A reasonably priced growth stock (ENOC)
The smart grid industry has not been given its share of attention compared to other cyclical industries. The enthusiasm for smart grid stocks had hit a peak when crude oil prices were persistently high in the first half of 2008. When crude oil prices subsequently fell the enthusiasm for smart grid stocks also subsided. But with crude oil prices creeping back above US$100 per barrel, smart grid stocks may find themselves in the limelight again as high energy costs would push Utilities to find ways to lower their generation costs. Furthermore, unanticipated spikes in peak power usages due to weather changes, the lag time to build power plants and the need to maintain high utilization rate on base load power plants, would force utilities increasingly, or at least partially, to complement their generation portfolio with smart grid.
EnerNOC (ENOC) is one of the leading developers of smart grids. The company’s key product is the demand response solution which helps utilities reduce aggregate power consumption during peak usage hours. How does it work? ENOC essentially has a network of large electricity consumers who are committed to lowering their consumption during peak demand periods. This reduced consumption effectively serves as a reserve capacity for utilities, thus avoiding potential black-outs and the need for new power plants.
In return for their commitment to reduce consumption, large electricity consumers are paid by the utilities, and ENOC collects a portion of the payment for providing the infrastructure and managing the process. However, this unique business model is not without its own set of challenges; (1) it takes a lot of capital expenditure and research and development to create a smart grid network and (2) the power market has to be well developed and deregulated.
The smart grid industry is generally regarded as a growth industry as it is a relatively new concept and there is a large addressable market. ENOC has demonstrated its ability to capture this growth in its past record.
There are reasons to believe that its growth would continue in the future. The bulk of ENOC's revenue comes from the U.S. and it is operating in only 22 out of 50 jurisdictions. It has only recently expanded overseas, to Canada in 2008 and the UK in 2010. There are still many potential countries, such as Germany and Australia, where the electricity sector is in the right conditions for smart grids.
Another advantage of the business is the recurring income as contracts are long term, ranging from 3 to 10 years. As ENOC grow the mega watts under management, its revenue would be grow faster due to the recurring nature.
The biggest attraction of ENOC is probably its leading position in the industry. There is barrier to entry as large capex and R&D are required to create a smart grid and it is estimated that ENOC holds 30-35% of the North American market share. In addition, ENOC’s strong financial position – zero debt and high cash (C/E about 136%) – place it in a strong position against competitors as contracts generally require collateral posting or guarantees.
Previously ENOC was priced as a growth stock; At its IPO in 2007, it was priced at 7.7x book value and it had negative earnings. Now it is priced at approximately 1 times book value when it recorded its first positive earnings. With the growth potential described above, earnings are likely to continue the momentum and ENOC looks poised to be re-rated positively in the near future.