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Power plays

It might sound paradoxical, but reducing the energy we use is big business. Here, we profile some of the companies at the forefront of a global drive towards greater energy efficiency
June 12, 2015, Alex Newman

Changes in global energy use tend to conjure very specific images. That might be because picture editors often accompany articles on the subject with visuals of wind farms, hydroelectric dams and fields of solar panels. But renewable sources of energy are only one side of the coin, the reverse of which – energy efficiency – is a little harder to illustrate. Were you to do so, a sensible choice might be the fluorescent lightbulb, which at least has a symbolic attachment to bright ideas, if not grand feats of engineering.

This also belies the fact that energy efficiency is a colossal and growing business. Admittedly, this sounds a) paradoxical and b) counter-intuitive in the context of energy markets, which we tend to look at as subject to an ever greater demand met by traditional or renewable sources. But if governments are to hit their international commitments to reduce carbon emissions, finding ways of using less energy has to go hand in hand with the broader transition to renewables.

The International Energy Agency (IEA) underlined this in a 2014 report, which found that the world’s annual spend on energy efficiency needs to increase at a far higher rate than the growth in energy supply if we are to simultaneously meet energy demand and emissions targets. Current energy supply of $1.6 trillion (£1.05 trillion) a year needs to rise to $2 trillion by 2035, during which time annual spending on energy efficiency needs to grow from $130bn today to more than $550bn. Fortunately for investors, there are many listed companies addressing this booming need to trim the energy intensity of the lighting, heating, power and water systems of homes, companies, governments and public infrastructure.

Government policy is already a tailwind for some of these companies. In the UK, companies will soon be legally obliged to identify energy efficiencies wherever possible. From December, the Energy Savings Opportunity Scheme (ESOS) will fine companies failing to conduct an audit of their energy use and identify potential efficiency savings. This brings into force an EU-wide directive addressing all companies with at least 250 employees, a turnover of E50m (£36.54m) or a balance sheet of E43m.

From an investment point of view, light-touch compliance is probably a better bet than relying on the whims of subsidisation or tax breaks, which are more susceptible to political mood swings. It is also likely that companies in the energy efficient sector represent less volatile investments than those focused on renewable energy, where changes in political sentiment towards certain types of production can throw a spanner in the works of companies’ future plans.

Further evidence can be found in the performance of the FTSE EO Energy Efficiency index over the past five years, which has grown by an average of 9.7 per cent each year, comprehensively beating its peer, the FTSE Renewable and Alternative Energy Index.

Unlike green energy providers, the energy efficiency industry is not competing against the traditional energy sector, and so is therefore less susceptible to oil price fluctuations. If it’s convinced it can and wants to make the savings, a company will choose to reduce its energy bill by fitting efficient LED lighting, regardless of the relative costs of producing wind energy or burning coal. Unless, of course, the oil price somehow falls to the point where paraffin lamps once again became economical.

Unsurprisingly, the companies we look at here aren’t oil and gas majors, even though such groups might advocate efficient energy use in their literature. But investing in the energy efficiency story needn’t be to the total exclusion of natural resources stocks. One commodity that will play an ever-more dominant role in energy efficiency is lithium, which is a highly efficient way of storing energy and can be found in the batteries of your phone or laptop. Demand is growing at between 8 per cent and 10 per cent a year, and is expected to accelerate from the expanding electric car market in Asia.

As the technology develops and becomes more commonplace in vehicles and buildings, the greater the market will be for Bacanora Minerals (BCN), a Mexico-based lithium miner listed on both Aim and the Canadian markets. Together with its joint venture partner Rare Earth Minerals (REM), Bacanora is conducting feasibility studies and believes it could eventually reach production capacity of 50,000 tonnes of lithium a year, which would re-rate Bacanora to many multiples of its 88p share price.

But while lithium mining is one of the more bombastic and game-changing green solutions, many other companies working in energy efficiency are fostering quieter revolutions.

 

Fuel cells: powering up for returns?

It’s fair to say that fuel cells – devices that convert a fuel’s chemical energy more efficiently than simply burning the fuel – have long been heralded as one such revolution. Unfortunately, investing in fuel cell companies is a risky business. The problem for investors trying to assess the value of these stocks is that it is still early days for fuel cell groups, and as a result the vast majority are lossmaking. A lack of broker research on such companies doesn’t help matters. Fuel cell returns are some way off and much of the cash raised is being used to fund growth. The focus at the moment for the bulk of these companies is on refining the technology and securing initial contracts to trial their products.

Of the UK-listed fuel cell companies, Intelligent Energy Holdings (IEH) is the most mature and therefore the closest to monetising its technology. The Loughborough-based group, which was founded in 2001, has three diverse end markets. The group’s largest generator of turnover is its distributed power and generation (DP&G) business. Management is seeking to capitalise on the dearth of reliable energy in India, focusing on powering telecom towers.

In August last year the group secured an interim deal with Indian telecoms group GTL to provide power to 10,000 of its towers, which had previously been diesel-fuelled. In April Intelligent Energy extended its contract to power 26,000 towers, generating the group £10m in revenue. At the time of the group’s half-year results in May, chief executive Dr Henri Winand told the IC that the group is set to extend this interim contract during the second half of the financial year. Management’s medium-term target is to power 125,000-135,000 telecom towers across the country.

Momentum has started to pick up at its motive division too. The group licenses its fuel-cell system design to automotive manufacturers and then collects a royalty on each vehicle. Intelligent Energy also receives an upfront payment. It took the division eight years to secure its first two clients, which included a deal with Suzuki for a fuel cell-powered scooter. The Japanese vehicle manufacturer paid an upfront fee of £45m and is contracted to pay millions more under a joint development agreement; the bike is currently in the process of mass production. The group has signed up another two car manufacturers in the past year.

Its consumer electronics business is also making progress. In November Apple launched the group’s ‘Upp’ app, a portable hydrogen fuel cell to power consumer devices on the go. The plan is to launch further versions of the product, culminating in Upp3 in the first half of the 2016 calendar year. Management sees this as a way to gain credibility, gather consumer energy consumption data and seed the presence of fuel cells in the market. Its overarching aim is to launch embedded fuel cells within the mass market of consumer devices.

While Intelligent’s revenues for the first half of this financial year grew by more than 600 per cent to £27.4m, its pre-tax loss also rose by almost a quarter to £27.3m. Broker Zeus Capital expects group pre-tax losses next year of £33.6m. It forecasts that the group will turn a profit of £51.6m in 2017. However, investor patience seems already to be wearing thin and the shares have suffered a monumental fall since floating on the main market in July last year. After listing at 340p, the shares have fallen to just 75p. Such a drastic drop seems unjustified. The group is well-funded, with just over £58m in cash, and for investors already holding the shares it would seem prudent to hang on.

 

A less mature option

Intelligent Energy’s closest competitor is much smaller fuel-cell group AFC Energy (AFC), which has a market cap of £109m. The group designs and develops alkaline fuel-cell technology. However it has a very different target market, aiming to sell its technology directly to utility companies and large industrial players. Like Intelligent Energy, trading has been bumpy for AFC Energy since its initial flotation on Aim in April 2007. However after a steady decline in price, which started in mid-2013, the shares have started to climb back upwards. Since the beginning of March the shares have gained more than three-quarters in value and now trade at around 41p per share.

The rapid uptick in the shares can be explained by management signing its first commercial contracts. In March this year the group agreed a development deal with South Korean construction and engineering group Samyoung Corporation and gas company Changchin Chemical Corporation to provide 50MW of generation capacity in Daesan, South Korea. In addition, the group struck an agreement with Bangkok Industrial Gas to install 10MW of capacity in the Rayong province of Thailand, 2MW of which is expected to be operational by the end of 2016. Finally, AFC signed a memorandum of understanding with the Dubai Carbon Centre of Excellence for an estimated 300MW of fuel-cell energy to be rolled out across high-profile events such as the Dubai Expo 2020.

AFC chief executive Adam Bond says North and Southeast Asia, the Middle East, north Africa and North America are where the short to medium-term opportunities are for the group, thanks to favourable government policies, as well as subsidies in countries such as North America. However it’s still early days for AFC and, despite these early commercial wins, the group is in the process of refining its technology.

The company is currently constructing what will be the world’s largest alkaline fuel-cell system at Air Products’ industrial gas plant in Stade, Germany. The system, known as KORE, will have 240kW capacity and is due to be switched on in December 2015. Mr Bond says the purpose of its agreement with Air Products is not to make profit but to “learn how to operate fuel-cell systems within a commercial and industrial environment”. That being said, the group is already in talks with “one or two German utilities” about selling the power into the grid, he says.

Management has set an aggressive target of 1GW of fuel-cell capacity under development by 2020. Revenues for the first half of the 2015 financial year increased by 60 per cent. However, house broker Zeus Capital still expects cash losses for the financial year of £2.7m, albeit down from £5.6m in the prior year. As is the case for Intelligent Energy, AFC is not expected to become profitable until 2017. Despite the recent rise in the shares, they remain a highly speculative investment. We think it would be wise to hold off buying the shares until the group’s ability to scale up its system to an industrial level has been demonstrated.

 

Business needs

Emergent technologies can make for exciting investments, but for businesses and investors innovation is only worthwhile if it’s adopted. Government directives and boardroom efforts to make cost savings wherever possible mean most companies are primed to expand their use of existing energy-efficient technologies.

One company to market those benefits is APC Technology (APC). Originally an electronic component distribution business to the defence, transportation and industrial sectors, APC is increasingly focused on its secondary energy efficiency division, which operates under the Minimise brand. The consultancy works with companies including WM Morrison (MRW) (see box, below) and Royal Mail (RMG) in the UK and Wendy’s fast-food chain in the US, delivering multi-million pound annual contracts that address water, energy measurement & generation and waste, efficiency strategies and finance. Interim results in May highlighted the growing demand for the company’s services, with Minimise’s revenues up 41 per cent. Big contracts mean earnings have been choppy, but APC now services more than 50 major customers a month, and large companies are alive to the potential savings.

APC works with companies including Morrisons to help them improve energy efficiency

 

“A year ago, I would have said the significant interest in energy efficiency was down to rising energy prices,” says APC chief executive Mark Robinson. “Those have come down in the past six months, but we’ve still got large demand – it’s difficult to know exactly what the drivers are, but it’s a long-term trend.”

He cites the example of one FTSE 100 company that APC works with that spends around £25m a year on energy savings. “Of that, we’ll expect £5m of direct spend relates to water, and probably £5m or so relates to renewable energy generation, which leaves £15m for broader energy efficiency programmes.” As ESOS becomes mandatory, APC thinks it could likely benefit from increased interest from companies wanting a one-stop assessment and solution to their energy needs. The consultancy is also well placed to benefit from operational gearing as sales rise, which analysts at Cantor Fitzgerald think will lead to earnings per share of 2.7p in 2017, or just seven times the current price.

Other companies active in this type of consultancy work include US groups Honeywell (US:HON) and Ameresco (US:AMRC), the latter of which was initially Mr Robinson’s model for Minimise – it works with major US cities and companies to finance and implement similar energy-saving projects.

Closer to home, Anglo-German IT group SciSys (SSY) also offers similar energy efficiency consultancy services, albeit from a more data-driven perspective. The Aim minnow helps large public and private sector organisations comply with the mandatory Carbon Reduction Commitment scheme, a reporting and pricing scheme it helped the Environment Agency develop. SciSys also helps companies manage energy-efficiency monitoring services, which large corporates are increasingly using for both regulatory and savings purposes.

Energy efficiency is just one of the many markets SciSys is involved in, which also include defence, aerospace, media and broadcasting. Unfortunately a recent major contract hitch in its defence division means profit forecasts for this year and next have been drastically downgraded. Given the uncertainty from the fallout, we move our buy recommendation to hold. Another UK company involved in energy consultancy is Utilitywise (UTW), which has seen its share price rally by 31 per cent since interim results in late April, helped in part by the approval of a European patent for its energy monitoring system Edd:e. The group, a longstanding IC tip, helps businesses reduce their energy bills by offering energy reduction programmes including the fitting of energy saving devices, outsourced energy management, audits and compliance. The company’s opportunity to grow its share of the energy advisory market is significant: as of March, the company counted just 23,000 out of a potential market of 2.4m, leaving plenty of room for further growth.

 

Housing efficiency

In February, the government lambasted the big six household energy suppliers for taking “no interest in real energy efficiency” and the concept of green homes. Given the utility companies’ business models, the sector was always an unlikely source of energy efficiency champions, but that doesn’t mean other companies aren’t fulfilling that role.

Recovery in the UK housing market, an increase in disposable income and a plethora of government incentives mean companies offering energy efficient services and products for the home are ripe for growth. The Department of Energy and Climate Change estimates that there are 24 million homes in the UK that would be suitable for cavity wall insulation and 27 million for high-efficiency boilers. What’s more, with households using around 20 per cent less energy than they were in 2004, there is clearly consumer appetite to save energy and therefore money in domestic power.

That’s good news for entu UK (ENTU), a supplier and installer of domestic solar panels, insulation, boilers and energy efficient doors and windows. The group only floated on Aim in October last year and now has a market capitalisation of £80m. However the energy group offers big rewards for investors not averse to a higher risk investment. It operates via a national network, where it plans to push new green energy products. In February this year the group signed a deal with fellow Aim constituent Flowgroup (FLO), to supply and install the first electricity-generating boiler. Chief executive Ian Blackhurst says while there is no shortage of innovation in the sector, the group is not directly involved in the R&D of such products. He adds: “We don’t want to be pioneers of new projects in case they don’t work properly, we tend to be followers.”

Entu has already revealed promising figures since its flotation. Its pre-tax profits for 2014 rose by half to £9m and sales by a quarter, thanks to its buoyant home improvements business. Admittedly growth this year will not be as impressive, if forecasts by analysts at Zeus Capital are accurate. Still, they reckon the group will bump up its adjusted pre-tax profits by £1.2m to £11.5m.

What’s more, entu’s low cash requirements mean it can reward shareholders amply. The group intends to pay 8p in dividends per share at the end of the financial year in October, equivalent to a bumper yield of 6.7 per cent. The group already paid out a special interim dividend of 1.5p per share in March. The shares have increased in price since we first tipped them, but they are still only trading on 10 times forward earnings. We think this offers value, considering the impressive yield and longer-term growth prospects.

Another Aim-newcomer looking to capitalise on the trend towards greener appliances is washing machine manufacturer Xeros Technology Group (XSG). Its washing machines use up to 80 per cent less water and up to 50 per cent less energy and detergent, according to management. This is because its system uses tiny, recyclable nylon polymer beads and only a small amount of water. Corporate customers subscribe to monthly payments of $1,500 for a five-year period, which includes servicing and detergent.

Xeros's tiny recyclable nylon beads enable its washing machines to use less water and less energy

 

The group is targeting the commercial laundry market, such as hotels looking to reduce their laundry costs. Its primary market is in the US where the price of water can vary greatly from state to state, due to water shortages. Some utility companies also offer incentives for users to reduce their water consumption. However chief executive Bill Westwater says the group is currently working on scaling down its, currently sizeable, machines for use in the home.

Take-up of Xeros’ technology has been slower than expected, however. Management had to cut its target for washing machines installed by the year-end to 80, from 149 at the time of its IPO in March 2014. The group’s pre-tax losses almost doubled to £6.7m in 2014. On top of this, Mr Westwater estimates it will take 26 months of fees to recoup the money invested in an installed machine. That being said, investor confidence has not waned. The shares have risen 167 per cent since the time of its 2014 year end results in October. We think the shares are only worth holding for those already invested. But the growing need for energy efficiency means Xeros is unlikely to be the last opportunity would-be investors will have to play this burgeoning industry.