CNBC Business | Profit scenter

Profit scenter

Josephine Moulds tracks down the hot stocks to watch this month

Last year, the European Union committed to producing 20% of its energy from renewable sources, cutting emissions by 20%, and increasing energy efficiency by 20%, all by 2020.  

These are binding commitments and governments will be obliged to offer generous incentives to drive investment into the industry if they are to meet them, making the renewables sector an attractive investment opportunity even in the current climate.  

London-listed Scottish & Southern became the leading producer of electricity from renewable sources after it bought Irish wind company Airtricity for more than €1bn early last year. 

People in the environmental industry joke that chief executive Ian Marchant has taken on the responsibility to single-handedly sort out climate change. He is a man on a mission and has earned the respect of even the most hardcore environmentalists for his commitment to generating electricity from renewable sources. The company is now planning to invest £6.7bn (€9bn) in a series of projects over the next five years, with a focus on renewable energy. 

To add to its ethical credentials, Scottish & Southern operates a fair pricing policy. Although it hiked rates twice as wholesale prices soared by 170% last year, it was the first company to come out and say it would cut prices again in 2009. As a result, it should be relatively immune to any political pressure to ease prices for hard-up customers.  

The delay in passing on tariff hikes did squeeze margins. Elsewhere, Scottish & Southern suffered technical problems in the first half and profits fell by more than 50%.  

The company should, however, benefit from a long, cold winter. Marchant expects to achieve “modest” profit growth of between 1% and 5% for the full year, despite difficulties during the first half. 

The current economic climate means it is, of course, difficult to raise funds for the expensive business of building and maintaining wind farms and power plants. Scottish & Southern needs to refinance just £300m over the next 10 months. This should be relatively straightforward as banks have promised another £1.5bn of loans that it has not yet taken advantage of. 

The shares have been hammered along with the rest of London’s FTSE, losing almost 40% of their value over the course of the year. Scottish & Southern is now trading on a very reasonable 10 times next year’s earnings. Perhaps of most interest to investors is the company’s generous 5.8% dividend yield.  

Belgian clean energy provider Thenergo is a smaller and therefore altogether riskier proposition. The company is a combined heat and power provider which sites its power stations where the heat by-product can be used. Thenergo also uses four non-fossil fuels, from wood chips to bio-oils, as well as natural gas. 

Diversification in terms of fuel is important as it is still not clear which fuels will be at a decent price in five years’ time. By spreading out across three countries, Thenergo has also reduced the risk associated with changing environmental regulations and incentives across the continent.  

But it is not going to be an easy ride.  The company hoped to raise €100m when it switched its listing to Euronext in August last year, but market conditions made it impossible. 

Electricity generation is an expensive business and Thenergo relies on the ability to borrow money. Until now it has funded projects with around 20% equity and 80% debt. Chief financial officer Christophe Van Nevel expects banks to start demanding a higher level of equity in deals and higher interest rates on loans.  

But Thenergo has a good track record and has succeeded in bringing another five plants into operation since June. It works with a core set of banks that are still willing to lend money against the prospect of very stable future cash flows. Van Nevel is also looking at private placements and the possibility of financial partnerships for individual projects.  

Because of the levels of debt in the company a straight price/earnings ratio gives little indication of its value. Thenergo’s enterprise value – market capitalisation plus debt – is around nine times this year’s earnings, dropping to six next year, which looks remarkably cheap considering its growth potential.