Tuesday, October 06, 2009

Efficiency Sector

It is my quixotic and nearly unnoticed mission to create a new investment sector - the efficiency sector. Granted the companies offering products that lead to energy or production efficiency could be included in other sectors - commercial services, industrial products, manufacturing. However, I do not believe their stocks are given full valuation when lumped in with the rest of the undistinguished pack.

The Rocky Mountain Institute estimates as much as 75% of electricity use in the U.S. today could be saved with efficiency measures that cost less than the electricity itself. Even if the actual savings figure is somewhat lower, the case is compelling for pursuing efficiency solutions rather than simply throwing money at expensive renewable energy sources.

Orion Energy Systems, Inc. (OESX: Nasdaq) featured in the September 29, 2009 post “Light in Demand Destruction.” Orion provides energy-saving lighting products and solutions for industrial and commercial customers. The switch to fluorescent bulbs alone is a big saver. A fluorescent bulb capable of emitting the same amount of light as a 60 watt incandescent bulb requires only 13 watts for a potential savings of 75% in electricity usage.

Even beyond electricity use and generation, the potential for savings is significant and could have a material impact on the U.S. energy economy. Approximately 45% of the fuel used by U.S. manufacturers (we assume the statistic includes all fuel sources such as coal, oil and natural gas) is for steam generation. Industrial boilers only offer about 30% energy efficiency. However, with co-generation energy conversion could be increased to as much as 90%.

In my view, companies that offer the energy-savings, efficiency-creation should be accorded valuations in-line with energy sources. Indeed, in terms of product risk, efficiency products are far less risky since their development is probably less time-consuming and their effectiveness easier to measure. The relative economic value of an energy-saving product is certainly greater than the average of say the manufacturing sector as a group.

Therefore, I argue that OESX, ERII and stocks of other companies like them should be gathered together in the “efficiency sector” and given credit for their unique economic contribution. The two stocks mentioned here are trading at premiums to their current categories - diversified electronics for OESX and pollution and treatment controls for ERII. Both stocks are trading at premiums to these groups and may to some investors appear fully valued even though neither compete with other members of their respective groups and may have entirely dissimilar business models.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. OESX has been mentioned in the Small Cap SEARCH newsletter with generally favorable commentary. Crystal Equity Research has a buy rating on ERII shares.

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