All charged up

Growing demand for high-speed Internet connections brightens the prospects for “power energy” stocks.

Growing demand for high-speed Internet connections brightens the prospects for “power energy” stocks.

By Shoba Narayan
February 2001
Institutional Investor Magazine

Even as blacked-out Californians confront the nation’s most dire energy crisis, much of the country lives and works with an antiquated power grid that may soon be unable to meet the unslakable thirst for electrical power. By all reckoning, the imbalance between supply and demand will get worse before it gets better.

To Jeff James, portfolio manager of Driehaus Capital Management’s $125 million-in-assets emerging-growth product, that’s a compelling reason to buy “power energy” stocks. He means not just familiar electric utilities but companies that generate “clean” power, also known as uninterrupted or digital power, which is used by the Internet and telecommunications industries. For these high-tech users, an outage of even a few seconds can crash a network.

To meet the growing demand, some utilities are ramping up their clean-power services; independent producers are delivering supplies to large companies like Cisco Systems, Dell Computer Corp. and Sun Microsystems; manufacturers of microturbines are delivering power to moving vehicles; and other firms are developing alternative-energy sources such as fuel cells and solar panels.

Power energy is a fast-growing, $600 billion industry. Among the leaders: Power-One, a manufacturer of AC/DC and DC/DC products that are mounted inside communications equipment used by Internet service providers; Capstone Turbine Corp., a maker of microturbines; and Calpine Corp., an independent power producer that provides environmentally friendly thermal energy to corporate users like Phillips Petroleum Co.

As a group, power energy stock prices increased more than 60 percent last year, according to a recent report by Banc of America Securities. James’s portfolio returned 23.3 percent in 2000 and is up an annualized 44 percent for the past five years.

While James looks for companies with dominant market share in their sectors, other stock pickers, like Robert Loest, manager of the $600 million-in-assets IPS Millennium Fund, make strategic bets on new technologies. Another contingent focuses exclusively on digital power, while environmentally conscious investors look for the cleanest power producers at any price.

Camarillo, California-based Power-One makes an appearance in many power energy portfolios. Driehaus’s James snapped up the stock last April for about $22; it recently traded at $47. With earnings projected to grow from 83 cents a share in 2000 to an estimated $1.35 this year, the company has been grabbing market share from rivals that include Lucent Technologies.

As he looks at the crowded field of solar panel producers, James shines a light on AstroPower, the only profitable public company. (Analysts project earnings of 31 cents a share on revenues of $50 million for 2000 and 62 cents on revenues of $73 million this year.) James bought stock in the Delaware-based corporation in the fall of 1999 for $37. In the second half of 2000, as AstroPower began to ramp up its capacity from a current 35 megawatts to 110 megawatts in 2002, margins have been squeezed, bringing the stock down from a 52-week high of $63 to a recent $34.

James’s other holdings include Shaw Group, a provider of piping systems used in power plants. The stock is on a roll. James bought his stake last March at about $22. It traded recently at $42.

He has realized far more modest gains from Chatsworth, California-based Capstone Turbine, a manufacturer of microturbines, which are installed in trucks, buses and small buildings. The stock has had a wild ride. James bought in during its late June 2000 IPO for $27 a share and watched it shoot up to $98 in September. Fast-growing, but not yet profitable, Capstone traded recently at $37.

James takes a pass on companies that make fuel cells, which use two electrodes of oxygen and hydrogen to generate clean energy for cars, phones and buildings. The sector is young

and the likely winners unknown. But IPS Millennium’s Loest is a big fan of FuelCell Energy, a Danbury, Connecticut-based manufacturer of electrochemical fuel cells. He first bought the stock last July at $37; it traded recently at $69.

FuelCell uses molten carbonate technology, which operates at about 1,200 degrees Fahrenheit and can consume coal-based fuels, to generate electricity. “It scales up very well,” says Loest. “This stock is a pure play on a technology that is the closest to large-scale commercial production.” Trained as a biologist, Loest believes that rival technologies, such as the proton exchange membrane fuel cells, which operate at 200 degrees Fahrenheit and are used by Ballard Power Systems, will be more difficult to deploy in great quantities. (Loest’s fund returned an average annual 34.5 percent for the past three years.)

The stock picker has done especially well with his largest holding, San Jose, California-based Calpine, which builds and operates miniturbine power plants and is rapidly expanding its megawatt capacity. Loest first purchased shares in June 1998 at less than $3. The stock traded at $40 in late January.

In deference to his “environmentally sensitive” shareholders, David Brady, portfolio manager of the $1.3 billion-in-assets Stein Roe Young Investor Fund, looks for companies that use clean-burning fuels to generate power.

These days Brady is also bullish on Arlington, Virginia-based AES Corp., a low-cost global power company with distribution in Europe and Asia as well as North America. Though its exposure to developing countries adds risk to AES’s strategy, Brady believes that management is savvy enough to manage the political uncertainty. He bought his stake at an average cost of $26 a share; the stock traded recently at $57. (Brady’s fund returned an average 14 percent a year for the past three years.)

Wexford Capital’s Joseph Jacob focuses on digital power stocks in his $750 million private equity fund, which returned 28 percent last year and an annual average of 19 percent since it was launched in 1997.

Jacob feels certain that Emerson Electric Co., a St. Louis-based manufacturer of electric motors and generators, is especially well positioned to exploit the surging demand for digital power; its digital division is growing 30 percent a year. Wexford bought the stock over the past year at an average price of $59 a share. It recently traded at $74.

Another Wexford holding that supplies needed digital power is American Superconductor Corp., based in Westborough, Massachusetts. The company manufactures superconducting materials that can transmit electricity with little electrical resistance. As a result, its electrical cables conduct 100 times more electricity than ordinary copper cables.

At the moment, Jacob is slightly underwater with his investment: He paid an average $23 for his shares, which traded recently at $19.

“Reliable digital power is the fuel for the Internet age,” says Jacob. That seems a safe bet. And it’s already provided fuel for strong portfolio returns.