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Few sectors better illustrate the irrational optimism during the late stages of the recent bull market than the disparate bunch of companies that make up the renewable energy sector. And few parts of the market have suffered more in the ensuing sell off.
One of the first challenges in considering the renewables sector is actually defining it. The London Stock Exchange does not class renewable energy as a specific sector, a factor which led companies from a wide variety of sectors to award themselves a green hue. From high-tech, blue-sky fuel-cell developers to old economy industrial engineers, renewable companies run the whole gamut of the stock market.
Fuel in the tank
The many fuel-cell developers that floated on the stock market during the boom years epitomise the image problem the sector has developed. The likes of Ceres Power and Ceramic Fuel Cells may be edging closer to commercialisation, but they have already eaten up significant amounts of the money they raised from shareholders and remain at least two years from true commercial reality. Smaller rivals, such as Voller Energy and CMR Fuel Cells, have already fallen by the wayside and delisted, and others, such as Acta , Polyfuel , ITM Power , Proton Power Systems and Protonex , remain glorified research-and-development operations.
The market sell-off has created a polarisation in the renewables sector. The blue-sky technology companies have seen their valuations battered into submission and have lost the confidence of investors whereas companies with sustainable cash flows, such as the wind power businesses like Hansen Transmissions and solar power manufacturers such as PV Crystalox Solar, have been rewarded with less awful share price performance.
The sector has reached a watershed where the stronger companies are easier to identify due to their solid cash flows, strong balance sheets and decent long-term prospects, while the weaker constituents have either disappeared or sunk into a friendless limbo.
Renewing old-fashioned values
The switch in focus to the old-fashioned values of balance sheet strength, cash flows and profitability has increased the popularity of 'traditional' renewables stocks in the wind and solar sectors. Wind and solar technologies are considered more mature, offer the best chance of producing competitively-priced energy in the next few years, and are favoured by governments. In Europe both wind and solar have grown rapidly, whereas the UK is moving towards wind as its prime source of renewable energy.
The problem is that there are few UK-listed pure wind-power plays. Most major wind-power portfolios reside within the utility or power generation companies. Smaller operators such as Novera , Renewable Energy Holdings and Renewable Energy Generation are developing portfolios of wind farms but it is a slow, costly and laborious process. The major hope is to amass a portfolio tempting enough to attract a bid from the utilities or power companies.
Head in the sand
The UK government has targeted a huge expansion of offshore wind farms but the credit crunch has left the economics of the plan compromised. Much of the capital equipment needed is priced in dollars or euros, which means sterling's weakness has sent costs soaring. Indeed Paul Golby, chief executive of E.ON UK, a partner in the London Array offshore wind farm, recently described that project as "on a knife edge".
Meanwhile, the solar industry, which has grown into a $20bn-plus global business, has been hampered by a shortage of its key raw material - silicon. This has kept input costs high and kept a lid on production levels. Nevertheless, countries such as Germany, Spain, France, Italy, the US, India and China have all invested heavily in solar power. With the global supply of silicon expected to increase sharply over the next two years, the price of end products should fall. This should bring solar-energy prices closer to being truly competitive with main-stay sources of power in some regions of the world, but could also put pressure on margins in the supply chain as selling costs are forced downwards.
Europe and Japan were initially centres of excellence for solar power manufacture, but the US and China have begun to feature strongly on the scene over the past three years. And as products, such as wafers and modules become commoditised, low-cost producers such as Renesola and Jetion, will thrive.
| FAVOURITES... |
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Although the global wind power industry is under some pressure right now as financing for wind farms remains tight, the longer-term prospects remain strong. Hansen, which makes gear boxes for wind turbines, is well placed to take advantage. It is replicating its European production capacity with new facilities in India and China, which will help to drive down its costs as it grows. Sales are forecast to exceed €600m (£531m) this year and on 12 times 2010 earnings, it is an interesting long-term play. Solar wafer maker PV has been around for more than two decades and is the lowest-cost producer in the industry. In the short-term margins could come under pressure and this has been reflected by a sell-off in the shares. But the bulk of its 2009 sales are already contracted and with its own silicon production facility expected to come on stream during this year it will have more control over input costs in the future. PV is compelling at 7.5 times expected earnings. |
| ...AND OUTSIDERS |
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Novera has a cash generative landfill-gas and hydro-power portfolio and a wind-farm-development portfolio. It has attracted takeover interest in the past from private equity and infrastructure buyout funds but for now better opportunities exist elsewhere |
Climate change
Saving the environment during an economic boom is a lot more palatable than during a sharp recession. The decline in the oil price also removed much of the imperative for change. When oil cost $100-plus a barrel the incentive to develop alternatives was strong. At $50 a barrel that incentive is lost. The onus is now on renewable technologies to reach grid parity - when renewable energy costs the same as that produced from traditional sources - but none has done this yet without government subsidy.
So the fall in the oil price threw the economics of renewable energy into stark relief, and this was exacerbated by the credit markets drying up. Most renewable energy projects are capital intensive in their development stages and require significant debt financing. So a lack of access to such credit is threatening smaller operators and has prompted major players, such as oil-giant Shell, to pull back.
But all is not lost. Despite the financial imperative having faded, the environmental imperative is stronger than ever. And this is where governments have to step in. The European Union (EU) has been the most proactive government body in addressing emissions through its European Trading Scheme (ETS) for the trade of carbon abatement products. EU member states have committed to sharp reductions in their emissions by 2020. There is some scepticism that all the member states will achieve their targets but the political will appears to be there. So for businesses like Climate Exchange , which operates carbon markets in Europe and the US, there is an opportunity to be had.
The elephant(s) in the room
With the EU leading the way in terms of establishing carbon emissions reduction schemes, the focus has shifted to the rest of the world and in particular the two major emitters - the US and China. President Barack Obama has consistently talked up his intention to encourage the use of renewable power in the US and to introduce a mandatory 'cap-and-trade' scheme similar to the EU's ETS which could be in place by 2012. This would give a huge boost to global discussions on the next stage of the Kyoto Protocol, the global emissions reduction initiative which runs to 2012 which Mr Obama's predecessor, George Bush, refused to sign up to.
Any significant move by the US would provide a big boost to renewable energy stocks and increase investor confidence. And it is likely that any development which pushes Kyoto beyond 2012 will have to also involve China, which is rapidly coming up as one of the world's largest polluters. Indeed, any post-2012 agreement needs to have the US, China and probably India on board to have any hope of overall long-term success.
| Company | Share price (p) | 52-week high (p) | YTD % change | PE ratio 2009 | Mkt Cap |
|---|---|---|---|---|---|
| Wind plays | |||||
| Clipper Windpower | 65.5 | 643.75 | -8% | na | £85m |
| Hansen Transmissions | 117 | 332 | 2% | 19 | £784m |
| Novera Energy | 34 | 96.5 | 1.5% | na | £49m |
| Renewable Power Generation | 53 | 133 | 4% | 40 | £55m |
| Renewable Power Holdings | 36 | 51.5 | -5% | na | £24m |
| Solar plays | |||||
| Jetion Holdings | 48 | 134 | 55% | 3 | £35m |
| PV Crystalox Solar | 103 | 201.5 | 3% | 12 | £428m |
| Renesola | 108 | 760 | -34% | 11 | £146m |
| Romag Holdings | 41.5 | 211.5 | -37% | 8 | £21m |
