₪ David Pescod's Late Edition November 13, 2007
AN INTERVIEW WITH SARA ELFORD
CANACCORD ANALYST,
(As of November 6, 2007)
Dave Pescod: We’re with Sara Elford, Canaccords prize winning stock analyst and first of all Sara I have to thank you for your call on Bennett Environmental, a stock that all the other analysts seemed to love and you said sell, and we actually shorted.
Sara Elford: It played out beautifully I guess. If you asked me what my thoughts are on it today, I obviously don’t think a heck of a lot of it. I think they’re in a real bind and the real question is, can they sell themselves or alternatively develop a viable business. So far they haven’t been able to generate any kind of revenue that’s going to result in sustainable business. So I’ve actually officially dropped coverage on it which means I’m not particularly optimistic.
D.P: Onto one of your 3 favorite stories today and that’s Arise and some people said that if oil was $20 or $40 solar power would just be a science project, with oil at $95 it’s generating real businesses.
S.E: That’s a very valid point because solar has had it’s day in the sun sometime ago back in the 70’s, not obviously to the same degree as today, but it’s definitely still subsidy and incentive driven. I think governments around the world are ultimately forced to be pretty long term, in terms of their outlook and energy policy. Consequently there is a very major focus on renewable energy. Over the long term, we are going to have to meet growing demand for electricity, and we can’t rely solely on fossil fuels.
So there is a big push around the world toward solar (and other renewable); not only because of pollution issues but also because of long term energy security issues. I think governments identify solar power as one of those areas that, although requires subsidies and incentives in the short term to be economic, has shown a past of consistent cost reductions overtime and the cost reductions have been pretty dramatic. As manufacturing capacities in the world have doubled, costs have come down by a meaningful amount, and this trend has been consistent. The view being that over the course of the next 10 years solar is going to be economic.
At that point you can look at the current penetration of the global electricity market at 0.04% and see that there’s lots of growth still to come. You don’t need to see massive penetration to see a continuation of pretty dramatic growth.
So I personally think, and think that my colleagues would agree with me, that the incentives are a mechanism that is likely going to stay and you’ll see increasing numbers of countries with similar policies as a way to increase solar within the overall energy mix within their country. It’s a good point and I think at these prices it simply fuels more and more of a push towards that end game.
D.P: Now Arise is one of your favorites in the sector. Could give us a little of your take on the company’s history?
S.E: The company was founded in 1997 and went public in 2003 as a systems integrator, which means they take other peoples technology and effectively put that into a solar system and sell it within the Ontario market place. In the early term, when you’re trying to break into a new market, Ontario didn’t have any incentives in place and so that was a relatively small market for early adopters of technology.
So the long story with Arise is that over the course of the last 5 years, they’ve worked very closely with the University of Toronto to develop a proprietary solar cell technology and a lot of that has to do with the way the cells are produced but also the overall architecture of the cells is different than what you currently see out there.
But in the last 3 or 4 months there’s been lots of action in terms of the commencement of construction of a manufacturing facility in Germany (to produce these cells) that has a goal of establishing manufacturing capacity of about 80 mega watts by the end of 2008. To put numbers behind that, 80 mega watts allows you to deliver revenues in excess of a couple hundred million dollars. The goal is to get to annual capacity of 360 million megawatts by the end of 2012.
Again 360 million mega watts translates into revenue potential of around $800 million. Based on my assessment, Arise is well positioned, with revenue potential of $800 million over the next 5 or 6 years. I think that will ultimately be exciting to investors.
Along side of that business is their systems business and the systems business is focused in on the Ontario market specifically. Over the course of the last year, the province of Ontario established a feed in tariff for solar that makes investment in small scale solar power systems very economically attractive.
Consequently, Arise has been indicating that they have seen a very solid increase in demand in their Ontario systems business and they’ve set a goal of establishing about 100 mega watts in capacity within the Ontario market over the course of the next 3 years. And again to put revenue numbers behind that; 100 mega watts translates into about $700 million of systems sales. That’s not going to happen in a year, but that’s their goal over the course of the next few years and I think that might be reasonable. In my current forecast, I use 50 megawatts, or half of this goal, to maintain a good buffer and potential upside ... so there’s two potential high growth revenue streams. One from the cell side which has good solid growth potential over the next several years and one from the systems side within Ontario. If you look at the German market which had similar feed in tariff established several years ago, the kind of growth they saw there was fairly substantial and Arise has indicated that they see a similar trend occurring in Ontario today.
So you’ve got two key levers for future growth to come I think that will ultimately prove to be a pretty exciting story over the course over the next several months and even years.
D.P: They also have interest in silicon as well, is that correct?
S.E: They do and the third leg which I think is potentially quite exciting because the solar industry has been growing so dramatically that there has been a resulting silicon shortage over the course of the last couple of years. There's been a lot of movement towards increasing capacity of silicon production and one of the methods of doing that is focused in on producing silicon from direct metallurgical routes and the issue in that area could be quality.
In terms of the quality, silicon quality has a direct bearing on cell efficiency and, by extension, the ultimate profitability of those cells. In Arise’ case they’ve been working with a consortium that includes the University of Toronto as well as others globally and producing what’s called “float zone silicon,” and that is the highest quality silicon you can produce and they think that they can do it at the same costs as the direct metallurgical guys.
That simply means that they’re producing very high quality silicon at a price that is comparable to those out there that are producing something of a much lower quality. And if they are able to do that I think it will feed directly into their own cell strategy but also has potential to be a significant source of value all on its own.
So far I think they’ve had several successful runs over the course of the last 14 months and they are quite optimistic that they’ve got something. Most investors have been familiar with Timminco, which is a silicon play within Canada, and that one has seen fairly substantial movements in share price.
Arise has got a lot more legs to the story than just silicon but it’s certainly an area that people should be aware of and we’ll be hearing more I suspect on that over the course of the next several months.
D.P: You’ve mentioned some relatively big numbers here in the last couple of minutes, obviously your $3.75 target is relatively short term. Over the longer term, this company could have numbers much higher than the current market prices.
S.E: From my perspective, it’s important to recognize there’s execution risk as they scale the business up to such a degree. That’s a very significant risk and that’s not going to happen easily and without hiccups and trial and error along the way. I think they’ve got a pretty good plan and it’s part of my job to assess that.
But in the short term my goal is to make sure that I properly reflect the risk of scale-up so as I get comfortable and they progress through the next several milestones and effectively demonstrate to me that they’ve dealt with various risks that I see, then there's lots of room for adjustment.
Over the long term one of the things that I’ve said in my research report is that I can see them generating well over $1.00 of earnings over the course of several years and certainly if you want to take a multiple of 15-20-25 times ..
The industry currently trades around 25 times, but assume it comes back to 20 times, you are dealing with much higher potential over time if they execute well.
The real question is let’s see them execute a little bit and if they do a bang up job then there's lots of upside to that target.
D.P: If you were going to worry about one thing with Arise what would it be?
S.E: One thing that I think is absolutely necessary to worry about is the scale up of the technology, just to clarify their line one is based on conventional technology so I don’t see a lot of risk in that line. That line will provide a base manufacturing process with base levels of output from which they will generate revenue and profitable revenue, so that I think is quite under control.
In addition, you have to watch your silicon program because that’s going to be fairly the key to the overall supply of silicon long term for them and the overall costs.
More importantly just the implementation of technology on a commercial scale, there's always risk because you add new technologies to a base process and the question will be, can they scale it up.
And again I think I’ve reflected the risks in my overall approach even if they had some hiccups along the way, I’ve adequately reflected that, but that’s certainly something to watch in terms of whether you see a $20 stock years out or not.
D.P: Now I should mention just to finish off this one piece that you have 3 favorite stocks right now. Arise and the solar sector and your 2 other favorite ones?
S.E: TSO3 has been a favorite for a long time, I think ultimately is well positioned to deliver improved results over the course of several months and that’s definitely 1.
Genesis Worldwide is another company that I initiated coverage on a couple of months ago and I see it as being quite similar to an Arise in terms of the overall opportunity.
They basically have put together a technology solution that consists of software and industrial technology that allows light steel to be used in a place of wood and concrete in terms of framing of buildings 6 stories and under.
The technology allows them to make sure that a good chunk of the actual construction of these buildings occurs off-site opposed to on-site.
There's a whole bunch of advantages associated with it but I think it’s one of these companies that has an opportunity to tackle a trillion dollar global market opportunity with a really good business model and a good management team. And the market has not yet caught on.
I think apart from what’s happening in the US market because of housing, the depression I think it’s safe to say you can call it down there. I think that’s why Genesis at this point is not yet on people’s radar screens, but the growth opportunity is significant.
They really have very little exposure to the US market and I think ultimately have a great business model that’s going to see this stock emerge as a really interesting Canadian growth story over the course of the next coming years. So it’s one I think is simply undervalued and has great long term potential.
Thank you very much Sara!
For those looking for further in-depth coverage on Arise, email Jenn at Jennifer_Lagdamen@Canaccord.com |
