5 Smart Grid Stock Keys: Washout Doesn't Mean Breakout
01/09/12 - 02:30 PM EST
NEW YORK (TheStreet) -- Smart grid stocks may be at washout levels after the decimation of 2011, but that doesn't necessarily mean the group is primed for a breakout in 2012.
A quick review of the stock losses in the sector in the past year paints a grim picture of the recent past.
Calling a bottom in alternative energy stocks is difficult business: Just look at the Chinese solar module makers that "washed out" several times in 2011 before they really did, (or maybe they still haven't found their bottom).
Here are some key themes in the smart grid stock universe to pay attention to in 2012 that will define the risk/reward scenario.
1. Is legacy revenue from "old school" metering a good or a bad thing?
When you look at stocks like Itron and Elster, one of the knocks on them is that all the stimulus money that drove smart meter deployment in the U.S. is rolling over, and that means growth is done. Absent the continued stimulus money for smart grid, Itron and Elster are poised to be very boring stocks in the short-term with slow growth profiles.
But these companies have the legacy assets to in the least grow, albeit slowly, and are currently trading at sub-10x multiples, so there may be a straight valuation call on these stocks even if the outlook for smart grid deployment remains uncertain.
"It may continue to be a difficult year in terms of fundamentals, but that's priced into the smart meter guys," said Ben Schuman, analyst at Pacific Crest. He expects North American revenue to be down while international -- where all the companies are focused -- ramps. Given that international and emerging market smart grid ramps are uncertain, though, Schuman likes these legacy metering business companies like Elster and Itron for the resiliency, or boring nature, of the core revenue.
"They have legacy revenue that isn't tied to the advanced metering cycle, and the earnings power of the legacy business provides a floor for them," Schuman said. He added, "These stocks aren't likely to go back to 20 times to 25 times multiples, but they can get to a reasonable multiple of 12 times to 13 times with moderate international growth and the core business. At sub-10 times, there is upside."
But here's the flip side ...
2. Shoot the lights out with an Echelon and forget about the boring legacy meters
Echelon doesn't have the legacy core metering revenue of an Itron or Elster, and it's embarked on an ambitious plan to ride the emerging market trend by selling metering components like chips and subsystems in markets like China and Brazil.
China is a market where pricing is beyond competitive -- metering companies like Itron have said you have to price so cheaply you can't make money. In Brazil, it's tough to break into the market without the right partner, though Itron and Elster are already active in Latin America. These factors are behind Echelon's approach to gain traction in these key emerging markets by just taking a piece of the action as opposed to enter as a metering company.
For investors concerned about where growth comes from next year after the last of the stimulus-funded projects in the U.S. ends, the major market to look to is Europe. But given the macroeconomic concerns there, European smart grid deployment could be derailed or in the least delayed.
Echelon has chosen a transformative strategy that places it further from the European question but far out on the risk spectrum -- selling chips in China and sub-assemblies in Brazil. If it works, that's a lot of upside to realize, but there are still many unknowns.
At what cost will Echelon gain market share? In other words, how will pricing play out in these markets?
It's transformation versus the incremental growth play of a "boring" company like Itron or Elster, and the transformation could take a few years.
3. If things are looking up for smart grid, where is the Silver Springs Networks IPO already?
The IPO of privately backed smart grid company Silver Springs Networks has been in the hopper for what seems like forever now, and the fact that it's still in the pipeline is a sign that sentiment for smart grid stocks isn't truly optimistic just yet.
There are general market reasons for the IPO delay: Capital markets appetite for IPOs and for alternative energy isn't strong right now and Silver Springs, specifically, may want to wait it out until it can get the valuation it believes its business deserves.
Previous year private rounds of financing valued Silver Springs at much higher multiples -- as much as $3 billion -- than current sector sentiment would support. With the sector trading at less than 10 times earnings now, it comes down to what investors are willing to pay for the smart grid space.
Sean Hannan, analyst at Needham & Co., said the general IPO market and general market issues don't help, but "caution with smart grid offerings" is part of the Silver Springs IPO issue. He said Silver Springs is trying to position itself as a wireless networking technology story, but at core it's a smart grid solution provider.
"Investors have seen smart grid decimated and anything tying Silver Springs to the utility space is slower speed. It isn't front end of the tech curve and they want to be associated with true tech thought leaders."
4. There's a takeout premium in all of these stocks not being realized.
Last year, Toshiba bought European-based Landis+Gyr and Schneider Electric bought Telvent, both deals struck at roughly 10 times multiples. So where is the takeout premium of at least 10 times for the rest of the stocks in the sector like Itron and Elster?
Schuman says there is strategic value in these names given the other global conglomerates among the "usual suspects" bidding for Telvent and Landis. The likes of Siemens, GE(GE) and ABB(ABB) are always rumored to be sniffing around in the smart grid space, and the smart grid pure plays left are trading at lower multiples than what Toshiba and Schneider paid.
That's one more reason why these stocks don't need to "shoot the lights" out in terms of new market growth to see an incremental multiple expansion.
5. Better to be an industrial than a pure play in smart grid?
The takeout argument brings up one last important point about the danger of pure plays in alternative energy
Toshiba announced on Monday morning that it expects $12 billion global smart grid sales by fiscal 2015, with $1.8 billion in sales to be generated in the U.S. That's a long-term time horizon that makes sense for a conglomerate that has a balance sheet on which the smart grid "lumpy" revenue is a blip in any given year, and it may support an acquisition at these levels.
It also shows that any near-term opportunity in these smart grid stocks -- with the North American market coming off its stimulus cycle, European economics to support energy policy a wild card, and the emerging market profit equation still a work in progress -- isn't the type of bet that a Toshiba has to make in buying into the sector.
"Saying the smart grid stocks are 'washed out' can only be done in terms of talk about the long-term," said Hannan.
-- Written by Eric Rosenbaum from New York.
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