Whitefish, MT / April, 8 2014 / Against a backdrop of slowing growth in China and pundits postulating about what the Federal Reserve is going to do with economic stimulus over the next year or so, analysts are looking for industries that will serve as growth drivers for the United States in 2014. Many are looking to the energy sector for sustained growth, especially companies that have operations in shale plays or those that are in the burgeoning alternative energy business, including NRG Energy, Inc. (NYSE: NRG), Hannon Armstrong Sustainable Infrastructure Capital Inc. (NYSE: HASI) and American DG Energy, Inc. (NYSE MKT: ADGE). Investors should note that the U.S. Energy Information Administration recently lowered its domestic oil production for 2014 and 2015, which will shrink margins for traditional energy plays. All three of these companies growing their footprint in clean energy posted significant top line growth in 2013 and offer significant upside potential.
NRG Energy is an industry giant with deep roots in generating power from fossil fuels, but chief executive David Crane spends more time talking about the company's solar initiatives as a key to the company staying nimble to support investment in NRG.
A look at just the past few months of activity gives a look through the keyhole at NRG's future as it balances it diversified assets. In February, the company struck a deal with business tycoon Sir Richard Branson to power Necker, Branson's private island home in the British Virgin Islands, with a renewable energy micro-grid solution employing solar, wind and energy storage technologies. From a grass roots perspective, NRG acquired more than 600,000 customer accounts from Dominion Resources Inc. (NYSE: D) in March to bolster its retail electric business. Also last month, NRG broke ground with partner Boeing Co. (NYSE: BA) on a solar power plant in Guam. The plant, slated to generate 25 megawatts of power and offset consumption of 2 million barrels of diesel and fuel oil, will sell its energy to the Guam Power Authority under two 25-year power purchase agreements.
Last month a bankruptcy court also gave the green light for NRG to buy substantially all of the assets of Edison Mission, positioning NRG as the biggest competitive power company in the country, as well as the third-largest renewable energy producer in the U.S. NRG also said that it is buying Roof Diagnostics Solar for an undisclosed sum as it aims to capitalize on the growing decentralized power market.
In 2013, operating revenues improved 34 percent to $11.3 billion from $8.42 billion in 2012. Impairment charges and other one-time costs were a drain on profitability with NRG registering a net loss of $1.22 per share ($395 million). Free cash flow for 2013 was $1.28 billion, exceeding corporate guidance by $107 million and helping to boost the current annual dividend by 56% from the end of 2012 to 56 cents per share. The bevy of recent activity will be reflected in revenue and earnings going forward. For fiscal 2014, NRG forecasts adjusted EBITDA between $2.7 billion and $2.9 billion and free cash flow in the range of $950 million and $1.15 billion.
Shares of NRG are ahead about 12 percent so far in 2014 and 33 percent since last summer.
The long name of Hannon Armstrong Sustainable Infrastructure Capital, Inc. explains a business model that some may not consider the most exciting, but it is designed to capitalize on the shifting energy sector. The company, official labeled as a real estate investment trust, or REIT, focuses its investments "on profitable projects that increase energy efficiency, provide cleaner energy, positively impact the environment, or make more efficient use of natural resources." It's similar to NRG Yield's (NYSE: NYLD) business unit; only it posts a current yield that doubles NYLD's.
Hannon uses a basket of metrics, such as reduction of greenhouses gases and reduction of water usage, in its investment analysis process. The company also provides investment banking services, including debt and equity financing, mergers and acquisition services and tax equity consultation.
With less than 16 million shares outstanding and an average 3-month daily trading volume around 100,000, this isn't exactly a stock that traders are going to sit at their computers sweating over daily movements. It's more of a "sock drawer," dividend play that showed strong growth in 2013.
In 2013, Hannon hit its target yield of 7 percent of its IPO price, originating of $600 million in transactions, nearly all of which were investment grade. The company also increased its fixed debt to 56 percent of total debt. Net investment revenue for the year improved to $7.6 million in 2013 from $2.0 million in 2012. On a GAAP basis, an impairment charge was an anchor, resulting in a net loss of $7.3 million, or 48 cents per share, in 2013. Excluding special items, core earnings totaled a net profit of 43 cents per share last year.
In 2014, Hannon expects to deliver 13-15% core EPS and dividend growth. Shares are only up at 7 percent in 2014, but have risen about 40 percent in the past six months.
A comment from Jeffrey Eckel, CEO at Hannon, in the latest earnings release speaks to the company's investment strategies. "The accelerating trend in electric utility markets towards smaller scale distributed energy assets, such as energy efficiency, distributed solar and co-generation, plays to HASI's historic strengths and is producing high growth investment opportunities with both existing and new origination sources."
It also speaks to the growth potential of American DG Energy (NYSE MKT: ADGE) as a quickly growing leader in providing on-site energy. American DG specializes in co-generation, or CHP (combined heat and power), systems. A green technology that exponentially reduces emissions compared to traditional energy creation, CHP creates two types of energy from one source, an operation that is up to 90% efficient, compared to about 35% efficiency for the existing power grid.
Generally speaking, the company only sells the energy generated to the client on a long-term contract and shoulders all of the upfront costs of designing, installing and maintaining a CHP system. By eliminating the initial capital investment and maintenance costs client companies are able to instantly recognize substantial cost savings. On that point, there are exceptions to the rule, such as a recent contract (valued at about $1.3 million) with Sunstone Hotel Investors (NYSE: SHO) for the DoubleTree Suites by Hilton in Times Square, NYC, where American DG managed an energy plant conversion, along with installation and maintenance of a CHP system.
American DG's target clients operate hospitality, healthcare, housing and athletic facilities where on-site CHP is most efficient because hot water demands can be met through capturing and repurposing waste heat made through generating electric. The company's business model would seem to be a hard proposition to pass by, given that American DG guarantees the onsite energy it produces to cost 5% to 20% less than the rate charged by their client's current utility provider. In addition to ongoing cost savings companies are able to conserve energy potentially qualifying them for LEED credits.
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This is translating to growing revenue for American DG. In its financial report for 2013, ADGE revenue improved by 32 percent to $7.46 million from $5.65 million in 2012. GAAP net loss contracted from 14 cents per share in 2012 to 10 cents per share last year.
Digging a little deeper into the report reveals some key growth metrics that bode well for the future of American DG. Gross profit from energy revenue was 36 percent, even though negatively impacted by thermal energy costs decreasing 10 percent and electricity costs decreasing 11 percent in the fourth quarter. Apropos, looking ahead, market analysts predict energy rates will be rising, which will serve as a catalyst for even stronger margins for American DG. Total energy production increased by 34 percent to 99.4 million kWh in 2013 compared to 2012. Total CHP energy systems operated by American DG increased 34 percent year-over-year to 123, with 29 more in backlog.
The company also paid a special dividend in August of an aggregate 4,880,720 shares of majority-owned subsidiary EuroSite Power (OTCQB: EUSP) to shareholders of ADGE. The dividend equated to approximately $4.8 million, or 4 cents per share of ADGE. EuroSite Power is headquartered in the United Kingdom and focused on Europe in offering CHP systems to commercial clients through the same structure as American DG.
It's important to remember that American DG carries the cost burden to bring the CHP systems to their clients. A typical contract is approximately 15 years, meaning that there is a breakeven point for the upfront costs where gross margins will jump exponentially. The 15-year annuity model brings with it predictable cash flow and controls potential volatility in the balance sheet, a major plus for the company, investors and analysts. After placing the CHP systems on site, American DG generates revenues with very little overhead and 3 – 5 year payback periods for their upfront costs, leaving two-thirds or more of the contract period generating high-margin revenue. So the company trending towards profitability while significantly growing top line figures certainly has ADGE on the right course. Wall Street apparently thinks so as well, with shares rising about 27 percent so far in 2014 and more than 50 percent in the past five months.
The energy sector overall will probably be in for a bit of a bumpy ride this year as Europe continues to recover economically and growth in China runs at the same pace as 2013. Alternative energy equities will likely outperform fossil fuel plays as incentives and mandates motivate companies to make changes for the good of the environment and their bottom lines. Above are three companies taking different approaches, but their track record of improving revenue and growing portfolios of clients, positions them to capitalize on the ongoing emergence of sustainable energy usage.
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