BETTING ON CLEANTECH

BETTING ON CLEANTECH

If you missed the boom in green energy and environment stocks back in 2007, you're probably lucky. "Cleantech" shares soared much higher than the broader market that year, which made it all the more harrowing for investors when the stocks crashed to earth in 2008. As measured by the WilderHill New Energy Global Innovation Index, cleantech dropped 63%, compared with a 44% decline for the benchmark MSCI World Index. A basket of solar companies, which investors bid up to dot-com-like multiples, plunged 76%. "These markets dropped off a cliff starting last January," says Michael Herbst, mutual fund analyst at Morningstar. "It's been ugly."

All things being equal, the green sector should recover once the global economy rallies and energy prices start to rise again. "Cleantech will come back with, not ahead of, the broader market," says Steven Milunovich, a Merrill Lynch strategist who covers this area. He and other analysts also believe the sector could regain its luster much sooner if President-elect Barack Obama pushes through a huge federal green initiative in his first few months. Any payoff for near-term bets investors place on cleantech stocks will depend greatly on the scale of his efforts.

Many experts look back for lessons from renewable energy's first mini-boom--call it cleantech 1.0--about 30 years ago. Companies selling windmills and solar systems flourished briefly following the nation's first oil shock, only to wither when energy prices fell and stayed low, says Paul Deninger, vice-chairman of Jefferies, an investment bank. What makes cleantech 2.0 different from the earlier boomlet--and more likely to endure--is the rise of China and India. Despite economic setbacks, those countries' industrialization is bound to keep energy demand growing faster than supply for decades to come, he adds. What's more, there is strong political support for cleantech in Europe, Asia, and at both federal and state levels in the U.S. Obama has said he will pump $15 billion a year into green policies and technology. If he does, and if the economy picks up, Milunovich sees green stocks recovering as early as 2010 or 2011.

For any investor who doesn't enjoy trudging through technical minutiae on thin-film solar cells and fuel cells, it's best to leave the stockpicking to a fund manager. There are around 50 mutual funds and exchange-traded funds (ETFs) covering renewable power and cleantech. The biggest of the bunch, the PowerShares WilderHill Clean Energy ETF, has more than $700 million in about 50 companies. In line with the sector, it fell some 70% in the year to Dec. 12. With holdings in U.S., European, and Asian stocks in a mix of small-cap, medium, and large companies, the fund offers broad exposure by placing bets on various green technologies.

SOLAR INCENTIVES

Solar is already the big winner in Washington. After years of patchy support, Congress granted eight years of incentives for solar as part of the October bailout bill. They take effect on Jan. 1 and allow homeowners and nonenergy businesses, as well as utilities and power plant developers, to deduct 30% of solar system costs from their taxes. Meanwhile, the stock market crash has brought shares of top solar companies back within reach. Piper Jaffray analyst Jesse W. Pichel likes Tempe (Ariz.)-based First Solar, the world's lowest-cost producer of solar cells thanks to its "thin film" technology. He also has a buy on China's Yingli Green Energy, which has locked in a large supply of low-cost raw materials.

It's probably wise to view these stocks as a long-term play. Oversupply of polysilicon, the raw material for solar cells, together with tighter credit markets and soft demand, may depress solar company earnings for the next year or so, reckons Sanjay Shrestha, alternative energy analyst at Lazard Capital Markets. But slowly, he says, the industry is inching toward "grid parity," when alternative energy costs the same as electricity from coal and other conventional sources.

Wind power offers less risk than solar. It is one of the most mature sources of green electricity and is also among the least expensive. As such, wind is the key to a plan Obama favors to raise America's use of renewable electricity to 25% by 2025, from 8.4% today.

After years of tight supplies, the number of windmills being produced around the world is finally catching up with global demand. The result is price erosion, which may pinch profits at manufacturers such as Denmark's Vestas Wind Systems. On the other hand, falling windmill prices benefit utilities and project developers that hope to profit from Obama's green stimulus program. In recent months some have slowed plans to build multibillion-dollar wind farms because of tight capital. But inexpensive equipment could fan their enthusiasm. HSBC analyst James Magness is bullish about Spain's Iberdrola Renovables, which has the financial wherewithal to expand its U.S.-based wind farms.

One mission most U.S. utilities eagerly endorse is building "smart grids." The term refers to a batch of digital technologies that improve the distribution and monitoring of electricity. For example, through the use of intelligent controllers on industrial machines and home appliances, power companies can compensate customers who ratchet down their consumption during peak periods. Shrestha likes an East Hanover

• East Hanover Township, New Jersey
• East Hanover Township, Dauphin County, Pennsylvania
• East Hanover Township, Lebanon County, Pennsylvania

 (N.J.) company called Comverge, which sells gear that helps customers cut power use during high-cost periods.

In biofuels, all eyes are on a new generation of ethanol makers that use everything from algae to plant waste to generate fuel. Cambridge (Mass.)-based Verenium is a front-runner thanks to a joint venture with BP and a steady business selling enzymes, a key ingredient in the conversion of plant matter to alcohol. The winner in this race? The company that proves ethanol is viable without using food crops such as corn.