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New Cap And Trade Legislation Could Be Watershed Moment For These Stocks

|Includes: Blue Earth, Inc. (BBLU), CCC, FTEK, PBW

January 12, 2012

Prime Equity Research, LLC

Financial Writer: Chris Engleman

Includes: BBLU.Ob, CCC, PBW, FTEK

New Cap and Trade Legislation could be Watershed Moment for these Stocks

New Cap and Trade Legislation could be Watershed Moment for these Stocks

An increase in government regulation is most often considered a burden to corporate America and industries subject to a high amount of regulation trade at discounts due to the risk. There is one industry where the growth of policy and programs adds to top-line sales and public sentiment is actually turning in favor of more regulation.

I'm from the government and I'm here to help

Growth in environmental regulation and energy efficiency mandates has increased over the last decade. While the US Environmental Protection Agency has driven some of that growth, many of the new rules have come through court decisions or settlement agreements. This sets a powerful precedent that will not be overturned by subsequent administrations or a weakening of the EPA. As such, future growth for providers of clean energy technologies and energy management is more reliable than it has been in the past.

In FY 2011, EPA enforcement actions required companies to invest an estimated $19 billion in actions and equipment to control pollution. This is the highest recorded injunctive relief in EPA history, and the agency is now under court order to promulgate rules that have been deferred for years.

Twenty-four states have adopted or have pending Energy Efficiency Resource Standards (EERS) which set long-term, fixed efficiency savings targets. Twenty states have budgeted over 1% of electric revenues for energy efficiency programs. Ratepayer-funded energy efficiency spending is estimated to increase at a compound annual rate of 16.1% from 2010 to 2015.

While utility rebate programs and other efficiency mandates will benefit the pollution & treatment controls industry, the biggest driver could be an increase in carbon cap-and-trade programs. Though a national bill was rejected in 2010, California passed its own plan with enforcement starting January 1st of this year.

The plan requires industries to purchase permits to release greenhouse gases and aims to reduce total emissions by 17% to 1990 levels. The state currently emits about 447 million tons of greenhouse gases each year with 10% originating from commercial and residential buildings. The country's largest economy has often been used as a proving ground for environmental policy and other states are watching the program closely. The state's first auction of pollution allowances saw all 23.1 million allowances offered at a price slightly above the $10 floor. A portion of the $289 million raised is mandated to go to furthering the state's clean energy goals. Purchase of pollution allowances is voluntary but companies who emit large amounts of carbon must either buy the credits or find ways to reduce their emissions.

As the program develops, it could significantly spark demand for alternative energy, renewable energy and for energy conservation. State public utility commissions are mandating that utilities help drive energy conservation among their rate payers.

An emerging industry with significant tailwinds

Despite having been around for decades, the pollution & treatment controls industry is still a nascent industry in its current form. Of the 71 publicly-traded companies listed on Yahoo Finance, 65% are nano-cap stocks with market capitalization of under $50 million. As with many early stage industries, the capital required for research and development creates a large barrier to entry and makes it prohibitively expensive until volume can be reached to recoup costs.

This has segmented the market into smaller companies created for research purposes and larger companies with a competitive advantage in M&A strategies. Once a viable technology is produced, the larger company will acquire the smaller and roll it into its product portfolio.

North America's public pure-play clean tech company population fell 3% in 2012. The segment had an aggregate net loss of $3.1 billion though total revenues increased by 30% to $30.2 billion. Despite loss in the number of companies, the total headcount increased 4% to 72,000 in the industry. Debt levels were increased by 79% indicating access to capital despite losses and a positive environment going forward.

Ernst & Young conducted a telephone survey of executives at 100 companies with revenues of $1 billion or more and across a diverse set of industries. More than half reported that energy costs comprised more than 5% of operating costs and 22% reported spending more than 20% of operational costs for energy. Sixty percent expected increased energy efficiency programs over the next year. Seventy percent reported that their company had a formal strategy and implementation plan to manage energy use. The Lawrence Berkeley National Laboratory projects the energy efficiency marketplace to grow to $45 billion over the next eight years, almost four times as large as currently. Of this, energy service companies (ESCO) represents about 25% of market revenues.

Reaching economies of scale and scope

Blue Earth Inc. (NASDAQ:BBLU), headquartered in Nevada, is a $22 million company engaged in the acquisition, licensure, development and marketing of clean-tech technologies and energy management systems.

After acquiring developed technologies, the company uses existing networks to cross-sell products to small commercial businesses and residential customers to enhance the efficiency of building systems. Product categories cover a range from refrigeration, lighting, HVAC and energy-efficient motors and controls. Management has built a strong base of customers at the local, state and regional levels that enables it to accelerate the introduction of acquired technology and products.

The company is expected to report sales of $11 million for 2012, more than double the $5.3 million in the previous year, though a net loss is still expected. Selling, general and administrative expenses were $6.86 million for the nine months ending September 2012 and will probably top $9 million for the year. Guidance is for a backlog of between $15 and $25 million in orders at the end of 2012.

There is evidence that management is improving margins. For the three months ending September 2012, the company grew revenue by 54% compared to the same period in 2011 but managed to keep growth in SG&A to just 13%.

CEO Johnny Thomas, providing guidance in November of last year, declared that the company had reached a critical inflection point where the, "ability to offer bundled energy solutions that provide meaningful cost savings to our customer will generate additional new orders," and that recent project financing agreements and a strong backlog of orders would accelerate cash flow through 2013.

The shares trade at a premium for 2.9 times sales versus an industry average of about 1.0 times trailing sales. Management guidance is for revenue to increase almost ten-fold to $100 million in 2013 with EBITDA of $10 million. Despite access to credit, some cash needs may result in an increased share count. Even at the average price-sales multiple in industry, the stock could easily return to the highs around $4.00 per share seen in 2010. Insiders and large individual owners hold 20% of the shares, representing strong conviction in the company.

Building a portfolio in the pollution & treatment controls industry

Calgon Carbon Corporation (NYSE:CCC) is an $870 million provider of air, water, food and beverage purification equipment. The company is a more focused play on water resources and has operations in the United States, Europe and Japan. The shares trade for a premium at 1.5 times trailing sales with revenue projected to increase 5.7% next year to $594.5 million. While 90% of the float is owned by institutional and mutual fund owners, insiders only account for 2% of share ownership.

Fuel-Tech Inc. (NASDAQ:FTEK) provides engineered solutions for the optimization of combustion systems in utility and industrial applications. The shares trade for a fairly valued 1.03 times trailing sales with revenue projected to increase 15.7% next year to $113.9 million. Insiders and large individual owners account for 31% of the shares outstanding, representing a strong conviction in the company.

The PowerShares WilderHill Clean Energy Fund (NYSE:PBW) invests at least 90% of total assets in companies that focus on renewable energy and technologies facilitating cleaner energy. Representative of the segment, most (77.5%) of the fund is invested in small-cap companies with 14.9% in mid-caps and 7.6% in large-cap companies. The fund trades relatively expensively at 19 times trailing earnings of companies held but pays a 3.9% dividend yield.

Risks to consider

While public sentiment has grown for energy efficiency and a proactive plan for the environment, any industry with such a close connection to government policy is bound to be subject to headline risks. While volatility may spike around key policy developments, the long-term should be positive. Additionally, individual companies are subject to considerable risk in creative destruction in technological competitiveness. This makes it important for companies to diversify across a broad mix of products and services.

Court precedent and public sentiment have set the stage for reliable and increasing revenue into the pollution & treatment controls industry. While significant revenue growth is expected, the success of California's cap-and-trade program could be used as a model at the national level and lead to a surge in sales for companies in the space. Risks remain due to costs and requirements for scale but investors could start to include the segment as part of an overall energy allocation. Companies with an advantage in strategic acquisitions and management, like Blue Earth, should outperform though shares will remain volatile until earnings stabilize.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results. This article contains the current opinions of the author and such opinions are subject to change without notice. This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Neither the writer or distributor of this article have any positions in any of the companies named.


Prime Equity Research, LLC

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.