Alternative Energy not Immune to Recessionary Forces

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

alt-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

solar-revenue-dips-in-4q08

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

solar-group-margin-structureSource: 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.

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