternative. They can raise prices and people will still pay them. That supports a good long-term growing business. They're cash cows.
Canadian Pacific Rail more recently brought on a new CEO, E. Hunter Harrison. He came from Canadian National Railway Co. (CNR:TSX; CNI:NYSE), CP's larger peer. His mission has been to grow the company's earnings significantly. His first initiative was to grow by 40% this year and then another 20% growth in the next few years. He's primarily achieving this through cost cutting. That's been driving CP's share price, and we want to benefit from that program. It is a great business and has one of the best growth profiles in the space.
TER: Is Targa's midstream service to the unconventional gas and oil industry risky in the long-term?
RS: There's always a lot of risk with these companies. The primary risks are they have large capex for their growth initiatives and that capex is subject to cost overruns and delays. There's permitting risk. They could set up their terminals in a location where the market demand dissipates. They acquire companies that may or may not end up being good investments. They risk credit rating reductions if they make poor investments. And it's a highly regulated industry. But these risks are offset by Targa's strong, solid cash flow and growth potential.
TER: Martin Midstream Partners' stock plateaued in the $30-40/share range throughout the last two years. Soon after the general election in 2012, it began a surge and seems now to have reached a new high. What's behind that?
"There's more clarity now that the tax status is determined for master limited partnerships."
RS: There are probably two primary drivers behind that. One might be the Obama administration's decision on tax status of the master limited partnership structures. There's more clarity now that the tax status is determined. The second reason is its yield. It does have a high yield and an expected growing dividend distribution. Investors are still hungry for yield and yield growth. I still think Martin Midstream Partners is going to benefit from the low interest rates that we're seeing in the U.S., but the market's going to appreciate the growth potential that it has in its dividend payouts.
TER: You have also expressed interest in Cheniere Energy Partners L.P. (CQP:NYSE.MKT). That company has two gas liquefaction trains under construction right now at its Sabine Pass liquefaction and just began construction of two more trains. The first liquefied natural gas is not expected before 2016. Why are you interested now?
RS: It's not necessarily my top pick, but what I do like about it is that it does have that stable dividend and a good yield. There is a price discrepancy between U.S. local and overseas natural gas prices. The bottleneck for that has been in the liquefaction plants that they're building right now. They stand to benefit from premium prices when these trains are built. That could be a positive near-term catalyst for the stock. This company has a good track record of building its projects on time and on budget as well. I'm happy to hold onto it so long as the company continues achieving its project development targets.
TER: Are there any other companies that you would recommend?
RS: There are a few others in the space as well that we're interested in. Another midstream company we like is Energy Transfer Partners L.P. (ETP:NYSE). In the solar space, First Solar Inc. (FSLR:NYSE)and Canadian Solar Inc. (CSIQ:NASDAQ) look appealing to us as well. I think the combination of the midstreams and solar makes a good portfolio balance when you're weighing dividend growth and corporate growth.
TER: Do you have any final words of advice for investors in the energy space?
RS: We like to invest on strength and sell on weakness and not tolerate any losses or losing positions. The other key would be to have a disciplined approach so that you reduce your losses and maximize your gains. We do that by using our progressive stop-losses to monitor portfolio operational risk. We also have a balance of long and short positions, which makes for a more conservative portfolio. The most important things to look for are stocks that should benefit from the current economic conditions. Just make sure to have effective risk control.
TER: You've given us a lot of good stuff to think about. I appreciate your time.
Rodney Stevens, CFA, is a registered representative and portfolio manager at Wolverton Securities Ltd. Since 2001, Stevens has worked in the mining securities industry, initially as an investment analyst with Salman Partners Inc. Stevens became a top-rated analyst by StarMine on July 17, 2007, for the metals and mining industry based on the profitability of stock recommendations and the accuracy of earnings estimates, generating an excess return of 7.9% over the corresponding industry benchmark.
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1) Tom Armistead conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
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