Morningstar's Favorite 'Green' Energy Stock

BOSTON (TheStreet) -- Researcher Morningstar (MORN), known for its safety-first, value approach, has turned more aggressive as the equity market corrected, beginning in April.

Morningstar, without much fanfare, added growth stocks -- companies with above-average expansion that tend to do well in bull markets -- to its exclusive five-star stock list, including tech darling Apple ( AAPL) and financial firm JMP Group ( JMP). The five-star list comprises 45 stocks of the 1,700 that Morningstar tracks. The firm, which targets savvy individual investors, has a sterling reputation, especially due to its mutual-fund rating system.

An unconventional company that Morningstar has warmed to is Ormat Technologies ( ORA), an independent power producer that builds, owns and operates near-zero-emissions geothermal plants. While most individual investors are familiar with the budding green investing movement and companies such as First Solar ( FSLR), few have heard of Ormat and understand the potentially lucrative growth prospects of its power production business.

Ormat was founded by Israeli husband-and-wife duo, Lucien and Dita Bronicki. Lucien is chairman and chief technology officer, and Dita is CEO. The two own 30% of parent company Ormat Industries, which, in turn, owns 60% of Ormat Technologies.

This convoluted corporate structure is a negative, in Morningstar's view, because it potentially reduces the company's likelihood of being acquired. It is one factor contributing to Morningstar's "fair stewardship" management grade. Also a negative is Ormat's economic moat, Morningstar's assessment of its long-term competitive safety. With energy-source uncertainty rampant, it's difficult to predict which green energies will emerge as the safest or most-efficient options. Still, Morningstar calls Ormat "one of the best pure-plays" in the renewable energy space.

Ormat derived 78% of 2010 revenue from building and operating plants and the remainder from manufacturing and selling geothermal and recovered energy equipment. Domestically, utilities are required to source their power needs to renewable energy sources, first, before they tap fossil-fuel powered plants. However, legal mandates differ based on municipality.

Ormat's 14 plants "operate around the clock, require no fuel, and producealmost no emissions. The obstacle to large-scale adoption is construction lead time and finding suitable heat resources." Ormat is currently constructing six additional power generation facilities.

Although two-thirds of Ormat's capacity is in the U.S., it also operates in the Philippines, Kenya and Central America. Morningstar expects this ratio to "shift more toward the U.S., specifically California and Nevada," over the longer term. In recent quarters, Ormat has suffered setbacks at its North Brawley Field in California. The company suffered a GAAP net loss of about $9 million, or 20 cents a share, during the first quarter, largely due to expensive replacement of pumping equipment utilized at the aforementioned plant. These costs drove the gross margin from 19% to 15%. However, absent charges, the spread would have advanced to 27%.

Investors, dismayed by the margin erosion, were pleased that power capacity grew 14% in the quarter and pricing strengthened amid a strong appetite for energy. But, Ormat's stock has dropped 22% during 2011. Morningstar forecasts 50 mega-watts of capacity by 2013 and views the stock drop as "an opportunity to buy a great business on the cheap."

Ormat's business is, in fact, a beneficiary of higher commodity prices as its key input, heat, is free and its relative price efficiency improves as commodity prices rise. Howeber, the downside is that "most of the low-hanging geothermal fruit has been plucked."

Nevertheless, Morningstar values Ormat's equity at $34, concurrent with 14% annualized revenue growth and continuation of the renewable energy tax credit at 0.022 cent per kilowatt hour through 2014. Morningstar expects an average operating margin of around 21% through 2014, though, given the recent jump in normalized margins, that spread may prove conservative. The $34 target suggests a 48% advance. Unlike sell-side researchers, Morningstar doesn't attach a time frame to its projections. Ormat is down 27% from a 52-week high of $31.24.

Risks to Morningstar's thesis include currency fluctuations in emerging markets where Ormat has a footprint. However, given dollar weakness and emerging markets' relative economic strength, this risk may prove to be a reward of overseas exposure. The researcher also lists geothermal instability and potential expiration of the renewable-energy tax credit as risks. The tax-credit issue, again, seems like a remote risk. Given the tepid pace of alternative energy adoption, domestically, greater tax credits or incentive schemes seem much more likely than any reduction.

Global warming is now an indisputable phenomenon, and resource conservation, of every variety, may prove the most successful investing theme of the next few decades. Given Ormat's first-mover status and expertise in geothermal, it appears to be an ideal takeover candidate for a larger energy company, perhaps even an integrated oil-and-gas player like Exxon Mobil ( XOM), or a bigger independent power producer or utility company.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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