Pitfalls on renewable energy

We would all like to live in a pollution-free world, but investment opportunities in emission-free renewable energy might not be as sustainable as interest in the sector would lead us to believe. The Merrill Lynch New Energy fund has posted stellar returns, with gains of 56 percent in the 12 months through Sept. 30. Poppy Buxton, a portfolio manager of the fund, attributed the performance to higher oil and natural gas prices, as well as growing concerns about climate change and energy security. She cautioned, however, against investing in renewable energy based on mood and macroeconomic data alone. "Although there is a high correlation between the oil price and stock market performance of clean-energy companies, there are other drivers to be aware of," Buxton said. "Many companies in the alternative-energy space are small and unprofitable. If market sentiment were to cool and small-cap stocks fell out of favor, clean-energy stocks would suffer, irrespective of commodity prices." That view is echoed by Ian Henderson, manager of a natural resources fund for J.P. Morgan Asset Management in London. "Investors have identified clean energy as an area of growth, but recent history has demonstrated that share-price performance does not always reflect alternative energy needs," he said. "Valuations and share price movements have been erratic, which seems to suggest that no one is quite sure how best to play." German solar companies have been on a tear this year, with one of the biggest companies in the subsector, SolarWorld, gaining 350 percent through September. At the other extreme, many fuel cell companies, which produce electricity from an external fuel supply of hydrogen and oxygen, have done little more than tread water. Henderson invested in one such company, Ballard Power Systems, more than 10 years ago in the belief that this was the energy solution of the future. He still holds the stock for philosophical reasons but would not recommend it as a "strong buy." "The market is wanting to see more evidence that fuel cell companies such as Ballard and Plug Power are going to be commercially successful," Henderson said. "When this happens and trading volumes improve, we might see a higher stock price." Michael Liebreich, chief executive and founder of New Energy Finance, a provider of data and analysis on renewable energy and technology stocks, has compiled an index that tracks the performance of the largest 50 clean-energy companies. Introduced at the start of the year, the Global Energy Innovation index has risen 32.5 percent so far this year. Top-performing subsectors during the third quarter were solar (39 percent), wind (25 percent) and efficiency (17 percent). The least strong sectors were hydrogen and fuel cells, which gained 5.8 percent, and electricity storage, which dropped 3.5 percent. Stocks that made the most headway in the three months through September were Capstone Turbine (174 percent) and Rentech (91 percent). The biggest losers then were ITM Power, off 16 percent, and Ultralife Batteries, down 24 percent. Liebreich said he expected stock prices to be supported by the attention paid to the sector as a result of the Kyoto Protocol, the pact on global warming, and by a favorable regulatory environment. He cautioned, however: "The rising tide will not flow to all boats. Given their strong run this year, there would appear to be little upside in German solar stocks, while fuel cell companies with low revenue streams could come under further pressure if investors become defensive." Some of the most promising long-term investment stories lie in energy efficiency, Liebreich said. "The investment cycle is long, as complex contracts take time to negotiate," he said. "But companies that manufacture and install intelligent power management, such as Itron and Power-One, will have their time in the sun." Todd Warren, a member of the natural resources team at First State Investments in Australia, said he preferred to play the alternative energy theme by investing in uranium exploration and production companies. "The spot price for uranium continues to increase on the back of growing demand for cheaper and cleaner power," he said. Warren's stock pick is Cameco, which sits on a high-quality, low-cost uranium mine. Henderson said he liked the uranium angle but found Cameco, at a price-to-expected-earnings ratio of 43, a little rich for his taste. For valuation reasons, he prefer smaller companies like Eurasia Mining, a uranium exploration and production company based in Kazakhstan. Henderson also holds International Uranium.