February 11, 2022

Welcome to the Inaugural Issue of Cabot Money Club Stock of The Month

Each month, in this advisory, we will be spotlighting a new recommendation from one of our Cabot experts. We will include an interview with the analyst and bring you his or her latest thoughts on the stock we pick as well as a summary of the analyst’s expertise and experience.

We will also include a brief market update, and a longer piece highlighting the macro industry—the pros and the cons—in which our stock pick resides.

And as is usual with our Cabot advisories, we will maintain a portfolio of our stock picks, to give you a one-shot picture of our holdings.

Welcome!

Market Overview

Here’s what is happening with the markets right now. January began with a rollicking ride as volatility heated up. Tech stocks took a bath. Value stocks are still holding up better than growth. And in February, we’ve seen a market rebound, with both Energy and Financial Services stocks coming out the winners. So far this year, Energy stocks have gained 24.1%, and Financials are up 5.1%. The worst-performing sectors have been Consumer Discretionary (down 7.5%), Utilities (-4%), and Communications Services (-7.5%).

But in the past few days, concerns over interest rate tightening by the Federal Reserve has again roiled the markets. The markets had been expecting a year with 3-4 rate hikes, which now may turn into as many as eight.

This uncertainty will most likely result in more volatility—at least in the first half of the year.

In the meantime, we will keep you informed of major changes in the markets and in our portfolio, via Alerts, when needed.

In this first issue, we feature a stock from the renewable energy sector. This sector is exciting for many reasons, which you’ll see in below, but this company’s business model, in particular, is very attractive to me. It reminds me of Darling Ingredients Inc. (DAR), a stock I first recommended in March 2009, at around $4 per share. At that time, Darling was collecting used grease to recycle into feed and fuel. Today, the company serves the pharmaceutical, food, pet food, feed, industrial, fuel, bioenergy and fertilizer industries, and its shares trade north of $66. I’m hoping we’ll see similar returns from the following pick!

Featured Recommendation

Archaea Energy, Inc. (LFG)—Turning Waste into Energy
This renewable natural gas producer is a favorite of Brendan Coffey, Chief Analyst of Cabot Sector Xpress Greentech Advisor. I asked Brendan to summarize why the shares of Archaea appeal to him and why like-minded investors might want to purchase them. Here’s his reply:

“Archaea Energy is a producer of renewable natural gas from landfills. It collects the gas that otherwise just goes into the atmosphere from garbage dumps. The company recently came public by SPAC (Special Purpose Acquisition Company) and has been one of the best performers of those types (SPAC shares often have trouble in early months of trading—due to trading market dynamics having little to do with their business).

The founder is Dan Rice, a one-time commodities trader who became a billionaire last decade forming a natural gas business during the shale boom. He’s using the same playbook with Archaea—combining smaller businesses into a larger portfolio to take advantage of scale and expected market strength. The company just opened the world’s largest landfill gas plant in Pennsylvania and expects to vastly increase production nationwide. It just signed a 20-year deal with one utility to provide (annually) more gas than Archaea produced in all of 2021.”

Brendan first recommended Archaea in December. The following is an excerpt of his original recommendation, beginning with an industry overview:

Renewable natural gas (RNG) is increasingly seen as a largely untapped, profitable way to produce carbon-neutral or carbon-negative natural gas. RNG is almost all methane, a type of natural gas that is 28- to 36-times as potent a greenhouse gas as carbon dioxide. Practically—for power generation—it is no different from natural gas. Capturing RNG means displacing fossil fuels that would be extracted from the ground while also redirecting gas that otherwise would be released into the atmosphere. The end result is less greenhouse gases.

RNG is generated in two broad ways, one is anaerobic digestion, of food waste, wastewater solids, animal manure and landfills. The other is thermal gasification, which is the burning of biomass like leftover crops and woodmass from harvests and crops grown specifically for energy production. A March study by investment bank Stifel estimates that there are enough dairy and pig farms to increase RNG production 80-fold, and enough landfills to increase production six-fold. According to the EPA, 30% of U.S. human-caused greenhouse gas emissions came from organic waste at farms, landfills and water treatment facilities. Right now, RNG accounts for 0.3% of global energy supply. In North America, this needs to increase eight-fold to achieve net zero, under energy mix scenarios plotted out by the International Energy Agency.

Business Model
Archaea Energy primarily focuses on another supply of RNG, mainly landfill gas (LFG, inspiring the company’s ticker symbol). The company gathers methane from landfills and sells it as RNG and also, at some projects, uses the methane onsite to generate electricity it sells to utilities.

Archaea is the recent combination of three entities: Aria Energy, a long-operating LFG company that was one of the largest in North America, with projects generating 207 megawatts (MW) of electricity and 24,880 MMBTU per day, with an MMBTU unit being the energy equal to about one-sixth of a barrel of oil. Aria was combined with a pre-merger Archaea entity, founded in 2018 to pursue landfill RNG by Daniel Rice. Rice was a BlackRock asset manager turned natural gas entrepreneur last decade. Rice’s Special Purpose Acquisition Company, Rice Acquisition, is the third entity. It bought Aria and Archaea together to bring the combined entities public on September 15. The new Archaea has 35 projects across the U.S. in landfill gas-to-electricity and RNG gathering of methane.

RNG projects industry-wide are generally profitable today, given the low cost of acquiring feedstock and the sales price into the market. A large part of the business model is capturing national and state incentives for the environmental benefits, primarily tax credits. For that reason, it’s important to recognize that RNG companies are judged not just on the price of natural gas, but on the changes in the tax credit structure.

As it stands, the business is a good one, and is expected to only see improving economics under the current administration and EPA. Archaea seeks to lock in 70% of production pricing in long-term (10- to 20-year) contracts to dampen the effect of market price fluctuations.

In Q3, ended September 30, Archaea made $46 million in revenue from 1.43 million MMBTU and 175,230 MW hours (MWh) produced by the combined businesses. The business lost $21.9 million, of which $19.2 million is a non-recurring expense from going public and various SPAC accounting measures. For the nine months of 2021, the business generated $136.4 million in sales and $52.8 million in net income. The company has $133 million in debt and $400 million in cash.

Business Outlook
For full-year 2021, Archaea should generate $200 million in sales and $72.5 million in earnings before interest, taxes depreciation and amortization (EBITDA).

Management says Archaea’s projects in development will raise EBITDA over time to $300 to $400 million annually (about three to four times the run rate now). Management projections during the SPAC merger process say the $300 million EBITDA mark will be hit in 2024, when sales should be over $600 million. The projections assume an average RNG price of $1.50 a gallon, which is conservative to current prices over $2. The $1.50 price equates to $30 MMBTU, compared to spot prices around $50 this year. Project costs, beside royalties, typically cost about $1 per MMBTU. Royalties to the landowners are the largest expense, at 10% to 20% of revenue.

In the near future, Project Assai, the world’s largest LFG project, outside Wilkes-Barre, Pennsylvania, is due to come online in early 2022. In its first year, it should generate $43 million in EBITDA, with 80% of the production under long-term contracts with the University of California system, Energir and FortisBC. All the company’s debt is related to Assai. The debt is at 4% and owned by Paclife, Barings and Nuveen as part of their green-debt investments.

Longer term, Archaea has a streamlined RNG plant it says will lower its capital expenditures by 40% to bring new facilities online starting next year and expects to start producing green hydrogen (that is, hydrogen made from carbon-neutral sources) from them in addition to power production and RNG sales. The lower capital costs aren’t part of management’s current projections.

The company believes there are 300-500 U.S. landfills that can be economically positive now in the country, and another 100 that will eventually be so, as municipal waste continues to pile up. That provides a pathway in the domestic U.S. market to $1 billion EBITDA in the long term.

Archaea also has some projects to capture dairy gas in California, which has an attractive carbon credit structure, and is also exploring carbon sequestration and co-locating solar on landfills as well. Neither is expected to play a major part in company economics in the next year or so, although between tax credits and additional revenue, they could be material down the line. For now, this is a landfill gas play.

Issues to Consider:
Do not buy Archaea warrants. They are in the midst of being redeemed by the company.

There are 52.7 million shares outstanding. That means shares are trading at about 14 times estimated 2021 EBITDA (management’s preferred metric), which will roughly equal net income after adjusting for Q3 2021’s one-time costs.

The acquisition of the Rice-owned Archaea entity by the Rice-led SPAC could trigger a regulatory review. We don’t know of any investigation or any reason for there to be one, but the optics of self-dealing by SPAC sponsors is believed to be an area of great interest to the SEC.

Archaea is highly reliant on federal and state tax credit and decarbonization incentives. It is possible U.S. political winds could change in coming years to reflect a previous executive-arm bias against renewables.

Management, the Rice family and the Saltonstalls, an environmentally minded family in Massachusetts, own 40% of the company.

Rice has previously created a profitable natural gas business, Rice Energy, which was sold to EQT in 2017 for $6.7 billion, about a 250% shareholder gain over three years from its 2014 IPO.

Brendan just published this update to his recommendation:

The landfill gas producer struck a purchase and sale deal with Fortis (FTS). Fortis’ British Columbia subsidiary will buy up to 7.6 million MMBtu of renewable natural gas (RNG) annually for 20 years. To put that into perspective, Archaea produced about 5.4 million MMbtu in 2021. Shares are challenging resistance around 17.50 this week and a move to over 18 would be nicely bullish. They continue to hold up well. Our sell-stop is “under 14.” BUY

Nancy’s note: Archaea’s warrants were redeemed on December 17. The company is expected to announce fourth-quarter earnings on February 21. Analysts are forecasting EPS of $0.03 on revenues of $ 57.39 million.

About the Analyst

Brendan has an impressive background in investing, and Greentech in particular. For more than 25 years, he has been involved in the investment community, as an investment advisory editor, investor, markets reporter and writer about and for a wealth of Wall Street’s most influential minds. He has discussed investing strategy with the likes of Carl Icahn, Mark Cuban and Leon Cooperman, and collaborated with hedge fund managers and entrepreneurs on books and essays. He’s written about investments and markets for Forbes, Bloomberg, Fortune, The Wall Street Journal and numerous other outlets.

Additionally, Brendan has deep expertise in technical analysis. He is a Certified Financial Technician (CFTe), representing extended study and achievement in technical analysis of securities, and he has successfully completed all levels of the Charted Market Technician (CMT) program.

Brendan has put both his technical and fundamental analysis skills to work in pursuit of a long-held passion for environmental and ESG stocks that began with the study of environmental law as an undergraduate at Boston College. Brendan’s also been a fellow at the Scripps Howard Institute on the Environment, served on a municipal energy planning board and, last decade, was editor of Cabot Green Investor and Cabot Global Energy Investor. In addition to ESG, he conducts proprietary research into SPACs.

Consequently, we at Cabot are thrilled to have Brendan as our go-to Greentech expert.

With that in mind, I took a few moments to get to know Brendan better, and to pick his brain about the current state of Greentech. Here is our interview:

Nancy: What are the top 3 reasons why you are interested in Greentech?

Brendan:

1. Greentech is the combination of two fields I’ve always been most fascinated by, the energy industry and the environment, and weaved in with those is a third sector that we know is transformative: technology. There is a great deal of innovation where those three intersect.
2. I love trends. Greentech to me is a macro trend on scale with the Internet, so it’s exciting to be in the early stages of that. As a trained technical analyst, it helps that Greentech is developing the same way we saw the market for Internet stocks. The dotcom boom-bust-dormancy then the now-10-year bull run in tech stocks is how I see renewable energy stocks developing. For Greentech, the solar stock mania of 2006-2007 marks the start of the cycle. I believe we’ve exited dormancy and are in the early part of Greentech stocks’ own long bull run.
3. Thirdly, and most important to me: climate change is potentially an existential threat if left unaddressed. Investing in Greentech is part of creating the solution. It reminds me of the famous Steve Jobs line when he was recruiting a Pepsi executive to join Apple: “Do you want to sell sugar water the rest of your life, or do you want to come with me and change the world?”

Nancy: Where do you see the Greentech sector in 5 years? Funding, investor interest, M&A, if you please. How is the future of the industry dependent upon politics?

Brendan: We’ve seen a lot of very young Greentech businesses come public the past two years, driven by the excitement of SPACs. In the long run, that’s great, because the number of public companies in the U.S. had been shrinking steadily since the mid-1990s. But the reversal of that trend does mean a lot of the sector’s stocks now need some time to gain their business footing. In five years, a lot of those exciting businesses that came public in an early stage of their development will be executing on their plans.

With that, I do think we will see a lot of M&A activity around EVs (electric vehicles)—manufacturers merging, EV charging companies combining, and component suppliers being bought out. There are so many EV producers and charging companies now for that to not become a significant factor in years to come.

More generally, ESG (environmental, social, and governance) considerations are becoming a core value in asset management, driven by individual investor demands. It’s estimated $35 trillion, or one-third of worldwide assets today, are subject to some sort of ESG mandate. Fifteen years ago, the idea was widely seen as futurists tilting at windmills. Greentech is the largest and most measurable segment of the ESG world, and therefore will be the biggest beneficiary of its continued growth.

To answer the last part of your question … around politics. Yes, politics matter. Government support can be incredibly useful, especially around policy. But let’s not overstate it. From 2017 through 2020 we had an administration that was indifferent—at best—to renewable energy. Yet renewable energy was the fastest growing electricity source in the U.S. over that time. In 2020, as overall U.S. energy demand fell 20%, renewable energy still grew 9%, because the economics of it are so compelling to utilities.

Nancy: Which sub-sectors of Greentech are the most appealing to you, and why?

Brendan: Hydrogen and fuel cells are very exciting to me. Hydrogen has the potential to jump a lot of the hurdles facing Greentech right now, like developing a practical way to have clean long-haul trucking and as a form to store excess energy from solar and wind plants. One day, hydrogen powered ships will refuel mid-sea at hydrogen storage facilities co-located with wind farms.

Another that excites me is nuclear. It’s a controversial topic because many people feel the radioactive byproduct should rule it out of Greentech. But we’re on the cusp of a new generation of more efficient, smaller reactors that will produce far less radioactive waste, and much less frequently. In the next 10 years, these small, much safer nuclear plants can make diesel plants a relic of our dirtier past.

Nancy: What are the 3-5 most critical challenges to growth of the Greentech sector right now?

Brendan: One is new companies meeting their projections. As I mentioned earlier, we’ve seen dozens of companies come public without much revenue now but projecting significant businesses by 2025. We need a good portion of those to follow through so investors don’t feel had. I’m confident we’ll see most grow into their plans.

Another challenge is getting Greentech into the developing world. Places like India and Africa are going to continue to develop economically, and Greentech has a chance to leapfrog the stage of building out new fossil fuel power plants to support that. It can be done. Look at cell phones. There was never a massive buildout of telephone lines in sub-Saharan Africa; the continent just jumped to mobile technology.

Lastly, there’s still a very active disinformation apparatus assailing Greentech. The latest is that if you get stuck in your car for hours in a snowstorm, EVs couldn’t heat the occupants. To the contrary, studies show they have essentially the same ability to heat a cabin for lengthy periods as a similarly fueled gasoline powered vehicle. The smart money is going into Greentech because they know better than to give much credence to sound bites from those with a vested interest in badmouthing it.

Portfolio and Industry Update

Renewables Industry Update
Renewable energy stocks had an impressive market in 2019 and 2020. But as you can see in the following chart, it wasn’t so great toward the end of last year.

But things are looking up! Congress recently passed the $1.75 trillion Build Back Better bill, which is slated to invest more than $500 billion in climate programs, with the goal of fighting climate change and reducing greenhouse gas emissions. Some of the bill’s mandates include tax credits for the installation of renewable energy systems—like solar and wind—as well as the purchase of electric vehicles.

That’s great news, but in reality, we are only at the tip of the iceberg in renewable energy efforts and consumption. According to Allied Market research, the global renewable energy market is valued at $881.7 billion today and is forecast to grow to $1,977.6 billion by 2030, an annual growth rate of 8.4%. Yet, renewable energy consumption is only 31.71 EJ (exajoules), compared to 556.63 EJ for total energy consumption, as reported by Statista.com.

And while increased spending is welcomed with open arms, the fact is that in global economic spending for recovery, renewables account for just 11% of governments’ outlays.

However, according to a new study by Deloitte, renewable energy growth should accelerate in 2022, due to climate change concerns, as well as growing demand for cleaner energy and environmental, social, and governance (ESG) considerations.

Certain pockets of renewable energy will receive the most investment.

According to the IEA, for the next five years, renewable capacity will comprise almost 95% of the increase in global power capacity. Renewable electricity capacity will rise by more than 60% (the equivalent to the current global power capacity of fossil fuels and nuclear combined).

Solar capacity accounts for about 60% of all renewable capacity additions and is seen doubling over the previous five years. Onshore wind capacity is expected to rise by 25%.

Global biofuels demand is forecast to rise by 28% by 2026. The U.S. is leading the charge, but Asia is expected to account for 30% of new production.

And speaking of Asia, that is where most of the new demand is centered. China will account for 43% of global renewable capacity growth. Next is Europe, the U.S., and then India. Together, those four regions make up 80% of renewable capacity expansion around the world.

Change is coming, but maybe not as fast as we would like to see. However, any rise in capacity and/or demand should help keep companies like Archaea on the growth track.

The next Cabot Money Club Stock of the Month issue will be published on March 3, 2021.