By
Morningstar
:
by Mark Barnett
One of the brightest stars in the Morningstar alternative-energy
universe is Ormat Technologies (
ORA
), the premier developer and operator of high-efficiency geothermal
equipment and power plants. Cost overruns at its newest plant,
North Brawley, combined with a drop-off in the products business in
2010 drove Ormat's shares well below our fair value estimate.
Concerns about the viability of U.S. renewable tax policy, a
primary financing vehicle for growth, have kept up the
pressure.
But with its recent financing successes and substantial new
plant orders, we think the time is right to scoop up shares before
results improve in a big way in 2012 and beyond. Ormat's low-cost,
environmentally friendly advantage makes it the only independent
power producer in Morningstar's coverage universe with an economic
moat, and it is currently the only alternative energy company
Morningstar covers with a 5-star rating.
Industry-Leading Growth on Tap
Ormat, whose vertically integrated business designs, builds, and
operates geothermal power plants, as well as supplies them for
third parties, is poised to grow EBITDA and earnings faster than
its independent power-producer peers without the volatility that
competing fossil-fuel generators experience.
Ormat's low-cost, environmentally friendly and reliable
generation gives it a unique competitive advantage in the power
generation industry, as geothermal uses the earth's natural heat
and no fossil fuels to turn turbines. Without exposure to
fossil-fuel commodity costs, emissions liabilities, or
weather-related operating variability like solar and wind, utility
distributors are willing to pay premium prices to lock in Ormat's
generation supply and prefer it where available. And if state and
federal environmental regulations remain in place, Ormat's
competitive advantage will strengthen.
Ormat's large pipeline of development projects supports the
significant growth we forecast at its flagship generation segment.
Improved development incentives and financing opportunities should
help Ormat bring on line nearly 150 megawatts of new capacity
though 2013 and another 150 megawatts between 2014 and 2015. This
represents more than 60% capacity growth from our 2010 estimate and
offers long-term, contracted profit growth independent of volatile
fuel costs.
In addition to Ormat's generation segment growth, we also think
the market is undervaluing the growth potential of its products
business. Two large deals signed so far in 2011 have boosted its
fast-growing backlog. In addition to the growth from its backlog,
we think the business could win supply contracts worth as much as
an estimated $400 million for a large project in Indonesia and a
recently announced project in New Zealand.
Combined, we think Ormat's generation and products businesses
will drive 28% annual EBITDA growth through 2015, with big step-ups
in 2013 and in 2015, when significant new capacity comes on line.
With Ormat's market valuation currently below its slower-growing,
commodity-sensitive peers, we think Ormat offers an attractive
risk-reward profile.
Cheaper Than Solar, Competitive With Wind
The source of Ormat's economic moat derives partially from its
leading position in low-cost geothermal power generation. The graph
below shows how geothermal is an economically attractive power
generation source, especially relative to solar sources. As the
largest pure play and most sophisticated geothermal industry
player, Ormat benefits the most from these attractive economics. We
note that for purposes of calculating the geothermal LCOE below, we
utilized the high end of industry capital cost estimates.
Another competitive advantage for Ormat is its access to
financing, typically the biggest challenge for geothermal
developers. Most geothermal projects require an initial exploration
phase to prove out the resource for development, typically funded
by corporate cash. This limits the ability of many smaller players
to manage the long development cycle for new geothermal
construction. Ormat's size and ability to fund early-stage
development from its balance sheet is a huge advantage over smaller
competitors. This allows the company to take more chances and
explore a larger portfolio of land, increasing the odds of proving
a viable resource and securing external financing.
Once a project is viable, U.S. federal tax incentives give
geothermal an additional cost advantage over its fossil-fuel
competitors. Current tax policy allows renewable energy developers
to utilize a production tax credit (PTC), investment tax credit (
ITC
), or cash grant. Developers like Ormat can pass these tax benefits
on to tax-equity investors in return for project financing. While
required returns for all renewable tax equity deals have gone up
significantly since the financial crisis, meaning lower returns for
Ormat, the ITC and cash grants have helped spur major growth in the
tax equity market after it contracted in 2008. Accelerated
depreciation is also a strong incentive. Standard tax policy offers
five-year depreciation for geothermal projects. The 2010 stimulus
bill offered 100% first-year depreciation for projects completed in
2011 and 50% first-year depreciation for projects finished in 2012.
Federal loan guarantees, which lower debt financing costs, are yet
another financing benefit for geothermal projects.
Are Renewables on Washington's Chopping Block?
Investing in renewable energy has certainly been a
roller-coaster ride recently. U.S. federal tax incentives and
increasingly demanding state renewable energy mandates swelled
investor optimism prior to the 2008 financial crisis, boosting
growth projections along with share prices. When the crisis hit,
financing for all but the largest renewable developers ground to a
halt. Some of the biggest players in arranging tax equity deals
either went bankrupt, like Lehman Brothers, or played out like the
Wells Fargo takeover of Wachovia, where Wells Fargo's tax base was
depleted by Wachovia's losses in addition to its own, shrinking its
appetite for tax equity. Many renewable energy projects simply fell
off the table along with stock prices. Geothermal suffered as much
as any, given the longer lead times to bring projects to viability
and high up-front construction costs.
Much attention has been focused on the potential for these tax
incentives to expire or be axed given Washington's focus on deficit
reduction. In addition, some states are reconsidering their
fast-approaching renewable energy mandates. Whatever your
ideological position, one undeniable fact is that renewable power
saw a renewed surge in investment interest with the extension of
the ITC and PTC and the creation of the cash grant program. Another
is that, like it or not, a majority of Americans polled
consistently support government incentives for renewable power,
regardless of their views on global warming. Given the tiny slice
of the federal pie that currently goes toward these programs, we
think incentives for renewable energy are here to stay, and that
Ormat is well-positioned to benefit.
See also
Obsessed With The Fed, But It's The ECB That Really
Matters
on seekingalpha.com