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Warm Your Portfolio With This Geothermal Stock

Erik Kobayashi-Solomon

Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, co-editor of Morningstar's OptionInvestor. Today, it's my great pleasure to welcome Mark Barnett, who is a power analyst and utility analyst here at Morningstar.

Mark, thanks for coming.

Mark Barnett: Always great to be here, Erik.

Kobayashi-Solomon: So Mark, as you know, a couple of months ago, I did an options strategy on a company that you covered called Ormat. It's a really interesting company, providing kind of green-energy generation. You just recently reaffirmed your fair value estimate for Ormat, and I just wanted to hear some of your reasoning for doing that, such as the timing and so forth.

Barnett: Sure. Well, since the last time that we've spoken, we had a number of operational updates and third-quarter earnings. So basically what we had been looking for were the answers these questions: "Where does our thesis stand, and what are some of the milestones we've been looking for?" And those were plants in operation. We looked at how are those going, especially the North Brawley problems and/or losses declining there.

Kobayashi-Solomon: North Brawley, it's a generation facility in Nevada that had some operational problems.

Barnett: Right, and it was making a loss, really hurting the bottom line for a while. Then second, we were looking for financing. One of the big topics we talked about before is looking at whether a company is on the right track. To start with the latter, there's been significant amount actually of success since the last time that we spoke. Examples include the Department of Energy loan guarantees, a private financing for a foreign power plant, and another financing here in the U.S.

Kobayashi-Solomon: The firm was able to pull down a total hundreds of millions of dollars between both of those loans, right?

Barnett: Yes. With the size of the Department of Energy loan, the first part is about $150 million, and there will be an equal-sized amount probably as that project progress next year.

Kobayashi-Solomon: So that's very positive news.

Barnett: Exactly. I think the market was a little bit skittish around whether those are going to come through, and we've really seen them deliver.

Kobayashi-Solomon: So that’s basically one big source of uncertainty kind of off the table?

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Barnett: Yeah. We think so. Then on the side of the operations, the Brawley plant losses were cut significantly in the third quarter. The firm gave us a lot of clarity on how they were going to operate that going forward. Management has really kind of bit the bullet and said, "Listen, we know that the plant is not going to reach that maximum capacity. We are going to stop spending a lot of money trying to prove that it’s going to hit a higher number. We are going to stop basically making a loss here."

Kobayashi-Solomon: So basically, they were saying "Let’s just work with what we’ve got and generate the power that we can generate. Let’s not kill ourselves."

Barnett: Yes, they sought to take pressure off of their covenants ratios because you ideally don't want to have those things reflected in a loss at the end of the year. So even though it's still kind of too bad that the plant is not working out, the fact that it’s significantly more profitable going forward is really going to start showing up in results.

Kobayashi-Solomon: At least those problems are a bit contained?

Barnett: That’s correct, yeah.

Kobayashi-Solomon: So let’s step back for a moment. You just talked about this DoE loan guarantee. I think I and a lot of other people who are watching mainly think of DoE loan guarantees in relation to this company Solyndra, the solar-energy company that went bankrupt and caused some problems with the Obama administration. What’s going on with this? Is this something that an investor should be worried about?

Barnett: Naturally, there’s headline risk for Ormat in a related company like Solyndra even though they use two very different technologies; it's a solar company (Solyndra) versus a geothermal company (Ormat). But I think the critical difference is that Ormat has the plants that are already going to be delivering electricity. I mean, it's not a the kind of a situation that you had with Solyndra, which had a very early-stage, new management team who hadn't done solar before and which had a lot of money going to where--if you had done your due diligence--it probably shouldn't have gone.

Now, with a company like Ormat, it has a very long track record of operating the technology for which the loan guarantee was going to go toward, and it has a number of projects that are already in the development phase and in the construction phase. So, I mean it's not apples and oranges, but it's about as different as you can get.

Kobayashi-Solomon: So the headline risk is the same, but if you'd take a deeper look, Solyndra is really more of a science experiment or something whereas Ormat is really a business.

Barnett: Right, and it's not to say that there are not solar projects operating that can work, but even the best solar projects are far more expensive and far riskier in investment I would say for the taxpayer than Ormat-backed geothermal projects. So, yeah, that's right.

Kobayashi-Solomon: Thanks very much for coming in and talking to me about it.

Barnett: You're welcome. It's always great.

Kobayashi-Solomon: Great to talk to you.

Barnett: Thanks, Erik.

Kobayashi-Solomon: And thank you for joining us. Please stop by the OptionInvestor website where you'll find many more option ideas based on Morningstar's fundamental research.