A great deal of work is being done on renewable energy sources. With very cool stats thrown around such as:
- the amount of energy impacting the earth from the sun in one hour will supply the entire world’s consumption for a day
- 1 square meter receives from the sun the equivalent of 1000 watts of energy
I could go on but the point is that energy is all around us. In fact, if we are to believe Einstein’s “signature equation” of E= mC2- then we ARE energy, albeit in a rather cool, slow and static format. There are untapped (and I am guessing unknown) realms of energy extraction from our surroundings that we have yet to imagine and explore.
So while we wrangle and create endless spreadsheets on the economical viability of one renewable energy source versus another, keep this in mind- the great game of innovation has only begun. It can only get more interesting from here.
In my last post regarding solar companies, I looked at the continuing revenue build out and the market share battle between First Solar (FSLR) and Suntech Power Holdings (STP.) We saw that First Solar’s thin film offering appeared to be taking market share from the phtovoltaic provider, STP. In this note, I will again revisit the revenue build of this nascent industry as well as look at what I consider to be a primary long term indicator of growth potential, research and development.
Revenue appears to be recovering from March Lows
In spite of stellar growth the previous 7 quarters, the 12 alternative energy companies that I track showed Q/Q declines in the December ‘08 and March ‘09 quarters. While the June ‘09 quarter was a positive Q/Q result, it was still an almost 22% decline on a Y/Y basis. Perhaps the worst is over for solar technology’s revenue growth, however, I believe that fledgling industries such as this with blockbuster demand curves remain anybody’s market for some time. For example, the Internet investment opportunity was kicked off by Netscape, America Online and Yahoo. Today, only one of those companies is operational and Yahoo is fighting to remain a dominant player in light of the fairly late market entrant of Google. Likewise, in solar technology, I anticipate that there may be category defining companies that are private or not even yet formed.
Figure 1. Revenue Build Recovers from the March, 2009 Bottom
Source: Chris Montaño, CFA; Gridstone Research
R&D -The Lifeblood of Technology Companies
In formative industries with great demand curves, I like to look at research and development. While there is no guarantee that spending money on R&D will result in winning products, it simply makes sense to me that companies investing in the future through research have the best chance to adapt to unpredictable market conditions and evolving technology. And even though the demand curve for solar power technology looks massive today, it remains an uncertain and difficult market in very early stages.
I also think that the key to solar technology’s long term viability as a renewable energy source is its economics- can we produce electricity from photovoltaics at the same cost as coal or gas? Without technologies that enable production of electricity at a price point equivalent to coal or gas powered generation, photovoltaic electric generation will remain a niche method. Efficiency of solar cells regardless whether they are thin film or silicon substrate is the cornerstone of economic viability. The company that can produce the highest efficiency photovoltaic device is in the best position to become a major company through the world’s most ancient energy source and newest business- solar energy.
Figure 2. R&D in Absolute Dollars and as a Percentage of Net Revenue
Source: Chris Montaño, CFA; Gridstone Research
As I look at the graph in figure 2, I am struck by a couple of things:
- Photvoltaics are still massively underinvested in view of the market opportunity. I was surprised at the modest quarterly spending in absolute dollars -$53M. Even on a trailing 4 quarter basis, this seems a bit on the small side. I think this means a couple of things- it could mean that there are simply not enough photovoltaic professionals to absorb more R&D dollars. Or it could also mean that the companies are still pouring all of their resources into a technology that is immature and requires so much engineering effort, that the industry itself could be considered “R&D.”
- 2.5% of industry revenue needs to climb for photovoltaice generation to achieve “grid parity.” It seems a stretch to think that 2.5% of industry revenue will achieve the products that will generate electricity as cheaply as utilities. The types of efficiencies that photovoltaics will need to attain economical generation without subsidies and tax benefits will likely require a lot more than $53M. And while the trailing 12 month number is a bit more encouraging on an absolute basis ($180M), it is still less than 2% of total industry trailing 12 month revenues.
In view of my previous post where I compared FSLR and STP revenue contribution, I thought it might be interesting to see how STP and FSLR fared in their respective R&D investments. Figure 3 makes an interesting graph depicting the divergent R&D priorities being invested by two companies. First Solar seems quit3 aggressive in its spend while Suntech Power appears to be tapering off.
Figure 3. A Tale of 2 R&D Budgets
Source: Chris Montaño, CFA; Gridstone Research
While it certainly takes a lot more than R&D to make a great company, one thing I am personally convinced of- without world class R&D, it is very difficult to attain and maintain a leading role in the technology industry.
Read this and hear how the world sounds when you are utterly, completely, beyond-comprehension, “tone deaf”. Link was courtesy of Paul Kedrosky’s ever relevant (and must read) linkfest.
Listen to the sounds of their world of entitlement and presumed privilege here… unbelievable.
Financial times columnist Martin Wolf commenting on Simon Johnson’s great piece in the May Atlantic Monthly regarding how America has been hijacked by banking/finance oligarchs. Seems that he agrees with most of what Johnson says and disagrees on the transparency of the corruption, stating, “…Yet do these weaknesses make the US into Russia? No. In many emerging economies corruption is egregious and overt. In the US, influence comes as much from a system of beliefs as from lobbying (although the latter was not absent).”
He is right, there is a much more refined system to obtain and lobby for your policies than in emerging market countries.
I especially thought Wolf’s comments on how the scramble to preserve Wall Street as we know it is driven by policy makers fears. I also agree that in essence this is more subtle than overt corruption and a coup. However, I maintain that these are all arguments in the fringe rather than the core of Johnson’s Atlantic Monthly piece.
We must wrest back control of our policy apparatus from the finance/banking oligarchs or else we become socialism rather than capitalism. No small irony that the vanguards of capitalism have somehow become the harbingers of a perverse sort of socialism whereby profits are privatized and losses are socialized and the bonus of the elite is a sacred cow.
One thing that Wolf and Johnson seem to agree upon, that without the real consequences of bankruptcy, reform will remain incomplete and largely cosmetic. And even more disheartening, a presage of worse crises yet to come.
When I took the intro course on money and banking I still recall the paragraph related to the definition of what money is… especially the sentence that stated… “a store of value.”
That has stayed with me. What I have since been continuously surprised by are the “values” I see reflected in the manner we go about acquiring, storing and using money. It has also got our national financial statement into a very tenuous position and even impacted our national security. I would like to believe that things will change going forward in how the financial world conducts its business… but I am skeptical. So I am taking a fall back position that hoping that perhaps our government can constrain the excess practices without stifling innovation. However, I see the utter compromised position that many advisors and political actors have in current or prior financial relationships with the financial services community and I doubt that as well. So it will have to be grass roots that change things. Rats. That is usually pretty slow, disorganized and uncoordinated. But if it sticks… then it can be the most effective, but in my estimation, the least probable.
Frank Rich says it so well in his article here in the NY Times. He is so well spoken here and in my view hopeful. Perhaps we will take some steps forward and reconnect with core, free market values that reward us based upon value creation rather than value capture. One thing is certain, we will see.
Last time I wrote about alternative energy stocks I looked at the basic business model and we saw how rapidly it became a money loser in 4Q08. This time I am going to look at the revenue dimension of the industry and see which company is winning or losing market share. By way of reminder, the companies that I looked at are included in Table 1.
Table 1. Select Alternative Energy Stocks
Recall that the total revenue for these 12 suppliers over the last 8 quarters has shown remarkable quarter over quarter growth until 4Q08 when there was a dramatic 16.7% decline (See Figure 1.)
Figure 1. Revenue Drop off in 4Q08
Source: Chris Montaño, CFA; Gridstone Research
I looked at the revenue composition to see which companies are gaining market share and which are losing. Sometimes a revenue shortfall is an opportunity to see which company has committed and financially capable buyers and which have a weaker sales channel that evaporates quickly. Along these lines, one very interesting metric I look at is the relative percentage contribution of industry total revenue by each company over the 8 quarter period. Among these percentages, I found one very interesting comparison that I thought chartworthy. It is the relative revenue percentage contribution by two companies, First Solar (FSLR) and Suntech Power (STP) (See Figure 2.)
Figure 2. Suntech Power and First Solar Relative Revenue Contribution
Source: Chris Montaño, CFA; Gridstone Research
You may say, “well that is interesting but how do I make money from it?” In order to answer that, I thought it might be good to look at the two stocks relative performance as well. So I went to Google finance and brought up a chart of relative performance over the same 8 quarter time frame. While both stocks show the scars of the bear attack, there is a distinct reward for winning market share (See Figure 3.)
Figure 3. Relative Performance over 8 Quarter Period for STP and FSLR
Source: Google finance
Does market share matter in growth markets? It seems that there is a 433%+ premium attached to it in this case. That is significant. The only challenge is making the determination in the first place. And for this, you will not usually find the answers in a set of financial statements.
Even the pentagon is getting into the financial business now. Perhaps they will be more successful than the bankers have been? There was a recent “war game” involving an economic attack against the U.S. We did not fare too well according to this article.
Glad to see that our national security apparatus is on the case… but it does make me wonder a couple of things…
- If there is a linkage between national security and economic security, what are the implications for those that cost the U.S. $12.8 trillion and thereby weakened our national security?
- If there has been reckless profiteering (a polite way of saying piracy), then why do institutions and people get a free pass?
… seems that there needs to be some careful thought on this. But there probably will not be. It seems that the Obama administration is inclined toward the policy of incrementalism from the base the Bush administration left. Too bad. The more things change, the more they stay the same…
Great Chart by McKinsey & Co. on how prior recessions have played out.
Source: The McKinsey Quarterly
Banking/finance oligarchs: $12.8 trillion
New Obama administration: 0
U.S. Taxpayer: -$12.8 trillion
Missed opportunities tend to act likes ghosts that linger long after the event is gone. I read this excellent opinion note this morning and wanted to do a “retweet.” It points out that the Obama administration had a golden opportunity to clean up the banking system and do some desperately needed house-cleaning. Nothing worse than “disasters masters of the universe” that have long since outlived their usefulness.
But Obama missed it. Instead, he put on his party sombrero and headed straight for the punchbowl and spent like a soon to be drunken sailor. Not that this was necessarily a bad thing, but it was the ripe time to clean up the smarmy pit of modern finance and he let it slip by. Too bad. When we get to reelection time, and the hangover hits even harder, there is no way he cannot say anything other than that he owns this mess now. For better or worse (and I suspect it will come back even harder down the road), this crisis is now his. I wonder if I have just seen the shortest time to failure by an administration?
Alternative energy has received a lot of investor interest in the past several years. A combination of heightened awareness of CO2 impact on the climate, uncertain oil reserves amid growing global demand and historic underinvestment in the fundamental research and technology have caused many to invest across the spectrum from early stage to publicly traded alternative energy stocks. And public stocks have reflected this renewed investor and business interest. (See Table 1.) I took a look at these companies and wrote up a short analysis of their recent performance.
Table 1. Selected Alternative Energy Companies
Industry wide revenue growth between these twelve companies has been blistering the last 7 quarters. However, the last quarter of 2008 was not kind to the companies in this arena. I took a sample of 12 companies that provide technology for alternative energy (mostly solar) and the results reflected a stunning 16.7% quarterly decline in revenue for the companies. (See Figure 1.)
Figure 1. Alternative Energy Industry Revenue takes a Turn Downward
Source: Chris Montaño; Gridstone Research
The revenue decline also impacted the business model and profitability. Industry wide gross margins, operating margins and net margins declined as well (See Figure 2.) This industry has not yet demonstrated a powerful business model, drawing investment primarily on the basis of the demand curve and eventual economies of scale. Typically the industry has a gross margin that has been running at between 25%-27% in the last 8 quarters. However, the industry was clearly caught off guard as the gross margin dropped to 5% on sales that were roughly equal to June 2007 when gross margins were 23.5%. Operating margin last quarter was -7.8% but has been running between 9%-18% in the same period. Typically, the industry yields a 7%-13% net margin. Not world class but respectable and given that it is a nascent market, we consider this promising.
Figure 2. Alternative Industry Business Model is Relatively Immature
Source: Chris Montaño; Gridstone Research
It would not be surprising to see a lot of changes in this market. the real question is how do we select those few companies to invest in? One way is to look at the relative contribution of various companies. This will tell me who is winning and who is loosing market share. It will also expose the variances in the business models of companies. As I am a true fan of the strong business model, I like to invest in companies with strong gross margins and operating leverage. We will look at these metrics in the next blog entry on this topic.
