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Smart Energy Plays: Smart-Meter Makers

Stockpickr Guest Columnist

As global power grids face a capacity crunch, a new bull market is emerging in a nascent industry, called demand response.

This new field of demand response systems is still a maturing market, and the definite leaders have yet to be determined. A few of these pure-play companies may prosper, but it is also likely that some will sink and disappear. If you want to play these stocks from a speculative standpoint, I suggest taking small positions in each as a basket of stocks.

Smart-meter systems are similar to the electricity gauges found in most home basements, but more sophisticated. They have the ability to communicate with the utility, providing reports and automation that the customers can use to manage energy during peak hours, when electricity is most expensive.

Eventually, smart meters will allow tiered pricing plans under which utilities can adjust energy prices according to real-time grid demand, and the meters will respond to such changes in costs.

Energy reduction programs take preventive steps to prevent rolling blackouts. During peak energy usage times, building administrators have agreements with the utility company to reduce energy usage in return for payments or discounts on electricity. Smart meters are often used to facilitate such programs.

Demand Response's Stock Beneficiaries

Driven by volatile energy prices, demand response programs have taken off in Europe and Asia. The U.S. is also launching pilot programs, which, according to IDC's Energy Insights, a research-based consulting firm, could result in the installation of as many as 51 million electric and gas meters. Energy Insights asserts that this industry can grow from $2.3 billion to $5.5 billion by 2011, with 22% growth in hardware sales.

Here are a few stocks that stand to benefit from this industry's growth:

Itron(ITRI Quote) is the clear-cut pure-play leader in smart metering. The Liberty Lake, Wash., company provides meters and power grid forecasting and management software. Along with low debt and improving operating margins and profitability, this company is in a stronger financial position compared to other pure plays.

Itron earlier this year acquired Actaris, a competitor in Europe. The acquisition is complementary because while Itron is dominant in North America, where it has 55% market share, it is much weaker globally. Actaris' strength on a worldwide basis will give Itron a chance to expand the reach of its product lines. According to a recent conference call, the merged company will be "the No. 1 electric meter supplier, No. 2 gas meter supplier and No. 4 water meter supplier in the world."

An added bonus is that Itron also builds water meters and water efficiency systems. Itron is well aligned to benefit from an impending global upgrade cycle as water utilities implement more automated meter systems to help curtail waste.

Comverge(COMV Quote) and EnerNOC(ENOC Quote) are two companies that recently became public and that provide energy reduction solutions for utilities.

Both of these companies manage programs and networks that help add power grid capacity to utilities during times near overload. They work by providing hardware and economic incentives encouraging customers to cut back on power-draining devices such as pool pumps and HVACs during peak times.

Because these companies have been public only a fewl months, not much financial data is available. These companies have yet to generate positive earnings per share, so are hard to value based on price-to-earnings multiples. While I consider these speculative stocks, I believe that over the long run this type of service will benefit from the rise in solar power as more customers will have the capability of adding electricity back to the power grid.

I consider Echelon(ELON Quote) the most speculative demand-response stock, but I believe it has the greatest short-term potential. The stock comprises 5% of the WilderHill Clean Energy ETF(PBW Quote).

Echelon specializes in automation technologies that help businesses reduce energy consumption by more effectively controlling lighting, HVACs and other energy-intensive appliances.

In an interview with TheStreet.com TV in June, Echelon's chief operating officer, Bea Yormark, said the company's product is differentiated through horizontal integration and interoperability.

That makes the applicability of the technology more universal, she said. "Because we have this whole two-way idea of communicating devices, we are able to do things that makers of vertical systems can't do. For example, in a building we can link the lights and HVAC system on the same network."

This networking angle seems to be catching on. Recently, McDonald's(MCD Quote) announced that it will be experimenting with Echelon's LonWorks technology in its restaurants. The goal is to cut costs by more efficiently managing each restaurant's energy consumption.

I expect that the biggest engine of growth will be international infrastructure applications of Echelon's technology. Its smart meters are catching on in Europe, with Austria recently announcing a pilot program. The LonWorks technology is also catching on with businesses in Asian countries such as Korea and Singapore, and even the Chinese government will begin applying the platform to street lighting systems.

For anyone who has visited China, the application of public lighting control systems is apparent when Shanghai's skyline goes dark at 11 p.m. and other city streetlights turn off into the night.

On the financial side, Echelon's income statement is less than stellar. Revenue has been shrinking as a large project in Italy gets completed, and the company has failed to turn a profit in recent quarters.

Furthermore, deferred revenue distort a clear snapshot of the company's current health. The stock's recent rally to $21 seems to be triggered by a short squeeze. Prospective investors should carefully consider whether the value of new and future contracts justify the recent increase in the stock.

Because these smaller companies have riskier financial certainty, a much safer way to play demand response is to invest in infrastructure conglomerates. Both General Electric(GE Quote) and Siemens(SI Quote) participate in the smart-meter market. The disadvantage of this approach is that the full benefit of this industry's growth will be moderated by these companies' other core businesses.

This new field of smart energy systems is still a maturing market, and the definite leaders have yet to be determined. A few of these pure-play companies may prosper, but it is also likely that some will sink and disappear. If you want to play these stocks from a speculative standpoint, I suggest taking small positions in each as a basket of stocks.