A Smart Grid Stock for Years to Come

With the distraction of the massive health care plan behind them, senior members of the Obama administration are gearing up to help modernize our aging and inefficient power grid. New sources of energy, new power lines and enhanced conservation measures should all help reduce our burden on imported oil while cutting greenhouse gas emissions. But to maximize all of the efforts, the entire system will need to make a leap to the 21st century.

That’s where Boston-based EnerNOC (Nasdaq: ENOC) comes in. The company uses its Network Operating Center (NOC) to provide energy management and energy efficiency solutions to assist grid operators and utilities. For example, many utilities must invest in excess capacity to handle unusual demand spikes that may only happen a few times a year. By sharing the load with other utilities and working with large customers to agree to curtail usage at peak times, the utility can save a great deal of money by cutting the need for additional power plants.

The International Energy Agency (IEA) refers to this as “cost avoidance,” and estimates that by deploying enhanced grid intelligence, utilities can save nearly $60 billion during the next 20 years. Executives at EnerNoc believe that an investment of $1 million in the company’s technology can save anywhere between $60 million and $100 million in construction costs. If a utility sees a demand spike coming, it can shed non-critical loads, deploy back-up power and optimize existing current flow — a far better solution that building more capacity “just in case.”

Nearly 3,000 commercial customers use EnerNOC’s Demand Response (DR) system to monitor and adjust real-time energy usage, including AT&T (NYSE: T), General Electric (NYSE: GE) and Pfizer (NYSE: PFE), as well as many universities. Those customers, with greater visibility into their power usage at peak times, can reduce power consumption or deploy their own on-site power sources. EnerNOC signs customers to long-term deals, typically three to 10 years in duration, so revenue growth is unlikely to be bumpy.

EnerNoc doesn’t directly benefit from stimulus funds earmarked for grid enhancement. Instead, utilities and large corporate power users have tax incentives to deploy grid intelligence products, and should increasingly turn to companies like EnerNOC. Similar efforts are just beginning in the U.K., prompting EnerNOC to pursue that market as well. The company has also recently acquired a pair of small companies to better target the building efficiency market.

EnerNOC is a young company: it had less than $10 million in revenue in 2006, but sales have increased at least +75% every year since. Sales hit $191 million in 2009 and could reach $260 million in 2010.

For many investors, EnerNOC has been a “show-me” story, as the company was hard-pressed to generate a full-year profits off its fast-rising sales base. (The company generates strong profits every third fiscal quarter from demand management during the peak summer season). The company finally generated positive cash flow in 2009, and is set to generate a modest profit this year (though close to $1.00 a share on a non-GAAP basis). The company has an opportunity to keep boosting sales at a fast pace and keep competitors at bay, so management is likely to keep pouring any earned cash flow right back into the business, which could make GAAP profits in 2011 look uninspiring as well. Investors should focus on the company’s widening moat in this burgeoning space instead.

Young, high-growth companies like EnerNOC may look expensive based on near-term metrics, but can often be real bargains in the context of long-term growth. Thanks to favorable tax breaks for smart-grid investments, the utility industry is expected to keep deploying these grid-enhancing solutions for the foreseeable future. EnerNoc, though, is not likely to reach maturity in terms of sales and profits before 2013. Assuming that the company can annually boost sales +30%, sales could hit $400 million by 2013. If operating expenses grow by a more moderate +10% in each of those years, non-GAAP net profits could approach $75 million by 2013, or $3.00 per share. In that context, the shares look attractively priced at $27 a share.