Are Green Tech Stocks Less Profitable?
Crab legs go quick at all-you-can-eat Vegas buffets because of demand – customers like eating expensive food at a lower cost. They also go quickly because of supply – the buffet operator doesn’t like giving away a food product they’re losing money on. It’s the same reason Indian restaurants get pissed off when you order a cheeky curry without a naan or rice. But they may cut you some slack if you order a fountain soda, as the profit margin on sugar syrup and water is quite high. So are the cups of hot flavored water you buy from Starbucks every day.
Many of the high-margin products peddled to retail consumers can be avoided, so they’re not resilient in times of economic turmoil. Retail consumers are fickle, so we always want to invest in high-margin products or services that provide solutions to businesses which can’t easily be displaced by competitive offerings or substitutes. Today, we’re going to look at a metric we recently introduced called “gross margin” and how it relates to some of the green technology stocks we’re holding.
Changing Priorities
The market’s reaction to The Rona was short-lived for an event that’s still unfolding. Even if we assume everything is back to normal, the economic impact is far from over. When going through our stock catalog to calculate gross margin, we refreshed Q1-2022 data points for around 75 companies we love and like. One commonality we observed is latest quarterly revenues aren’t growing much for high-growth firms, especially now that there’s a new Russian boogeyman to point the finger at when investors’ lofty expectations aren’t being met. (We’re looking at you, UiPath.)
We often take the piss out of company management teams that still blame The Rona for their troubles, but they may be telling the truth. A decent supply chain class can explain why, often by splitting students into groups for a simulation of the bullwhip effect. It’s a phenomenon that affects supply chains when they’re disrupted. From MIT:
Distorted information from one end of a supply chain to the other can lead to tremendous inefficiencies: excessive inventory investment, poor customer service, lost revenues, misguided capacity plans, ineffective transportation, and missed production schedules.
Credit: MIT
Sound familiar? Global supply chains are getting hammered as the effects of a global shutdown begin to manifest themselves. Then, there’s the impact of record-high inflation which affects consumer spending. As investors, we should be asking a simple question. What stocks in our portfolios may not fare well in times of crisis?
When capital was cheap and readily available, we focused on revenue growth at all costs because we always assume that competent management teams have a path to profitability. Using free money to capture market share is intuitive. As capital dries up, we would expect there to be a plan in place to survive which includes enough dry powder to reach profitability or significantly decrease cash burn. If growth slows a bit because everything is going to hell, we’re totally fine with that. What we’re not fine with is a company that can’t stop burning cash and needs to start raising capital at extremely unfavorable terms. Seems like a fitting time to audit our own portfolio of 35 tech stocks for signs of weakness.
Analyzing Gross Margin
After researching technology companies for nearly a decade, we compiled the Nanalyze Disruptive Tech Stock Catalog which contains over 420 disruptive tech stocks along with links to our latest research and 24 data fields. One of these is our simple valuation ratio which is calculated using market cap and “last quarter revenues.” We recently added “last quarter cost of goods sold” which now lets us calculate gross margin for 82 stocks we love and like in our catalog. The average gross margin across these stocks was 56% which also happens to be the average gross margin in our own 35-tech-stock portfolio.
High gross margins are characteristic of software companies which is one reason why software-as-a–service (SaaS) business models are so appealing. A quarter of all companies we’re holding are SaaS, and you’ll find them all grouped on the left side of the above chart. Today, we’re interested in looking at the companies on the right side of the above chart with gross margins of less than 30%. One thing most these stocks have in common is that they’re targeting green themes.
What’s the Deal With Green?
We’ve been talking smack about ESG way before Elon Musk made it fashionable. That’s because we have firsthand experience of how shite the underlying methodologies are. Weekly astrology readings make more sense than some of the absolute drivel driving ESG index constituent selection. Our choice to invest in green technologies is solely because we believe it’s a potentially lucrative niche. So, we were surprised to see four of the six stocks with the lowest gross margins in our portfolio are green-themed:
Let’s briefly touch on each of these firms, starting with the worst.
Beyond Meat
When we hold a stock, we say that we “love” it. So it’s understandable when subscribers ask us how we can possibly love Beyond Meat. While we’re holding a very small position in Beyond Meat (the smallest weighting of any stock in our portfolio), we’re increasingly disliking the direction the company is taking. In particular, we question whether any faux meat companies out there will ever achieve price parity with meat. If consumers are required to subsidize these meat substitutes, then they’ll largely be a niche novelty item consumed by people who invest in ESG stocks because it makes them feel good. We’re not surprised to see Beyond Meat struggling to run a profitable business with a gross margin of zero percent, and we recently looked at all the problems they’re facing. So, why do we still love the stock? That’s because we don’t bolt at the first sign of turmoil. If management can turn the business around as they promise, we’ll stay on for the ride.
Then today, we saw this.
If there was any way to make fake meat more fake, Beyond Meat takes the fake cake. If we decide to exit our position because Kanye West’s ex-wife can’t turn the ship around, Nanalyze Premium subscribers will be the first to know.
Next Era Energy
We’ve been investors in the biggest renewable energy company in the world for a long time now. That’s because this dividend champion has not only paid a dividend for 25 years in a row but increased it as well. Try getting a raise at your place of employment for 25 years in a row. There’s every reason to like this firm despite their 1980s investor deck which makes War and Peace seem easy to follow.
NextEra Energy is a large company with an impressive track record that now falls under the simple rule we use for all 30 dividend growth stocks we’re holding – if they stop increasing the dividend, we sell the stock. Simple. In other words, the 20% gross margin they have today seems to be working out just fine.
SolarEdge
We’re not fanboys by any means, but does anyone else find it odd how the U.S. media suddenly turned on Elon Musk? The most successful entrepreneur ever has done more to help this planet than any of the placard-waving muppets now condemning him. Mr. Musk may have made the electric car go mainstream, while at the same time making space accessible to humankind, but he doesn’t dance to the beat of other people’s political drums, so let’s throw him under the bus. Makes perfect sense.
So anyways, here’s what Mr. Musk said a few years back.
Experts predict that solar will be the dominant energy source in the future, so we wanted to take a punt on it. After holding the Invesco Solar ETF (TAN) for quite a while, we decided not to hold ETFs anymore and scoured every solar stock out there for the one with the best risk-vs-reward ratio. SolarEdge came out on top. We noted their need to expand into complementary products aside from just inverters and optimizers, something that could increase gross margins if/when solar becomes the dominant source of power. Areas such as energy storage products, e-Mobility products, UPS products, and automated machines happen to be experiencing very strong growth for SolarEdge. Speaking of energy storage.
Enersys
Finally, we have Enersys, a profitable battery company that’s currently the best way we know to play energy storage based on our tech investing methodology which emphasizes low risk. That’s not to say we won’t find a better substitute in the future. There are still some energy storage SPACs to vet, and there are always companies coming and going in the public markets. While companies like NextEra and SolarEdge are dabbling in energy storage, it’s not their forte. Ideally, we’d like exposure to lithium batteries without investing in lithium miners or large battery-producing conglomerates.
Considering Gross Margins
You may be wondering about the other two stocks we’re holding that have gross margins below 30%, but we’re exceeding our word limit now, and it’s almost time for Thirsty Tuesday. So, we’ll leave you with some teasers.
- Mystery Stock A: We’ve been eyeballing this firm suspiciously because it’s now more than 80% below our cost basis. It’s obvious we significantly overpaid for the stock, but it’s also obvious we need to check in and make sure our thesis hasn’t changed. Hopefully, it’s not a case of a firm paying $1.50 in marketing for $1.00 in revenues.
- Mystery Stock B: The name of this company is kind of whacked, and maybe that’s why it took ARK a while to finally catch on to their potential. On the tin, we can totally understand why this might be a lower-margin business, but we need to peek under the kimono to better understand their business model.
Our research team is diligently working on both these articles which we’ll publish in the coming days. (If you keep running into our paywall, you can just sign up for one free month and read all the Nanalyze articles you want – gratis.)
The gross margin metric becomes more useful when capital dries up because it’s an indicator of how soon a company might reach profitability. For example, SPACs that may have tried to acquire their way into growth are now under pressure to start showing synergies. Desktop Metal actually had a negative gross margin last quarter which means they’re not producing a profitable product. Then there’s Rocket Lab with a gross margin of just 9% which doesn’t leave much wiggle room for the firm to maintain profitability over time. Both these firms will need to work quickly to create the 2 + 2 = 5 synergies investors have been promised after the dust settles from all their acquisitions.
Conclusion
Now is a good time for investors to scrutinize any holdings with low gross margins to see how well they might fare when capital dries up. While profitable companies have less to worry about, we also need to consider people’s priorities when times get tough. Sure, it feels good to put out a few press releases about how you planted some trees in Honduras to offset your carbon emissions, or talk about how many divisive employee resource groups your D&I department wasted everyone’s time on, but these are the heads that will be first on the chopping block when cost-cutting measures arrive.
Always question whether a product or service is indispensable. Cheap electricity will probably always be in demand, even more so in times of crisis. Fake meat? Not so much.
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