Motley Fool Money - Bloom Energy’s “Time-to-Power” Moat

Starting point is 00:00:01 Does Bloom Energy have a competitive advantage? Motley Fool Hidden Gems Investing starts now. Welcome to Motley Fool Hidden Gems Investing. I'm your host today, John Quast, and today is Labor Day, which means that we're not covering a lot of news. We're actually going to triple dip into our mailbag today with our guest, Matt Frankel and Rachel Warren. And I'm just going to go right into it.

Starting point is 00:00:28 Here is the first mailbag question that we have for you today, and this comes from Sabir. He says that he lives in Austin and is a regular listener of the podcast, and this question is for anyone. While comparing company stocks, are there metrics that speak to the underlying structure of a business, which potentially might suggest how much they would return to their investors over time? For example, Coca-Cola has higher return on invested capital than S&P Global and WM, but it hasn't returned nearly as much historically with dividends. reinvested. So I don't know if ROIC is the right metric to monitor or if I should compare these

Starting point is 00:01:11 businesses at all since they are in separate sectors. But to include one in my portfolio, I need to make assumptions about how much my money would grow if I had invested in each of them. Thanks for the amazing content. Please keep doing the same forever. Okay, Matt, this is essentially a question about ROIC or return on invested capital. And, you know, is this the, the magic bullet that we need to screen for to find the stocks that are going to make us money over the long term. I mean, first of all, I don't think you'll go wrong with any of these capital efficient businesses that you mentioned. But, you know, RIC, it's only one piece of the puzzle. It depends whether the company can reinvest those high returns on capital in efficient ways to, you know,

Starting point is 00:01:56 grow its business. This is the big limiting factor for Coca-Cola, just to name one of the examples you just did. So it doesn't have as many places to reinvest into its business. It's a massive company. It already has its distribution network. It's already everywhere. And that's why it distributes so much money, so much of its returns as dividends instead of reinvesting into the business. Yeah, it reminds me of Warren Buffett talking about his C's candy business. The returns are great, but there's not a lot of places to reinvest that money into C's. So it winds up just kind of taking that money and reinvesting it elsewhere. But Rachel, are Sabir's instincts right here, because he's wondering if he should even compare these businesses since they're in different sectors.

Starting point is 00:02:36 I mean, Coca-Cola, S&P, Global, this is the stock exchange, waste management, this is trash. They're not in the same place of doing business. So is he right to say, maybe I shouldn't be comparing these? I mean, yeah, these are businesses that are operating in very different landscapes. And I do think there are certain growth factors and you can compare them in the context of what you're looking at for your specific portfolio. And ROC is one, I think, very important metric when you're evaluating businesses that you want to buy and hold for the long run. But I think that it's just one of many tools that you should have in your toolkit when you're trying to look at how a business protects and handles its cash. And free cash flow conversion is another very important one.

Starting point is 00:03:19 I mean, this tells you really how much of every dollar in revenue turns into cash after a company addresses its liabilities and continues to maintain its operations. And it's important to look at a wide range of factors like this because, for example, a company can have a very high return on capital on paper. But if that profit doesn't convert into actual free cash flow, it can't be returned to you the shareholder. So RIC is great, but it should just be one of many tools you use when you're evaluating businesses, in my view. And Matt, you mentioned that the limiting factor here with Coca-Cola is just not really having too many places to put that money to, reinvest for good returns. But what about the other two here that we mentioned, SPGI and waste management? Yeah, they both have had far more opportunities to reinvest. Even waste management, which a lot of people think of as a boring, mature business. I mean, they're not everywhere.

Starting point is 00:04:13 They've been investing in growing out their footprint. They've been investing in, you know, the latest recycling technologies. There's a lot, there have been a lot of investment opportunities. SPG Global, I mean, they reinvest in building out their data assets and new indices. And that ROSC helps compound the business's intrinsic value over time. That's the big difference here. And of course, then that is actually then supported by the actual returns of the stock over the long term. Yeah, and I mean, if you look at the returns, I mean, over the past 15 years, Coca-Cola generated about a 327% total return as we're recording this.

Starting point is 00:04:49 that's about 10.2% annualized. I don't think anyone would call that a bad investment, which is why I said I don't think you'll go wrong with any of these. But if you look at waste management, 779% over the past 15 years, SPG Global, a little over 1,800%. And the difference has been not just that one's more capital efficient than the other, but the latter two have more reinvestment opportunities,

Starting point is 00:05:11 and that's been a big percentage of those returns. So, Rachel, I want to circle back to you here because you did say that you kind of start by looking at this free cash flow conversion, how much free cash flow is the company able to generate compared to its revenue. But, okay, so we generate free cash flow. Now we have some cash sitting there. What is the next thing on your so-called checklist or the next thing that you're going to look for after we have cash in hand?

Starting point is 00:05:37 Yeah, I mean, once a business has that cash, another thing I would look at as well as share count reduction, you know, when you have a company that's consistently buying back its own stock, your ownership slice grows automatically. And you know, you can go back to examples of waste management, S&P Global. I mean, waste management specifically, they had authorized a $3 billion authorization late last year. They've repurchased about a billion dollars in its own shares in the first half of this year. So these are companies that tend to use buybacks fairly aggressively that can create a nice tailwind for your long-term compounding, even if the top line growth looks modest. Yeah, I mean, I pushed back on the aggressive framing just a little.

Starting point is 00:06:16 little bit. I mean, $3 billion is big, but in comparison to its size, I mean, only reducing that share count by about one a year for waste management. But still, point taken, reinvesting buyback. So that is a long-term compounding. It can have a long-term compounding effect. But Rachel, you mentioned a moment ago about reinvestment. How do you actually measure whether reinvested dollars are being put to good use. Yeah, I mean, it's definitely worth going a step further. You want to look at how much of their retained earnings actually go back into the business versus out the door as dividends and what return those reinvested dollars earns. I mean, if you have a company that say reinvesting 80% of its earnings at 20% returns, you're going to look at a business that's compounding very

Starting point is 00:07:02 differently than one reinvesting 20% at the same return. I think that's so important what you just said, and I want Matt to flesh that out just a little bit more here with those percentages. Matt, what is Rachel? I don't want to take for granted that everyone understands what Rachel just said. Yeah. So, I mean, this is the genius of Berkshire Hathaway's business model, which he mentioned Seas Candy earlier. So I wanted to circle back to that. You know, Seas Candy does not have a lot of opportunities to reinvest. It's a pretty mature business. They don't really need that much incremental capital. But Berkshire has 60 other businesses that it could decide which ones are the best efficient places to put that capital. And that's why Berkshire's been so successful. All of the 65 businesses or whatever

Starting point is 00:07:42 it owns now, all the returns go into one pool and then management can decide where the most efficient places to invest. So the more efficiently you can invest your capital. And obviously with one single business, like a waste management or a Coca-Cola, it's a little trickier because you only have one business that you're investing in. So it's really important to find businesses that not only generate great returns on capital, that are really capital efficient, but that also have places to put that capital to work. That's a lot of the chip makers right now.

Starting point is 00:08:13 They're investing a ton of money in building out their factories to increase capacity. That in turn will allow them to sell more chips. And you can see where that cycle compounds, and that's why so many of those companies are doing so well right now, because they have so much opportunity to not only make profit,

Starting point is 00:08:27 but to reinvest that profit. So that's a really, really important thing that you don't want to overlook that as a, investor. Rachel, you mentioned here buybacks a moment ago. We can do buybacks in a variety of ways. We can pay for it from the balance sheet. We can pay for it with cash flow.

Starting point is 00:08:42 We can take on debt. It doesn't matter. It absolutely matters. You really want to check and see how those buybacks are being funded. If you see a business you own or want to own announce a buyback, it may be great news, but it's always important to dig a bit beneath the surface. So a buyback paid for with free cash flow, essentially it's shrinking in that share account for free.

Starting point is 00:09:01 but buybacks that are funded by piling on debt, you're really just swapping one form of dilution for financial risk down the road. This isn't what you want to be seeing a company do as a long-term investor. So that's something to pay really close attention to. Okay. Final question. We're going to wrap it up here. Just a final word from each of you. Maybe Matt, a little bit more on the qualitative side.

Starting point is 00:09:23 Yeah. So return on invest the capital or any single metric for that matter is just one part of any thorough analysis. and a lot of the factors you should be looking at are qualitative. Pricing power is a big one. Coca-Cola, it's secret sauce. It doesn't really have room to reinvest. It is great pricing power over its rivals. It's got a great distribution network that saves it money.

Starting point is 00:09:44 And so ask yourself, how much can a business raise its prices without hurting volume? Waste management that you mentioned is another one. They offer an essential service to its customers. Everyone needs to get rid of their garbage. And its contracted income is linked to inflation. So pricing power is definitely a big one. Yeah, I think that another thing to consider is, you know, all of these factors we're talking about, nothing replaces, you know, price, valuation.

Starting point is 00:10:11 Even the best compounder can disappoint you if you overpay going in. So make sure when you're looking at these businesses or others, you know, weigh the quality of the business against what you're actually paying for those future cash flows, profits, you know, use your preferred valuation metric, but make sure that that is baked into your overall Jesus. All right. So, Sabir, thank you so much for the question. I want to congratulate you. I really like how you are thinking deeply about investing. I think that is going to serve you over the long haul, and I hope that we did your question justice. When we come back from the break, we are going to be looking at some numbers that are crunching in the electricity generation space. You're listening to

Starting point is 00:10:51 Motley Fool Hidden Gems Investing. You've got to try bread. And what better way than with a delicious pratt, organic coffee, starting to just $1 all day, every day now until December 31st. You gotta try breakfast. At participating A&W locations in Ontario. New from Nespresso. Blend wellness into your coffee routine with a coffee plus range, infused with functional benefits.

Starting point is 00:11:34 Choose the coffee you love with added B vitamins, like coffee plus B12 to help support immune function, and coffee plus B6 to keep your day moving. Or go with the flow and choose ginseng delight. Our new double espresso, with ginseng extract. Whatever lies ahead, don't change your morning. Let your morning change you.

Starting point is 00:11:53 Discover Coffee Plus on espresso.com. Welcome back to Motley Fool Hidden Gems Investing. We're going back into the mailbag with a question from Isaiah. Isaiah says that they've been a daily listener for nearly two years. That is incredible. But they want to ask about end phase energy. And the question here is AI data centers are creating a rapidly growing need for new sources of electricity and more efficient power.

Starting point is 00:12:17 infrastructure, N-phase Energy, has recently entered this market with its IQ solid-state transformer, targeting the shift toward higher voltage DC architectures and AI data centers, while companies such as Bloom Energy are pursuing the opportunity through on-site power generation. How should investors compare these different approaches to the AI power bottleneck? Specifically, what would need to happen for N-Fase's data center opportunity to become a meaningful contributor to its revenue and earnings? and how does it potentially, how does it potential opportunity compare with Bloom Energy and other companies providing power generation grid infrastructure storage power conversion to data centers,

Starting point is 00:12:54 which technologies appear most likely to capture the economics of the trend over the next five to 10 years. What are the biggest risks? Rachel, let's start with a big picture here. How do you frame the bottleneck in power generation? Yeah, and I love this question from our listener because I think that this hits on so many important themes that are happening in the space right now. So this bottleneck, it really comes down to a two-part challenge. You've got power generation and then voltage conversion. And I think as

Starting point is 00:13:22 investors, you know, we can evaluate these different approaches by looking at where a company sits within the energy supply chain. So Bloom Energy, they're tackling the generation shortage. You know, right now the power generation shortage. They're deploying on-site solid oxide fuel cells. And they're letting the tech giants bypass a lot of the traditional utility grid cues. They're spinning up megawatts of capacity immediately. And because the utility grid faces really long delays, Blume Energy has emerged as a very important player that offers this fast, off-grid alternative

Starting point is 00:13:54 for data center developers that need the power right now. And Enphase Energy, on the other hand, they target that conversion challenge I was talking about. So they're focusing on stepping voltage down efficiently at the chip level. All right. So since the question did focus a lot on end phase, we want to put some numbers behind that. Matt, put some numbers behind the MFA's story

Starting point is 00:14:15 and what the actual opportunity is here. Yeah, so this is not talking about NFACE's existing business. This is just what it's hoping to do with data centers. So the company estimates a total addressable market of about 11 gigawatts of U.S. opportunity by 2031, expects to launch full system demos late this year, customer pilots in 2027, volume shipments in 2028, So the best way to think of what I just said is there's a lot that needs to go right before

Starting point is 00:14:44 it can capture a significant part of that addressable market. So the company's core business is contracting. Revenue and the core business was down 20% year every year. So it's kind of looking to this for a pivot, I guess you would say. Well, and let's ask that. I mean, what does need to go right here, Matt, for M phase two, for its opportunity to actually become meaningful? I mean, the industry's voltage standard would need to become the industry standard. The 800 volt standard would need to be the standard. I just said standard a lot in that sentence. They would need to get a hyperscale or win in 2027.

Starting point is 00:15:23 I mentioned they're hoping to ship product to consumers in 28, so they would need a big customer to ship them to. And the residential business would need to stop declining at least long enough to fund all of the data center ambitions. Okay, so let's flip over to Bloom Energy. This is the other company that got mentioned here and just getting added to the S&P 500, I'll add. So that's an interesting timing.

Starting point is 00:15:49 But Rachel, what's the risk profile here once you get past the near-term story with Bloom? Yeah, I mean, there's clear near-term monetization tailwinds for Bloom Energy. They are becoming one of these kind of key AI infrastructure players. But there's long-term risks, you know, in the event of a slowdown of the AI build-out. If spending scales back at some point in the next few years, you're probably going to see a slowdown in that girl's story. It doesn't mean you have a bad business.

Starting point is 00:16:18 But this is a company that's seen a really significant run-up in a short time because they've become such an important player amidst this bottleneck. And then, you know, outside of the AI space, you've got the longer-term risks as well from shifting carbon mandates, fuel supply constraints, as cleaner utility power skills. scales into the 2030. So I'm not saying it's a bad business. I actually think it's a really fascinating company. It's one I have on my watch list. But be aware of these potential shifts and changes that could impact the company of the years ahead. Matt, I guess as I look at this space, I mean, there are so many players chasing such a big opportunity, but it is quite competitive. Does Bloom have any sort of moat? And, you know, this is a company that's attracting a lot of attention from investors. So it seems like the stock has run up. Does the valuation

Starting point is 00:17:07 here concern you at all? Yeah. So these companies, they're two different animals, really. They both kind of have competitive moats. Bloom has proven its moat. Bloom's mode is providing power quicker than it's the alternatives. They can deploy solutions in 90 days or less. Compare that with multi-year timelines to connect to a grid when you're building a new data center. They have a $20 billion backlog. Only $6 billion of that is product. The rest is service revenue, and that's the real opportunity here. There's lots of valuation risk with Bloom's stock. I mean, 80 times forward earnings. It's, you know, up about 500% in one year. Bloom is monetizing its opportunity today. Enphase is a 2028 option on a shrinking company that has a really good market opportunity.

Starting point is 00:17:52 All right. Well, let's start thinking about that market opportunity a little bit. Rachel, for someone who wants exposure to this trend without betting on a specific chip architecture or specific technology, where would you point them? Yeah, I think there's a few places you can look, but really evaluate, you know, where that physical grid infrastructure, the independent power producers, the industrial storage providers, you know, where they're coming from. I mean, companies manufacturing the high voltage cables, transformers, and switchgeer Eaton is one company that comes to mine, Schneider Electric as well. I mean, these are companies that possess really favorable multi-year backlogs. They don't depend on.

Starting point is 00:18:32 which specific chip architecture wins. And this is also, I think, a landscape that's benefiting utility providers as well that are controlling a lot of the energy assets through these direct power purchase agreements. The foundational constraint is still that physical fiber-connected real estate that's held by data center developers who secure land and power allocations over the coming years and in advance of the continued buildout. So there are a lot of ways to play this space that can depend on, your risk tolerance and your preference.

Starting point is 00:19:05 Yeah, and I mean, you're kind of talking a little bit about the three to five year. I mean, how do we think about it further out? I mean, I think if you look ahead five, ten years, you know, I think a lot of the durable economics are going to be really captured by the physical infrastructure providers, the energy asset owners, the land developers. And I think this is, again, going back to these very regulated, you know, contracted backlogs. All right. So thank you, Isaiah, for that question, writing in.

Starting point is 00:19:31 and I hope that you will keep an eye on the space as we move forward. When we come back, we are taking another question regarding trillion-dollar IPOs. You're listening to Motley Fool Hidden Gems Investing. You've got to try breakfast at A&W. And what better way than with a delicious pre-organic coffee, starting with just $1 all day, every day now until December 31st? You gotta try breakfast at participating A&W locations in Ontario. New from Nespresso.

Starting point is 00:20:20 Blend wellness into your coffee routine with a coffee plus range infused with functional benefits. Choose the coffee you love with added B vitamins, like coffee plus B12 to help support immune function, and coffee plus B6 to keep your day moving. Or go with the flow and choose ginseng delight. Our new double espresso with ginseng extract.

Starting point is 00:20:40 Whatever lies ahead, don't change. your morning. Let your morning change you. Discover Coffee Plus on espresso.com. Welcome back to Motley Fool Hidden Gems Investing. A quick note, we obviously want to make you part of the conversation with a triple bag mailbag episode, but if you have a stocker investing question for anyone on the show, you can email us at podcast at fool.com. We'd love to take your questions on air when they are short enough to read, when they are foolish, and when you keep in mind that we can't give personalized investing advice. If you can check those three boxes, then send in your questions. to podcast at fool.com.

Starting point is 00:21:15 Podcast at fool.com. And our final question today, this comes from a listener named Mike living in Singapore, who writes, the SpaceX IPO is as a huge disruptor having a pretty volatile effect on stocks I was holding, such as Alphabet and Rocket Lab. Does the team think that an anthropic or open AI IPO will have the same effect? And would it be wise to hold or sell now or buyback later? Thanks so much. So, Matt, let's start with you here.

Starting point is 00:21:45 And let's talk about what actually did happen with the SpaceX IPO that Mike is referencing here. Yeah, so SpaceX, it was the largest IPO in history so far. And it was extremely volatile in the first few weeks, as you mentioned. It was up to $226 a share within a few days. Then it has since dipped back below its IPO price for a little while, which was 135. Now it's up a little bit. It had some ripple effects. I mean, Rocket Lab, you mentioned, fell 18% the week before the IPO,

Starting point is 00:22:16 fell another 10% on IPO day. So that suggests that there was some sector rotation going on. This was noise. It wasn't a real repricing. It wasn't because everyone was giving up on Rocket Lab. It was because there was an X amount of investment dollars in the space economy, and now it had more places to go. I mean, the almost immediate entry of SpaceX into the NASDAQ 100 is something that

Starting point is 00:22:39 almost that's never happened before. And that was certainly a disruptive force as well. So you're right. You're seeing a lot of disruption, but it was all near-term kind of noise and volatility, not, you know, anything long-term fundamentally changing. Okay.

Starting point is 00:22:54 So it seems like what Mike is saying here is that SpaceX went public, huge IPO, there was a ripple effect. Therefore, when OpenAI and Anthropic go public, there could be a similar ripple effect. And so the question, basically is, should I sell now, buy back later and kind of play the timing of this all? Rachel, what do you think?

Starting point is 00:23:17 I understand that inclination as an investor. My response would be, you know, attempting to time the market by selling holdings now with the intention of buying back later. It is a strategy that rarely favors long-term investors. And, you know, that doesn't even mention the fact that trading in and out of positions can introduce tax friction. Obviously, there's execution costs. It's also a strategy that as an investor sort of forces you to be right two times, one time on the exit and one time on the reentry. And if the market reacts differently than expected, as it often does, or if there's an IPO that triggers an immediate sustained sector rally as well. On the flip side, you know, a stock can move away entirely. So that would not be a strategy that I would favor.

Starting point is 00:24:01 Well, and let's further examine the premise of the question, right? Just because there are ripple effects with SpaceX IPO, I mean, that doesn't necessarily carry over to Anthropic or IPO, or does it? Yeah, that's right. I mean, just to kind of clarify those dynamics, so you have the SpaceX IPO. Obviously, this caused an industry-specific shakeup for Rocket Lab. Both companies compete within the same space economy. They're both key players there.

Starting point is 00:24:26 Now, looking at the impending Anthropic and opening eye listings, you're probably not going to see that same impact on Rocket Lab. I'd say the rotation risk might be more applicable to the big tech providers, you know, Alphabet and Amazon. And the reason for this is we might see institutional fund managers trim a portion of those legacy holdings to free up capital for more pure play AI allocation. So, you know, I wouldn't try to outsmart this rotation if it happens by selling early. I think if anything, you know, as an investor in both these companies, I'm saying this, you know, one could treat that any temporary pressure that might occur on Alphabet or Amazon as a buying window to pick up shares at a relative discount.

Starting point is 00:25:08 Well, it seems like Anthropic is going to be the one that goes public first, just based on where we are right now. Anthropic may be going public this year. Open AI, it seems more like next year. Matt, what do we know so far about the Anthropic? Well, out of Open AI and Anthropic, not only is Anthropic looking like it's going to go first, but it looks like it's going to be much larger, just based on what we know. now. The company, it was reported, they're targeting a $2 trillion or a $2 trillion or higher valuation. It takes them getting used to to say the word trillion when you're talking about IPOs. And they aim to raise even more money than SpaceX did, which that was $75 billion in its IPO. I mean, there's a few interesting dynamics. The question mentioned Alphabet specifically. Alphabet owns about 15% of Anthropic. Amazon owns a lot of Anthropic as well. So we may see some sector

Starting point is 00:26:00 rotation out of both of these and into Anthropic because right now they're the way that a lot of people are playing Anthropic in the public markets. But I mean, any sector rotation, especially in those names, there's nothing, alphabet is specifically as my favorite mag seven stock to buy right now. So any, I would treat any sector rotation as weakness. Again, expect volatility, but I'm looking for opportunities when this kind of thing happens. I'm so glad that you mentioned that person, I think Alphabet and Amazon are my two favorite of the Mag 7, so I'll be watching that. But Rachel, back to you here. Instead of maybe trying to time the market, like we said, not our favorite strategy here at

Starting point is 00:26:42 the Motley Fool. What should investors do instead? Yeah, I mean, I think, as always, really instead of guessing on short-term price swings, focusing on the financial health of the ecosystem of these companies, the upcoming public disclosures for the likes of Anthropic and opening, I can provide some insight into that. And that also helps investors build grounded positions when the market presents a strong opportunity to do so. You know, just to kind of go back to something Matt was saying, it's also worth remembering that you may already have exposure here. If you own shares of Alphabet or Amazon, you already hold an indirect stake in Anthropics.

Starting point is 00:27:18 So factor that in, you know, before you look at any future IPO purchase and, you know, factor that into your overall plans for your portfolio. All right, Matt, final word. Anything that we can leave our listeners with regarding what might be procedurally important for this Anthropic IPO? Yeah, I mean, they already confidentially filed their S-1, but once their public S-1 drops, it'll be really important to take a close look at that. Pay attention to any lock-up expiration.

Starting point is 00:27:48 Remember, SpaceX had this weird, convoluted lock-up expiration calendar where it was in several trenches. It was very non-standard. So see what Anthropics might be index inclusion. They made that big exception where SpaceX. got included in the NASDAQ 100 quicker than any company in history. I'm assuming that's going to apply to Anthropic as well. But the S-1 is going to have a ton of information about the business that is currently not publicly

Starting point is 00:28:12 available. So that's really what I'm waiting to see. As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards, and is not a not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. Thanks to our

Starting point is 00:28:42 producer Dan Boyd and the rest of the Motley Fool team behind the glass. For Matt Rachel and myself, thank you so much for listening to our show today and we will see you again next time.

Motley Fool Money - Bloom Energy’s “Time-to-Power” Moat

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