Peasgood Preaches Patience on Geothermals
Source: Brian Sylvester of
The Energy Report
Wellington West Analyst Sean Peasgood covers the geothermal,
plasma gasification and "Smart Grid" subsectors of the alternative
) market. He believes there's room to make some dough in each of
them but believes investors may need to be patient as these growing
markets gain traction. "As these (geothermal) projects come online
and are proven out, the reward to investors is going to be large,"
Sean says. He even reveals some names to help you earn your reward
in this exclusive interview with
The Energy Report.
The Energy Report:
Sean, can you tell us a little about yourself and your coverage
area at Wellington West?
I've been covering the technology and clean-technology sectors with
Wellington West now for about 10 months. Before this, I was with a
bank-owned dealer for about four years covering the technology
sectors as an associate analyst. I now cover the alternative energy
space, focusing on geothermal, plasma gasification and the Smart
Could you give us an overview of those alternative energy
subsectors and their respective outlooks?
Let's start with geothermal. While the stocks in this sector have
been relatively weak over the last few quarters, we have a positive
long-term view on the space. It takes significant capital and time
for these projects to come online. I believe that early stage
investors will benefit as projects generate significant free cash
flow in the future. Eventually, they will look more like utilities
and less like exploration companies. Investors who get in today
will benefit from capital gains in the short term as projects come
online and then from dividend-yielding equities in the future.
Given the baseload nature of geothermal, we believe utilities
are more interested in signing attractive power purchase agreements
(PPAs) than relying on more intermittent sources of renewable
power, such as wind and solar.
We also cover the Smart Grid market, which is essentially the
deployment of Internet protocol (
)-based communication networks across the existing power grid. The
goal is to increase efficiency, enhance control and provide
visibility across the grid for utilities. The lack of
infrastructure and maintenance upgrades over the last several
decades, along with increasing demand for power, have reduced the
reliability and quality of power not only in the U.S. but around
the world. This problem is only being exacerbated as the world
looks to add renewable energy sources to the grid. While some of
these upgrades have already begun, we believe this deployment will
take place over the next 5-10 years. This should translate into
strong revenue and earnings growth for a variety of IP
communications-infrastructure companies both wireless and
Finally, as I stated, we cover the plasma-gasification market,
which is an emerging alternative technology being used in
waste-to-energy projects, as well as producing cellulosic ethanol.
Plasma gasification reduces emissions and produces a synthetic gas
that can be used to generate power. In cellulosic ethanol
production, this synthetic gas is fermented and converted to
ethanol. There are a number of projects getting underway in North
America, and we're seeing interest for this technology in India and
China, as well.
Given the speculative nature of these alternative energy plays,
what type of investor should be looking at this sector?
I think investors should look to balance their traditional energy
exposure by adding newer alternative energy companies to their
portfolios. In many cases, these new technologies are just
emerging; so, while they have more risk than more traditional
energy plays, when they begin to gain traction, investors could be
handsomely rewarded. That said, there are ways investors can reduce
this risk exposure. For example, investing in early stage
geothermal companies is, obviously, more risky than investing in
some of the larger players that have a portfolio of projects and
stronger balance sheets. We believe risk-averse investors should
look to the larger players in the market to gain exposure to these
Investors in the geothermal market need to have a multiyear time
horizon, as development can take several years. As these companies
bring projects online, I expect the share prices to continue to
increase as a reflection of lower exploration and development risk.
Then, as they start generating stable free cash flow, they will
trade more like utilities and, eventually, provide dividends.
What's the timeframe on that?
Generally, projects take about three to four years to develop.
Depending on who you're looking at in the space, most companies
that we cover-I'm talking about
Magma Energy Corp. (TSX:MXY)
Ram Power Corp. (
-have a portfolio of projects that will come online over the next
few years, leading to a steady increase in megawatts (
) online. Ram, in particular, has a 32 MW project in Nicaragua that
will come online in the second quarter of 2011, which will
immediately provide them with an increase in their top
bottom lines. Two quarters later, they're going to bring an
additional 32 MWs online, meaning the company will be generating 72
MWs in total by the end of 2011.
Companies have been developing things in sequence. So you're
going to see multiple projects coming online every year, which will
be positive for the stocks and help fund future growth.
In looking at your research, some of the price targets in your
recent reports are a bit more aggressive; but some targets you set
earlier this year were rather conservative. For example, in a
RuggedCom Inc. (TSX:RCM)
dated May 28, 2010, your target price was a mere 21% above the
existing price. Using that as an example, are your conservative
targets more indicative of your approach or sector weakness?
Generally, I try to weigh the growth opportunities with the risk
factors and be as fair as possible. As far as RuggedCom is
concerned, I've become more aggressive on it lately given the
recent slide in the stock, the company's leading market position
and the significant growth opportunity in the market. They are
actually benefiting from not only Smart Grid opportunities but also
from other industrial ethernet markets like transportation and
For the geothermal space, while we are bullish long term,
investors need to understand the risks involved in these projects.
There's financing risk, which has recently been improving, and
political risk, as government grants can enhance the value of
projects and some of the projects are in foreign jurisdictions. As
projects advance and get de-risked, then I will become less
conservative. But I think at this point, it's fair to provide
investors with the full set of risks and that's reflected in my
forecasts and price targets.
You've mentioned Smart Grid a few times. Everyone has heard of the
grid, but what's a Smart Grid? And why should investors look
specifically at this alternative energy subsector?
Essentially, the Smart Grid is the deployment of a communications
backbone over the existing power grid-all the way from power
generation out through transmission and distribution, and then into
the home. Most of the infrastructure out there really hasn't
changed in 100 years. What we have now is significantly higher
demand for electricity across a decaying grid infrastructure that
is becoming less reliable and efficient. The idea of the Smart Grid
is to deploy a communications backbone, so utilities have full
visibility across that grid.
Over the last few years, there's been a real focus on putting
smart meters in homes. Smart meters provide the user with
visibility and the ability to switch their habits to use more power
at off-peak times and also provide the utility with information
about electricity demand patterns. For example, with a smart meter,
the utility can charge a little bit more for running your
dishwasher during peak times and try to encourage you to run that
dishwasher at night. That's the first phase.
But we believe the next phase is the more important part of the
Smart Grid, where communication infrastructure is being placed in
substations across the grid, so utilities have even greater
visibility and control. Right now, if power goes down, the utility
has no visibility and must wait until customers contact them to let
them know. The Smart Grid provides the opportunity to put a
communications network in place, so utilities know if they've just
lost a whole block and immediately take action. This should reduce
power outages, which negatively impact GDP and are becoming more
This is where RuggedCom has been focused for about seven
years-putting routers and switches and IP-communications equipment
into substations. Currently, in most substations, there is no
infrastructure to alert utilities, which can result in a fault in
the substation. But with this equipment, all of those things can be
monitored in real time; and the equipment will make the appropriate
adjustments with very little need for human intervention. This full
communications backbone is the real solution to providing utilities
with the visibility to meet growing demand, increase efficiency and
reduce greenhouse gas emissions.
RuggedCom has a strong management team, backed by a number of
General Electric Company (
. I really like this stock (we have a Strong Buy rating on it and
$20.50 price target), and I think it's a good way for Canadians to
play the Smart Grid. Currently, there aren't many public companies
in Canada that are exposed to this space like RuggedCom. The major
risk for investors is the potential for lumpy quarters, which can
lead to volatility in the share price. To gain a better
understanding of the business, investors should look at results on
a trailing four-quarter basis, which illustrates the consistency in
revenue and earnings growth over the last several years.
What countries are deploying this technology at a rapid rate?
There's been a lot of attention on smart meters in North America
and Europe. Substation automation is happening globally; however,
the upgrade process has been one or two substations at a time,
rather than the mass smart-meter deployments we have seen to date.
When utilities upgrade a substation, they'll upgrade all the
communications equipment inside at the same time. Given utilities'
risk aversion and new technology, the sales cycle for these
products can be 12-18 months. To put this in context, last year the
market for substation automation-communications infrastructure was
roughly $150 million. If you just look at all of the substations in
the world and assume that 20% of those have been upgraded, which is
probably a conservative view, to upgrade the rest of the
substations would be about a $4 billion opportunity.
That's not an overly huge market though.
That's just the substations-just one piece of the overall Smart
Grid opportunity. It shows you where the market could go. I mean
it's very, very small right now as utilities are really only
upgrading a few substations at a time. Could it multiply
significantly over time? We believe it will, but it's really going
to be about how quickly these utilities adopt this technology
across their footprint.
You mentioned Asia earlier. In other sectors like mining, China has
changed the way businesses operate. Last year, according to an
alternative energy report that came out earlier this week, $34
billion was spent on solar and wind projects in China. What sort of
impact is China having on the AE sector?
As one of the world's fastest-growing economies, China is going to
be an important part of this market for many years to come. Right
now, about 90% of China's energy is from nonrenewable sources. The
Chinese government wants to get that to 18% by 2020. Electricity
demand there is growing significantly, so you know this is going to
require significant investment. We're already starting to see that
in wind and solar. We believe all of the markets we have spoken
about so far should benefit from that region.
What are some companies other than RuggedCom that have significant
exposure to China?
One would be
Alter NRG Corp. (TSX:NRG; OTCQX:ANRGF)
, which is in the plasma-gasification market. The company just
signed an agreement with Wuhan Kaidi Holding Investment Co. to
develop a number of waste energy plants in China. They're going to
start with a small demo plant, which is expected to be online in
mid-2011. Then they're going to look to develop up to 50 additional
plants in the future. Alter NRG is also in discussions with other
parties in the region that want to take advantage of the
waste-energy market. Currently, most waste sites are still using
landfills and incinerators. These Chinese engineering companies are
looking to use plasma-gasification technology to eliminate waste
and generate electricity.
How does that work?
Plasma gasification is a thermal/chemical process that converts
low-value, carbon-based feedstock into a synthetic gas (syngas),
which in turn, can be used as a fuel or combusted to generate steam
or electricity. Alter's plasma-gasification technology has been
recognized for being very flexible, enabling it to handle a variety
of feedstocks. This is important as some competitors' gasifiers
require the feedstock to be treated or prepared prior to
gasification, which can increase project costs.
That technology sounds interesting. Did they develop it?
Westinghouse Plasma Corp. (
gasification technology in 2007 for US$29 million. Alter is working
with a number of large players to bring projects online over the
next several years. For example, Coskata Inc. is developing a large
cellulosic ethanol facility that is trialing Alter's technology in
their pilot facility. Alter is also working with
NRG Energy, Inc. (
to retrofit coal-fired plants to use gasification and reduce
emissions. While all these projects are still in the early stages,
they offer large opportunities. Any one of those, if they come in,
would take this company from $1M-$3M/quarter to between $30M and
$90M for just one of these projects. I think it's just a matter of
time before the company gets one of these large projects across the
finish line, which would help prove to investors the large market
opportunity for this technology.
What's your target price for Alter?
Given the projects are still largely in the trial phase, we have a
Speculative Buy rating on the stock and a price target price of
Another statistic in that same report was that investments in
geothermal power fell from $2.2 billion in 2008 to $1.5B in 2009.
What accounts for that drop, and how should investors interpret
that 31% decrease?
I will start by saying we continue to see strong demand and
development both here in North America, and all around the world in
the geothermal market. There's a lot of development going on in
Africa, Indonesia, the Philippines and Australia, to name a few. We
continue to see new projects being explored with companies and
governments promoting the development of geothermal projects.
I think the drop in 2009 was largely due to the tightening of
the credit markets following the credit crisis. These projects need
significant amounts of debt financing to get across the finish
line. Before the credit market seized up, geothermal companies
needed to have 50%-60% of the resource proven out before getting
construction financing. This increased to 100% in the height of the
crisis. Good news for investors and the market, in general, is that
we are beginning to see the credit markets loosen up. On Ram
Power's recent conference call, management indicated that one
developer in California was able to get debt financing after only
having 60% of the resource proven out and the terms on the paper
were more attractive by 200 basis points. It's nice to see that
those markets are starting to open up, because geothermal is so
capital intensive that this was a barrier to development. As long
as the credit markets continue to behave, then I would expect those
investment numbers to reverse.
What companies are you following in geothermal?
We cover four companies in the space. The two large ones that we
cover, Ram Power and Magma, probably get a little more attention
given the larger project portfolios and strong balance sheets. The
Ram Power management team has significant experience in the space
and has a number of people working for them who were formerly with
Ormat Technologies Inc. (
. The Ram team has numerous projects that they're developing right
now, which, as I said, are slated to come online in 2011. They also
have a number of properties in the U.S. that they're developing and
recently announced that they were going to acquire
Sierra Geothermal Power Corp. (TSX.V:SRA)
to add to those properties, some of which are adjacent to their
Clayton Valley project.
What's the status of that takeover?
Management indicated that they expect the transaction to be
completed in the third quarter. They also said they would come back
to the market with specific details as to how capital expenditure
requirements may change, and how quickly some of those projects at
Sierra may advance. It's a nice acquisition for both companies
because Sierra was having trouble raising the funds needed to
continue development, and Ram has a much stronger balance sheet and
the ability to access capital markets to develop those projects. I
think the combination of the two is going to be positive.
What are Ram's catalysts for growth?
I think the catalyst is that Ram has done exactly what they said
they were going to do. Their projects are all advancing on time and
on budget. The share price has been weak recently, but really the
whole sector has shown some weakness.
My view is that, as we get closer to the Nicaraguan project
coming online in 2011, investors will be able to better understand
the cash flow from these projects. While it's capital intensive
upfront, investors who get in early are going to benefit as these
projects come online. But, from an investor's perspective, getting
in front of that, and then having the second project come online
later that year, are two big catalysts for the company.
But these geothermal projects in development are in Nicaragua. Do
you consider Nicaragua a safe jurisdiction?
Well, obviously, there's some political risk; but, from what I
understand, the government is very supportive of the development
and the country needs access to reliable power. Ram has a PPA in
place and management has been operating in the region for some
time. I don't see this as a major risk, but investors should always
stay tuned into political issues where these geothermal projects
are located (as things can change over time).
What's your target on Ram?
We rate Ram Power a Buy with a $4.50 price target.
What are some other geothermal companies you're following?
I also cover Magma Energy, which is similar to Ram in that it has a
strong management team, healthy balance sheet and is also helping
to consolidate the industry. Right now, the focus at Magma is
what's going on in Iceland. They had a 46% stake in HS Orka-an
Icelandic company that generates about 175 MWs annually. They
recently made a bid to increase their stake to 98%. However, over
the last few months the Icelandic government, spurred on by some
high-profile people in Iceland, has become more concerned with
foreign investment. They are now reviewing that acquisition by
Magma. There has been some uncertainty in the stock over the last
month or so given these developments. The company has stated it's
going to move forward with that acquisition and recently announced
they had closed an additional tranche, taking them to 84%. We
continue to believe this transaction will be successful; however,
investors do need to weigh this political risk.
You mentioned Magma's management. That company is headed by Ross
Beaty, who made a name for himself in mining and, more
specifically, as chairman of
Pan American Silver Corp. (TSX:PAA;
. Could you comment on Magma's management?
Obviously, Ross is very well respected and has done a great job of
creating value for investors in the mining space. I think investors
expect that to continue in the geothermal space. Coming from the
mining industry, the company is familiar with exploration activity,
working in different regions of the world and working with
different governments. I think those are all synergies as far as
moving from mining into geothermal.
Ross has done well to attract talent from across the industry
and now has a strong management team behind him, as well. And
that's another aspect of this Iceland acquisition-he is adding
significant human capital that he'll be able to leverage across
other projects they are developing. The stock has been weak, but I
think it offers investors an opportunity to get into a company with
proven management, a very attractive basket of assets and a strong
balance sheet that should allow them to develop those assets. If
this Iceland ordeal can blow over, we believe the stock should
recover nicely. We rate Magma a Buy and have a $2.40 price
Do you have some final thoughts on the sector?
Investors in the geothermal space are going to have to be patient
while projects come online. That said, the rewards for early stage
investors are likely to be higher than for those who wait until the
companies are spitting out strong cash flow. At this point, a new
set of income-seeking investors will likely look to take advantage
of utility-like stocks that will generate stable free cash flow and
are likely to produce dividends.
The other question is: Will large utilities step in and
potentially buy these companies in order to meet their renewable
targets? We believe that utilities are unlikely to take on
exploration risk today; however, as projects come online, we
believe these companies could be strong acquisition targets.
Sean Peasgood is an equity analyst at Wellington West Capital
Markets, covering the clean-technology sector. Before joining
Wellington West, Peasgood worked in the equity research
department of a bank-owned dealer covering the technology space
as an associate analyst for four years. Sean has a HS.Bc. from
McMaster University and an MBA from Saint Mary's.
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1) Brian Sylvester of
The Energy Report
conducted this interview. He personally and/or his family own
shares of the following companies mentioned in this interview:
2) The following companies mentioned in the interview are sponsors
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3) Sean Peasgood: I personally and/or my family own shares of the
following companies mentioned in this interview: None. I personally
and/or my family are paid by the following companies mentioned in
this interview: None.
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