The ups (mostly) and downs of cleantech in Q3 2007

It’s been quite the quarter.

The U.S. dollar plunged to new lows. Foreign equity markets strongly outperformed those in the U.S. Takeovers by private-equity firms slowed. And fears of an American recession have been stoked by a weak housing market and sub-prime lending woes.

So it’s especially noteworthy that, despite volatile market conditions, the performance of some U.S. cleantech companies in the third quarter of 2007 continued to outpace the major U.S. market indices.

As tracked and reflected in the Cleantech Index (CTIUS), which has a heavy weighting of U.S. companies (about 85 percent of portfolio) and industrial companies, the quarterly results are impressive.

Most of the Index stocks are not particularly cyclical; they respond much more to energy prices, water and power shortages, demand from major Asian economies and government policy changes than they do to changes in construction, consumer spending, mortgage lending, or factory utilization. Their products and markets tend to be global rather than local.

Naturally, rising resource prices (energy, water and materials) that we saw in Q3 are a boon to a portfolio highly leveraged to resource efficiency and conservation.

There are three primary factors that drive the long-term component of the CTIUS’ long-term performance:

1. Its correlation with global stock markets, and hence their performance
2. The continued growth in demand for cleantech-driven goods and services, and
3. The ability of Index companies to grow earnings when they:

a. Create and/or convert intellectual property (cleantech) into successful new and lower-cost products

b. Execute good and dynamic business strategy and sound capital allocation to exploit new markets and favorable long-term trends

c. Create and strengthen ties with customers and channel partners

d. Do ‘A, B and C’ better than the competition.

Also helping the Index was its lack exposure to grain-based fuel and ‘clean coal’ stocks. Grain ethanol stocks, in particular, have been plummeting due to concerns about rapid supply growth, and grain ethanol’s negative impact on both food prices and the environment. Similarly, increasing skepticism about the viability of clean coal has hurt related stocks. (Those companies are not represented in the CTIUS, and would have a tough time getting past the 18 rigorous screens that companies must pass for Index inclusion.)

Star power

Leading the way in Q3 was the stellar performance of many solar stocks: LDK Solar (up 120%), First Solar and SunPower (both up over 30%), and Power-One (+27%) and Suntech (+9.8%). Besides strong earnings growth, LDK benefited in Q3 from the roaring Chinese equity market and from apparently becoming a darling of momentum investors.

Yet in the last few weeks, LDK has fallen sharply over concerns about polysilicon prices and rumors (so far unfounded) of inventory issues. See the Cleantech Group’s Mishaps and murmurs and LDK Solar continues to make deals.

Power-One (PWER) rose strongly as it launched several promising new products especially for the solar PV inverter market and robust DC/DC converters with minimal toxic PCBs. PWER also signed a significant technology license agreement with Murata. While solar still represents a small part of Power-One’s business, it holds a lot of promise, and adds a lot of sex appeal to a previously unglamorous stock.

Despite winning some new solar PV contracts, Energy Conversion Devices (ENER) fell 26%. August saw ENER hit a 52-week low after it announced a larger-than-expected quarterly loss and the retirement of the brilliant Stanford Ovshinsky, its founder, chief scientific officer and largest investor (see the Cleantech Group's Stan calls it quits.) Analysts expect a clearer business strategy from ENER management when it presents in November.

Another momentum investor darling, Echelon, soared over 60% as it announced several major new contracts in Europe and Asia as well as new product offerings worldwide. Echelon still expects to deliver its first positive earnings quarter ever this coming quarter and a near tripling of sales.

Ormat was up over 20% as it signed contracts to develop geothermal power plants in Indonesia, a country considered the ‘El Dorado’ of geothermal markets due to its abundant geothermal resources and a huge population hungry for electricity. Meanwhile Ormat’s operations in the Western US continue to expand and meet targets.

LED-maker Cree rose over 20% on unfounded acquisition rumors; Cree has already returned those gains in early October.

‘UPS’ Stocks: Just Delivering Results

Trimble Navigation rose 25% due to profit growth, higher Q3 earnings expectations and a European acquisition that should accelerate Trimble’s growth there. Woodward Governor rose 17% on strong cash flow growth and a $200M stock buyback.

Strong results also lifted Donaldson nearly 20%. Martek rose 15% on strong earnings growth, new product approvals and major new customers for its microalgae derived nutrients for food products and supplements in Europe, China, and the U.S. Badger Meter rose over 17% on rising earnings estimates and a major new contact with the City of Chicago.

On the Downside

Trex fell nearly 44% as the collapse of the U.S. home-remodeling market and high recycled plastic prices forced Trex to shut one of its main plants. However, brutal market conditions have also forced some of its main competitors to exit the composite wood business entirely. With Trex trading near its book value and a decent pipeline of new products, its long-term prospects remain positive.

The weak U.S. housing market also took 12% off Headwaters. Insituform plunged 30% due to disappointing earnings results and a less rosy earnings outlook. However, Insituform's long-term fundamentals still look good. Baldor fell nearly 18% on recessionary fears, while production woes at Fuel Tech resulted in lower 2007 revenue forecasts and a 36% ‘haircut’ for investors. Fuel Tech’s long term fundamentals remain excellent.

New addition

Polypore International (PPO) joined the Cleantech Index in the fourth quarter. Polypore is a leading maker of specialty membranes for lithium and lead-acid batteries, over 70 percent of its business. The addition of Polypore increases CTIUS’ exposure to the critical energy storage subsector, which is a difficult one in which to find quality companies able to meet Index criteria.

Rafael Coven is Managing Director of Cleantech Indices. He runs the market-leading CTIUS index of publicly-traded U.S. cleantech companies, tracked by the PowerShares Cleantech Portfolio and KSM Cleantech Index exchange-traded funds (ETFs). View the historical performance of the CTIUS Index here. Rafael has spent most of the last 21 years in cleantech as a manager, entrepreneur, equity investor, and management consultant.

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