Taking Stock of Green Energy Options

Pure-play alternative-energy stocks can be dicey. A smarter bet: The companies that will supply the infrastructure for the sector's growth

While the dot-com stocks were staging their spectacular rise and fall several years ago, other sectors were having their own bubble moments. Take the case of alternative-energy player Capstone Turbine (CPST).

In 2000, Capstone, a producer of small, low-emission generators, saw its market value climb above $5 billion. Seven unprofitable years later, the stock trades for less than a dollar, and the company has a market cap around $120 million.

Capstone is just one of several clean-energy stocks to have seen stunning valuations evaporate. Unlike the Internet, alternative energy has yet to see substantial growth in the wake of its bubble.

Capstone still makes generators used as backup or replacement power sources, but the buzz around renewable energy has shifted to other sources including solar and wind. The seesaw price of oil, conflicts in the Middle East, and worries over climate change have pushed the subject back onto the front page and brought a new round of government and venture capital investments. But investors looking to ride the renewable energy wave should remember the experience of Capstone.

Investment Investigation

Where should eco-focused investors look? The best plays may not come from the obvious places.

The better bet may lie with established industrial companies with their own alternative energy businesses that have the stamina to ride out fads. Or consider a contrarian move: Old-line companies that will be needed to help speed the transition to a greener energy infrastructure.

It's easy for eco-focused investors to get drawn into the hoopla. A scan of the landscape of publicly traded alternative-energy companies shows thrilling and exotic possibilities. Depending on which eco-conscious pundit is talking, an investor is bound to wonder if the U.S. economy might one day run on wood chips, algae, corn, hydrogen, manure, clean coal, the tides, or heat generated beneath the surface of the earth.

For the investor looking for a stake in a cleaner future, each of these options carries a high degree of risk. "Renewables [alternative energy solutions] are much more like a life sciences investment," says Dan Pullman, vice-president at investment bank McNamee Lawrence, who specializes in clean energy.

As with biotech, it can take seven or eight years to see whether a technology will win acceptance from the market. Then, even if the investor has backed the right horse—whether solar, biofuels, or hydrogen will end up in the winner's circle—he or she must also pick out which of the contending companies using that approach will prove dominant.

One possibility is to invest through a mutual or exchange traded fund with stakes in a basket of companies. However, the options available to U.S. investors are unsatisfying (see BusinessWeek.com, 3/1/07, "Green Funds: Less Than Meets the Eye"). They include wildly volatile funds investing in companies like Capstone to self-proclaimed "green" funds that have holdings in sectors such as fossil fuels and Las Vegas casinos.

Slow Growth

Despite the excitement surrounding alternative energy, investors have to realize that it will take decades to emerge as a major part of the American energy supply. "Realistically, it's going to take a long time to reinvent the economy," says Peter Fusaro, chairman of consultancy Global Change Associates.

What's more, the emergence of alternative energy in the U.S. is likely to happen in a much more fragmented fashion than is the case with hydrocarbons, where a few giant companies rule. Sunny California is a leader in the U.S. solar energy market. Meanwhile, gas stations selling e85—gas made primarily of corn-based ethanol—are concentrated in the upper Midwest. With fragile startups looking to carve out renewable energy niches, "I think small investors will get their heads handed to them," Fusaro says.

And some of the most intriguing outfits are off-limits to small investors, at least for now. In 2006, U.S. venture capitalists invested $723.3 million in alternative energy startups, according to the National Venture Capital Assn., more than in the past 10 years combined. Goldman Sachs (GS) has stakes in a portfolio of private renewable energy companies including cellulose ethanol outfit Iogen, and energy management company Gridpoint.

The Big Picture

So what are alternative energy-minded investors to do? They can start by broadening their horizons.

A more certain gamble than betting on a particular renewable energy company is betting on an increased use of renewable energy in general. Ironically, the smart way to play that may be to invest in the traditional industrial companies that will facilitate the transition of sustainable energy sources, much like Cisco (CSCO) helped to build out the communications infrastructure that facilitated the rise of the Internet.

Consider ethanol. Last year ethanol prices spiked after the corn-based fuel was added to the gas supply in several regions. Because ethanol cannot travel in pipelines premixed with gasoline, it required its own transport, often railroads.

With more ethanol use required by law, that could present a strong revenue stream for railroads including Burlington Northern Santa Fe (BNI) and Union Pacific (UNP). Even so, Morningstar analyst Peter Smith says that ethanol by itself isn't enough to make the railroads a buy, especially as both stocks have performed well in recent years, making analysts question if there's room for more upside.

Even with the rails poised to pick up an increasing share of nonpetroleum fuels such as ethanol—as well as the old fossil-fuel standby, coal—investors may wish to bide their time until valuations of these companies become more attractive.

Similarly, Standard & Poor's analyst Stewart Scharf says companies like construction engineering concern Jacobs Engineering (JEC) and rail and transport group Trinity Industries (TRN), both of which he rates strong buy, could benefit from a push into renewable energy.

Exploring Their Options

Another option for investors: Well-established companies that are taking steps into renewable energy such as Siemens (SI) and rival General Electric (GE). Among their initiatives, both companies have wind power businesses.

Neither, however, is strictly a renewable energy outfit. "You can't play them that way," says consultant Fusaro. As purely green companies they're overvalued, he points out. But it's easy to think that these industrial giants will deepen their push into alternative energy in coming years as carbon emission and scarcity worries surround oil and natural gas.

It's not easy being green, but motivated investors can make the best of their limited options. For those wanting to put their money on the growth of alternative power sources, a little homework—and lot of patience—may be required.

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