Smart Money Jumping to Green Energy

 | May 19, 2014 | 5:00 PM EDT
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A major transformation in renewable energy is under way. It happening behind the scenes, but driven by some of the nation's largest companies. Renewable energy will help these companies deliver solid earnings for shareholders.

According to the Environmental Protection Agency's (EPA) Green Power Partnership, the biggest buyer of renewable energy is Intel (INTC). The company purchases approximately 3 million megawatt-hours a year of renewable energy: wind, solar, small hydro, biogas and biomass. If it paid average retail rates, Intel's investment would represent $372 million a year.

In order of size, the next 10 largest players are Kohl's (KSS), Microsoft (MSFT), Whole Foods Market (WFM), Google (GOOG), Wal-Mart (WMT), Staples (SPLS), Apple (AAPL), Starbucks (SBUX) and Unilever (UL). Combined, they buy approximately 8 million megawatt-hours of renewable energy, representing almost $1 billion per year.

Kohl's is a solar-only company. Starbucks is a wind-only company. Whole Foods is a solar and wind company. The others use a combination of solar, wind, biofuels and other sources.

While purchase sizes are important, they do not necessarily represent commitment. For example, at 650,000 megawatt-hours per year, Wal-Mart is the nation's sixth largest buyer of renewable energy. However, its purchase represents only 6% of its electricity use. The same is true with Starbucks.

According to the EPA, at least 30 companies purchase 100% of their electricity from renewable energy resources. These companies are all-in on renewable energy.

Leading the pack is NYSE Euronext (NYX). It actually buys 123% of its normal electric use. Joining NYSE Euronext in buying more than 100% of its normal electricity purchases from renewable energy sources are Estee Lauder (EL), State Street (STT), Deutsche Bank (DB), Whole Foods Market, Staples, Kohl's, MetLife (MET), privately held Mohawk Fine Papers and Nokia (NOK).

Leading the list of companies purchasing 100% is Intel. The list includes Unilever, privately held DHL, Steelcase (SCS), WhiteWave Foods (WWAV) and several others.

Are these companies foolish? Are their management teams wasting shareholders' resources? Are these investments intended to address political concerns or are they designed for marketing purposes?

The answers are mostly no. While it is true that many companies gain a marketing advantage by using renewable energy, it is about delivering long-term earnings for their shareholders.

Keep in mind that all of these companies normally buy electric power. All they are doing is substituting traditional power for green power. In the process, they expect to deliver earnings for shareholders.

It is not just profits. Many companies also seek energy security. They need distributed energy to assure reliable sources of power for their operations. Some also believe they can lock in prices over the long-term by making prudent investments today. Still more need air permits, and renewable energy provides a time-tested strategy that can lead to new permits.

While every company is different, solar panels can deliver incredible returns. Assuming a typical project financing arrangement, a leveraged investment can deliver a 100% return to shareholders within the first year of operations. The secret sauce is the Investment Tax Credit (ITC). Approximately 30% of the cost of equipment earns the ITC as soon as the facility becomes operational.

If a company builds a 10-megawatt facility that costs $37 million, it will earn $10 million on day one of operations. If management leverages the facility 80%, the equity investment becomes approximately $7.5 million. Shareholders' $7.5 million investment earns them a $10 million ITC in the first year, which is about a 30% return. That's not bad.

It gets better. If the asset was treated as an independent profit center, the asset generates steady revenues and steady cash flows. Not considering the ITC, accelerated depreciation rules cause the asset to become profitable at the bottom line after year two. Beyond year five, the assets print money for the next 20 years because there are no production costs or depreciation expenses.

Solar power pro forma

The graphic above does not include the ITC benefit. It does adjust depreciation expenses as required under ITC rules. Nevertheless, financial results will vary based on geography, state energy policies, business strategies and technical considerations.

Putting this altogether, there are some important lessons. First, Fortune 1000 and other companies are jumping into renewable energy because it makes financial sense. Second, a lot more renewable energy is in the pipeline as companies increase their positions and as competitors discover the benefits of distributed energy. Third, investors should expect healthy returns from forward thinking companies, including Intel, Whole Foods, Staples, Kohl's and others. Finally, an important tool to analyze companies heavily invested in renewable energy is cash flows; earnings can be somewhat obscured by a company's tax strategy.

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