Stars Align for Renewable Energy

Around the world, investment in renewable energy projects is skyrocketing. S&P has buy ratings on three stocks poised to benefit from the boom

You know something is hot when Google (GOOG) wants in. The dominant Internet search company stunned investors last month with an announcement that it will begin hiring engineers and other energy experts for a project that plans to generate 1 gigawatt (GW=1 billion watts) of electricity—the output of a fair-sized nuclear power plant—from renewable sources. Not just any renewable source will do, however. Google's goal is to find sources that can generate power more cheaply than power from coal—the ultimate goal of any renewable energy technology.

Google said it will use its experience building energy-efficient data centers to invest in renewable energy technologies, particularly in solar, geothermal, and wind power. If it succeeds, the company would be in a position to provide a large amount of electric power while reducing carbon dioxide emissions. "We expect this would be a good business for us as well," says founder Larry Page, adding the company expects results "in years, not in decades."

Business Imperatives Meet Policy Initiatives

"Google is very focused on operating efficiencies and sees renewable energy as good not only for the environment but also for the company's bottom line," says Standard & Poor's equity analyst Scott Kessler, who has a hold recommendation on Google shares. Google does not disclose its annual power bill, but "energy-related expenses are becoming more material for Google and other corporations," Kessler says.

Around the world, investment in renewable energy projects is skyrocketing and will only increase further as calls grow for tighter restrictions on emissions of carbon dioxide and other greenhouse gases. Major U.S. corporations, including General Electric (GE), Johnson & Johnson (JNJ), DuPont (DD), and AIG (AIG), pledged their support in late November for "a comprehensive, legally binding United Nations framework to tackle climate change." It would supercede the Kyoto Protocol—a U.N.-sponsored treaty that commits developed nations to collectively reduce their greenhouse gas emissions below their levels in 1990—when it expires in 2012. "We believe that tackling climate change is the pro-growth strategy. Ignoring it will ultimately undermine economic growth," the group said.

In the U.S., a bill passed by the House of Representatives would force electric utilities to source 15% of their power from renewable sources by 2020. Nonhydroelectric renewable power sources contributed just 2% of the U.S. power supply in 2006.

While the money being spent on renewable energy projects is real and rising quickly, S&P Equity Research does not believe that every renewable energy stock is attractive. S&P has buy recommendations on just three U.S. stocks with significant exposure to renewable energy. All three companies are involved in solar power, which has so far lagged in development compared with wind power, and which is expected to expand rapidly in the years to come. Photovoltaic (PV) power uses silicon wafers, as well as other light-absorbing compounds, to produce power directly from sunlight—the same silicon wafers used to make the semiconductor chips found in computers.

Profitable PV Cells

MEMC Electronic Materials (WFR), the only one of the three with S&P's highest 5-STARS ranking, makes silicon wafers that are used to manufacture PV solar cells. With demand for wafers rising as sales of solar power cells increase, a silicon shortage has developed, which is driving up the price of MEMC's wafers.

Having started selling wafers to solar power customers only in 2006, MEMC now has more than $15 billion in orders for solar wafers for delivery over the next 10 years.

S&P equity analyst Jim Yin says the strong buy recommendation is based on his positive outlook for the solar energy industry. He sees demand for solar cells rising by 30% a year through 2010, outstripping available supply and driving prices higher.

Suntech Power Holdings (STP), one of the world's largest solar cell manufacturers, is another stock that S&P analysts are bullish on. The company has grown rapidly in recent years and says it is now the largest producer of solar PV cells in the world, with an annual manufacturing capacity of 420 megawatts (MW=1 million watts) as of Sept. 30. It expects to more than double that, to 1 GW of capacity by the end of 2008, a fourfold increase since 2006. Suntech, says S&P equity analyst Mike Jaffe, has locked in a large number of orders for the coming years. Jaffe expects Suntech's revenue will more than double in 2007 to about $1.4 billion, and rise by another 50% in 2008 as manufacturing capacity expands. Profit margins should widen during that time also, he says, as Suntech starts to receive cheaper silicon wafers under a seven-year contract that begins in midyear.

The third renewable energy company recommended by S&P is Cypress Semiconductor (CY), which bought San Jose-based PV cell maker SunPower in 2002 and has sold some of its shares since then. It now owns 57% of SunPower (SPWR), which trades on the Nasdaq and supplied about half of Cypress' revenue and net income in the third quarter ended Sept. 30, 2007. Through Dec. 15, SunPower shares surged by 236%; shares of Cypress—which also makes a wide range of chips used in autos and consumer electronics—doubled over the same period, far surpassing the performance of the S&P 500 and reflecting the increase in value of its SunPower stake.

S&P equity analyst Clyde Montevirgen believes the shares of Cypress are undervalued. Although he thinks SunPower will keep growing, "we have a buy recommendation on Cypress not only because of its solar business, but also because we think Cypress' core semiconductor business is overshadowed by its solar business and is grossly undervalued."

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