My pick in clean energy is one of the safest

In a risky sector, stick with this tried-and-true global operator -- with 45% upside to boot.

By StreetAuthority Dec 10, 2013 1:54PM
Electricity pylons © Digital Vision., Photodisc, Getty ImagesBy David Sterman                                                              

The appeal of clean-energy stocks is evident. Billions of dollars are at stake as the world tries to wean itself off fossil fuels.
 
There can be little doubt that clean energy will account for at least 20% to 30% of our total energy picture a few decades from now. But the road is bound to be bumpy. The sudden plunge in solar stocks in 2011 and 2012 -- not to mention their remarkable rebound this year -- highlights just how risky these clean energy stocks can be. Indeed, many investors have concluded that they just can't stomach that degree of risk.

But there is a better way: a focus on companies that already derive significant revenue streams in support of clean energy projects. These stable firms don't own breakthrough technologies, but they are helping the industry pioneers to scale up their production. And in light of the long-term future for clean energy, these firms face robust growth potential.

My favorite pick in this group: Spain's Abengoa (ABGB), which derives more than $10 billion in annual sales by helping construct clean energy power plants, water desalination systems, biofuel production facilities and highly efficient energy transmission networks.

                                          Abengoa's Steady Growth

                                          
As you can see, it's not an extremely profitable business, as many projects are contracted on a cost-plus basis. But management has done a solid job of generating scale economies, and operating margins have risen from around 7% a half decade ago to around 10% these days.

Yet it's the company's growth trajectory that has my attention. Even though sales rose roughly 150% from 2007 through 2012, they're still on track to grow much higher. Sales in the first nine months of 2013 were up 17% from the same period last year. Operating margins grew in excess of 25%.

Despite its Spanish roots, this is really a global firm: The U.S. and Latin America each represent roughly 30% of sales, with the remaining 40% split between Europa, Asia and Africa. Residents of Arizona already know this company, thanks to the just-opened Solana solar thermal power plant, which is big enough to power 70,000 homes.

Subscribers to Andy Obermueller's Game-Changing Stocks newsletter also may have come across Abengoa. Andy is a big fan of Dyadic International (DYAI), a small biofuels company that has created enzymes that are being used in a radically new energy production facility. That plant, in Hugoton, Kan., which will produce up to 25 million gallons of alternative fuel per year, was built and is being operated by Abengoa (which will pay royalties to Dyadic).

Yet many other people in the U.S. may have never heard of Abengoa before. That's because the company went public in late October though a U.S.-listed IPO, and shares haven't done much since the offering. (This stock already traded in Europe for many years, and the U.S. offering was used to increase Abengoa's visibility stateside and to raise $700 million in cash to help lower debt.)



The recent U.S. IPO marks an important shift for this company. In recent years, the company has spent $3 billion to $5 billion a year on capital spending, leading to a cumulative free cash-flow deficit of more than $11 billion over the past five years.

Not only will the IPO proceeds pay off debt maturities that were to come due in 2013 and 2014, but management recently announced that the company will finally be free cash-flow positive in 2014. As a result, debt-to-EBITDA (earnings before interest, taxes, depreciation and amortization) is expected to fall to 2 by the end of 2014, as the company's debt load, which had risen above $13 billion at the end of 2012, is expected to fall below $11 billion a year from now. A decision to throttle back capital spending should help debt to keep falling in subsequent years.

Rising sales, falling debt and a massive potential target market are the key reasons to like this stock. But you won't hear much about this company from Wall Street, considering how few U.S. analysts cover the company. John Quealy, an analyst for Cannacord Genuity, is one of the handful who do. He rates the stock a "buy" with an $18 price target.

"We continue to like the longer-term prospects, as management's deleveraging strategy progresses on plan and the core business shows resilience across the energy and environmental end market," Quealy wrote in a note last month to clients. His target price equates to 7.5 times EBITDA on an enterprise value basis. That target represents 45% upside from the current price.

I'm taking the longer view: This is a stock to buy and hold for an extended period as demand for massive clean energy power production facilities is a clear long-term trend.

Risks to consider: Some major clean energy projects rely on government financing, and further global economic distress is bound to impede this industry's development, as we are currently seeing in Europe.

Action to take: This is not an investment poised for a quick upside. Though shares are well below that $18 price target, it will take time for that to happen, as Abengoa still needs to boost its visibility among U.S. investors. But with an established track record and a bright future, there's no need to wait for the crowd to show up and embrace this stock.

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