Disruptive Technology: The Sun - Part 2

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Previously, I’ve discussed how utilities could become just secondary power sources, but is all hope lost? Some companies have seen the writing on the wall and started shifting their business models in subtle ways, so they can embrace the unthinkable - lower demand for electricity from them. 

Peak time opportunity

SolarCity has been converting customers into competitors for utilities, but there is a flip side to this whole equation. SolarCity could be exactly what some utilities want. By installing solar panels on the roofs of homes and businesses, it takes the strain off of the current aging grid during the peak load times of summer.

This little company just signed a deal with Wal-Mart (NYSE: WMT) to install solar panels on the roofs of its stores in California. Currently, Wal-Mart has solar panels on over 200 of its rooftops. With more than 4,500 stores in North America, there is a lot more ground to cover. Wal-Mart is looking to save money wherever it can. In the ultra-competitive environment of retail, every penny counts.

Wal-Mart currently has gross margins of 24.8%, and pays out 60% of its earnings to support a 2.4% dividend yield. Wal-Mart’s gross margin is, however, below the industry average of 33.6%. Interestingly, Wal-Mart makes up for these lower margins where it counts – the bottom line. Wal-Mart has a profit margin of 3.8%, whereas the overall retail industry is at 0.4%. This huge savings is due to years of Wal-Mart cutting fat in its supply chain and lowering expenses wherever possible. Any reduction in the company's electricity costs will translate dollar for dollar into its bottom line.

When the peak rates of the hot summer days are reduced at a Wal-Mart, or other large “Power suckers” it makes the possibilities of brown-outs and grid overload less. This translates into less maintenance costs to utility companies.

Defenses in the industry

Consolidated Edison (NYSE: ED) is one of the utility companies likely to benefit from cheaper solar energy. This company services the New York Metro area and surrounding burrows. Geographically this utility company hit the sweet spot. Consolidated Edison serves 3.3 million customers in one of the densest populations in the country.

Consolidated Edison currently has a gross margin of 36% and pays out 67% of its earnings to support a 4.1% dividend. This is a very conservatively run company with a large population supporting its business. It’s reliance on the regulated market will make this power behemoth stand with a market cap of $17.5 billion and will continue to act “bond like” for the foreseeable future.

The competitive generation portion of ConEd makes up only about a third of revenues, as it relies heavily on the distribution network to reward shareholders. The fact of the matter is that Northern cities that have high population density do not receive enough sunlight to power them, they will always need a middle man to funnel it through the grid. And, in this case that middle man is Consolidated Edison.

Utility with impenetrable barriers to entry

Aqua America (NYSE: WTR) is the largest supplier of water related services in the U.S., and it’s growing. This year the company has announced that it acquired seven water and waste water companies along the East Coast, both private and public.

Municipalities are not as able to leverage the expertise of their engineers across multiple sites. This gives Aqua America a cost advantage that local governments just don’t have by nature. The CEO Nicholas DeBenedictis recently said “The acquisitions we’ve completed in the first half of the year indicate that our growth-through-acquisition strategy is continuing to fill in our footprint in key growth areas.” As these areas expand, the company's water volumes will continue to increase.

Aqua America currently has a profit margin of 25.6%, and pays out 47.9% of earnings to support a 2.26% yield. This is by no means the type of yield that you can get from an electric utility stock, but Aqua America is growing. There are currently over 10,000 different water and waste water entities in the U.S., mostly run by local governments. This gives Aqua America the opportunity to leverage its expertise and continue it’s merger strategy.

The reduction of the price of solar energy could even give this company an opportunity to move more into the water desalination business.

Foolish bottom line

Regulated utilities is a good market to be in. Electric companies that have a lot of revenue coming from generation are the ones to worry about. Consolidated Edison is making moves to reduce the risk of its power plants that may be obsolete or no longer run at an efficient capacity. However, if you are an investor looking for safety and stock appreciation as opposed to a high dividend, Aqua America would be the choice for you.

Another strategy to take advantage of the solar invasion is to look for customers that stand to benefit the most. Companies like Wal-Mart can now run their air conditioning systems at a lower cost, and have their buildings naturally shaded. If investing in a utility, be sure it has an electric distribution division that will provide stable revenue if the company’s generation fleet becomes less competitive over time.

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Wes Patoka owns shares of Aqua America. The Motley Fool recommends Aqua America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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