Big Bang
The world needs to invest $110 trillion dollars to transition to a low carbon future by 2050, according to the International Renewable Energy Association. We’ve all known of the world’s necessity for getting to net-zero and then net-negative-carbon emissions for some time now. Even so, the clean energy movement has only showed up in the market in fits and starts.
Until now.
Finally, the shift to Greentech is taking hold. Even as oil and gas prices have stayed low, a situation that used to dampen renewable energy demand, we’re seeing renewables take market share. In the U.S. alone, Greentech grew 7% in 2020, even as overall energy demand declined 5%. Solar is now the cheapest electricity in history, according to the mainstream International Energy Agency. A decade ago, it was the most expensive, on a utility scale. The great shift is on.
There are 235 U.S.-listed cleantech stocks in the SX Greentech Advisor universe, plus we also track the 50 most-held ESG (Environmental, Social and Corporate Governance) stocks in mutual funds and ETFs, with some of our own exclusions. We aim to be fully invested with 12 equally sized positions. This debut issue, we start building our portfolio with a growing desalination equipment maker and a market-leading maker of alternative building products.
Enjoy!
“Our emissions, it seems, are no longer a problem we are willing to kick down the road.”
-Bill Gates, writing in his book How To Avoid A Climate Disaster
Featured Stock: Energy Recovery, Inc. (ERII)
By 2030 the world will have a 40% shortfall of the fresh water it needs, according to the United Nations. Occurrences of what is called Day Zero, the day a municipality runs of out fresh water, are increasing, the most notable being the Indian city of Chennai, which ran out of water in 2019 (officials trucked in water from elsewhere for their 6 million residents). Over half of the world population feels some type of water stress annually, according to the World Bank.
The most logical solution is desalination – making seawater potable. Already there are more than 16,000 desalination plants operating globally, with nations such as the Bahamas, Malta and the Maldives generating all their freshwater from seawater. Another 174 other countries generate some portion of freshwater from desalination. Making drinkable water can be done by distillation, usually sped along by boiling in what’s called thermal desalination, or by reverse osmosis.
Seawater reverse osmosis (SWRO) is increasingly a popular choice because it’s less energy intensive than boiling. A challenge for Greentech as a whole is being able to support increasing economic activity while shifting to environmentally healthy systems. In water, that’s where Energy Recovery (ERII) comes in.
ERII is a California company that has a virtual monopoly on pressure exchangers used in SWRO plants. SWRO facilities take in sea water, pressurize it greatly (to roughly 1,000 PSI) and push it through a filter that removes salt and other impurities. About 40% of the water comes out as drinkable while the rest, the brine, is discharged. Pressurizing the water takes energy, of course. Energy Recovery’s flagship product, the pressure exchanger (PX), allows the energy from pressurization to be reused, vastly slashing energy usage.
In Energy Recovery’s design, the pressurized brine is diverted to hit new low-pressure seawater coming in and ratcheting that new batch up almost to the power needed (the PX is 98% efficient). That results in a lot less additional energy for pressurization. It’s classic energy transference, like the cue ball in pool hitting its target.
Energy Recovery’s PX works exceptionally well: It has four ceramic parts, just one of which moves, and it never needs to be replaced in the 25- to 30-year life of a desalinization plant. Overall, the company’s customers save about $2.5 billion in energy costs and the equivalent of 2.5 million auto emissions annually.
Energy Recovery management says it has lost just one project to a competitor the past decade. That market position gives ERII a high gross margin of 69%, compared to an average of 25% for other Russell 2000-sized companies. (Energy Recovery has a market cap of $1.2 billion).
Growth in PX exchanger demand comes from two areas. One is the replacement of existing thermal desalinization plants. Largely due to energy demands, thermal desalinization got overtaken by SWRO about 20 years ago, to the extent almost no thermal plants are built today. Existing ones are being replaced at the end of their lives with SWRO. Over over the next decade, those replacements are a $500 million market opportunity for ERII, an amount of money equal to all the revenue its generated in its 20-year history.
The broad increase in desalination provides additional growth. Energy Recovery’s business grows about in line with desalination growth overall, which is expected to roughly double (in terms of global expenditures) in the next five years. The number of “mega” projects has been rising too, although they remain relatively few at around a dozen a year.
Energy Recovery also seeks to grow beyond desalination. The company launched a wastewater PX late last year, to take advantage of mandates in for zero liquid discharge. That means all waste is stripped from water used in industrial processes and only clean water is discharged back into the environment. This affects industries ranging from textiles, steel, coal and so on and is a regulatory focus in India and China. In those two countries, wastewater PX should bring about $100 million in one-time replacements and about $10 million a year in continuing business afterward, according to a company presentation at a recent investor conference. The PX for this process is slightly less efficient than its saltwater cousin, but still high at around 93%. It’s possible in a few years this business could be bigger than the desalinization business as zero discharge rules take hold worldwide. Energy Recovery is marketing its new pressure exchanger with DuPont (DD), which makes the filters for both zero liquid discharge and desalination.
One longer-term focus for growth is in refrigeration, where there is a pressing need to eliminate hydrofluorocarbons – HFCs – a manmade gas which pound for pound are 1,000 times more potent greenhouse gases than carbon. Naturally occurring gases, such as carbon dioxide itself, can work for refrigeration in the same method as HFCs. The sole – but major – difference is that HFCs don’t need to be pressurized very much to work. CO2 needs to be pressurized much more to be as effective, but if you believe the market will move this way, it is something Energy Recovery can be a major player in, since the technology is much the same as desalination and wastewater pressurization. That market is more nascent, but could be a significant one within five years.
Management is also focusing on improving its profitability. Energy Recovery has no debt, but has long run large operating expenditures and seeks to cut those by a third by next year, from about 60% now to 40%. The company will do this in part by making a decision on a long-stalled product called VorTeq, intended to service the oil and gas industry seeking to slash energy spending on fracking and wildcatting. The product has been problematic for years and management has pledged to make a definitive decision of moving into production with VorTeq – or not – in the coming months.
Technically, earlier this year ERII stock broke out of a three-year range between 6.50 and 16, which gives us a ballpark of about 25 as a near-term target and 30 as a longer-term price projection. Shares have been very resilient in cleantech’s recent correction, advancing higher on huge volume and consolidating with little selling pressure. First-quarter earnings are released tomorrow, May 6, after the close of trading. That brings immediate volatility as a risk, though there is little trepidation in the price action.
What To Do Now
Buy here and down to the first area of support at 19 a share. At the current price, in the mid-21 area, the initial sell-stop should be around 18.83, a confluence of support from an area of recent consolidation and projection three times the Average True Range, a measure of recent price action that allows for normal volatility.
Energy Recovery, Inc.
Revenue (most recently reported trailing twelve months): $119 million
Earnings per share (TTM): $0.47
All-time high share price: 22.42
Market cap: $1.22 billion
Recommendation: Buy at current price, with a sell stop about $2.53 below.
Trex Company, Inc. (TREX)
Home improvement surged during the pandemic, as consumers stuck at home crafted nicer places to be together – or apart – from their families. It looks to continue this year: the Leading Indicator of Remodeling Activity, a Harvard University index meant to track the U.S. market, projects an almost 5% growth rate in 2021. New construction and renovations often overlap in terms of materials but there’s a distinct difference in some spots: for one, renovating homeowners are more willing to pay up for better materials that offer less maintenance over time, whereas a homebuilder is only looking to sell, and will trade up-front costs for future maintenance done by someone else.
One area that sees a lot of that calculus is using wood versus composite decking. Wood needs staining or painting periodically and, at times, rotting boards need to be swapped out for new ones. Composite decking comes in a variety of colors that never need staining and never rot. There’s a trade-off though: a 16-by-20 foot deck in wood will cost about $576 in materials; a composite deck will start at double that and goes as high as $3,050, depending on color choices and quality levels. However, that wood deck will cost another $4,688 in maintenance over 25 years – the composite decking won’t add more.
Composite decking is generally made with a high recycled plastic content – bottles and, increasingly, thin film plastic bags, which are considered a lower cost recyclable source. Recycled wood and sawdust are also mixed in, providing for an overall carbon impact about 40% less than wood. Composite boards are uniformly formed (no knots or warped boards) and easy to work with from a carpenter’s point of view.
Trex (TREX) is the leading composite decking producer in North America and rates as the highest quality in industry consumer surveys. It sold $881 million of decking in 2020, up 18% from 2019. It earned $1.51 for the year and has no long-term debt. It reports first-quarter ’21 earnings next week, on May 10.
Trex focuses on decking with some railing products and in every case its products are constructed out of 95% recycled material. It sells tiers of boards that are differentiated by color choices, with less common colors that resemble tropical woods being more expensive. Wood commands the decking market – it has 78% share compared to 22% for composites, so Trex is mainly competing against wood, rather than other composite makers. The company is likely benefitting from record lumber prices: the benchmark lumber price is four times its seasonal average at a record $1,550.50 per thousand board-feet. Mills say they are backlogged into the summer, meaning wood for autumn delivery is also priced quite high. Still, though Trex does sell to new home business, its primary market is renovation, by DIYers or contractors working on behalf of homeowners. Every percentage point of market share taken from wood adds about $50 million to Trex’s sales, the company says.
Trex management began implementing price increases over the winter and just finished new factories in Virginia and Nevada that increase capacity 70%. That will undoubtedly help the company meet demand from Europe that it was unable to fill in 2020. In short, the home improvement boom should continue to boost Trex’s fortunes.
There are some cautions, of course: one concern is the rise in composite decking produced by Trex and another publicly traded competitor, Azek (AZEK), means recycled plastic is becoming more costly. Trex is now paying retailers for collecting those newspaper and produce bags often recycled through grocery store drop boxes.
Another consideration is that Trex is sometimes traded as a proxy for broader short plays on economic and homeowner conditions. The thesis of short-sellers, as best we understand it, is that consumer spending may be constrained. Currently, short-sellers have 7.7 days to cover their positions on Trex – a bearish bet significant enough that in turn is potentially bullish. Thus, any rally is likely to spark some buying by shorts to lose out their positions. Shares are priced for growth, a price-to-earnings of 63 times the trailing 12-months period, and at 8 times sales; the S&P is at 37 and 3, respectively. That means any disappointment in earnings could affect shares to the downside quickly. The company reports first-quarter 2021 earnings after the close Monday. The consensus expectation is for $0.38 a share.
Also worth noting for our purposes, Trex management has 8.8 million shares left to buy on a share repurchase plan – that’s plenty of powder dry to support the stock price, equal to almost 8% of the number of shares outstanding.
Technically, Trex has a nice, orderly chart, with support at 103, 98 and 87. Shares have tread water since the last earnings announcement, but that actually is a better than Greentech as a whole. That resiliency sets up for a good reaction to a good earnings report next week. The Trex chart doesn’t present a firm price target, but there is room to advance toward 150 if shares can break the all-time high sitting about a dollar higher.
What To Do Now
Buy at market price. The sell stop can be a bit looser here, given the 40-day moving average sits near 98. We’ll set our sell-stop in the mid-93 area, which should provide additional support. For those more cautious, a reasonable stop is just above or below 100 (avoid round numbers like 100, where many stops tend to sit clustered), which is about threes time the Average True Range, which is a measure of normal price movement based on the past three weeks of prices.
Trex Company, Inc.
Revenue (year through December): $881 million
Earnings per share (TTM): $1.51
All-time high share price: 110.79
Market cap: $12.6 billion
Recommendation: Buy at current price, with a sell-stop around 93.50.
The ESG Three
The ESG Three are the top three stocks from the environmental, social and governance universe of stocks we follow. Selections are made primarily on our multi-level technical analysis screen. These aren’t stock picks but suggestions for those looking to explore additional stocks beyond the Greentech portfolio.
Unitil (UTL) is an electric and gas utility that mainly serves seacoast New Hampshire and Maine through Portland. It’s cleantech because its expanding natural gas service supplants dirtier fuel oil in those states and it encourages customer solar in its Fitchburg, Mass., franchise. Shares gapped higher last week on a strong outlook from management: the economy reopening plus a relocation interest from now-permanent work-from-homers should boost energy demand. It will pay a 38-cent dividend to people holding shares on May 14 and management expects to pay $1.52 out a year. The broad market shows a recent preference for utility shares, which is a plus. A move to test resistance at 62 seems likely and may pause any rally. Support should be strong down to 51.
Roper Technologies (ROP) is a large-cap industrial conglomerate providing software and specialty equipment to a big range of niche industries: think power turbine software, water management tools, foodservice inventory applications and medical ultrasounds. Shares have been rallying since early March on increasing volume. They face near-term resistance but could add 10% if they push through. Support is found $20-$30 below the current price.
Waste Connections (WCN) is a residential and commercial trash collector which, like most of the segment, has a robust business in recycling. Waste Connections, like other waste collectors, has generally been strong and should benefit from improving economic activity. WCN’s business is more rural, and therefore more profitable and less open to competitors. Shares broke out of a range in April and are at all-time highs, which clears the road for a push to around 160 by one measure. There’s support at 115 and 110.
Our Greentech Timer
Greentech right now is in the midst of a medium-term correction within a long-term uptrend. That makes it a bit of a tricky market – on the one hand, it is likely a buying opportunity for some quality names, but on the other it indicates a test of long-term support is imminent, and where a break below would cause us to get firmly defensive.
Since peaking at 281.41 on February 9, the Wilderhill Clean Tech Index, one of the benchmarks we watch, surrendered more than 38%, a retracement level that often brings support. (Not to get too technical, but it’s right on top of a step-back goal cited in two theories of price action, one called Gann and the other Fibonacci). The retracement also happens to coincide with Greentech’s 200-day moving average, a long-term indicator of price support. Add to that the fact we see declining volume on down days in Greentech funds, indicating the bears are running out of steam. That doesn’t mean the sector won’t test support again here and it certainly doesn’t rule out the chance of a more concerning breakdown. But odds are, support will hold and the long-term uptrend will resume.
Now’s the time to stay away from more speculative names – the great business ideas that are still in development stage – and focus on the higher quality names. The broad market, too, is signaling caution, with utilities, consumer staples and health care gaining strength in the most recent week while technology, energy and consumer discretionaries are showing a rotation out. Generally speaking, Greentech is correlated with technology, although our ESG universe of stocks includes companies in other sectors and, in the social and governance areas of ESG, a diverse array of blue-chip stocks that can serve us well in defensive times.
Our Greentech Timer, shown here, is familiar to those of you who subscribe to some of our Cabot Wealth advisories. Ours is similar, plotting the Wilderhill Clean Energy Index. We’re fully bullish when the index is above the 20-day and 40-day moving average and those averages are upward trending. The price and those two averages are downward trending. The purple line, peeking out at the bottom right, is the 200-day moving average, and shows that the long-term trend remains bullish.
The next Sector Xpress Greentech Advisor issue will be published on May 19, 2021.