Shares in Climate Exchange look far too pricey at current levels.
If you think global warming is a murky business plagued by both doomsters and die-hard science sceptics, you'll feel at home with the shares of Climate Exchange (LSE: CLE).
As the leading emissions exchange operator in Europe and North America, talk that the carbon market will eventually be bigger than the oil trade puffed up the AIM-listed company's share price to the increasingly hot high heavens.
As recently as Spring 2008, shares traded for £20 a pop, giving the company a market capitalisation of £1 billion. A billion company -- on revenues of under £23 million! As for profits, they were as elusive as a Toyota Prius in downtown Houston.
The share price quickly cooled off though as the economic downturn reduced both the oil price and oil consumption, cutting emissions faster than any green policy has managed so far. I suspect fears of the financial markets rolling over also had a knock-on effect.
The shares still cost £8 by the start of the ill-fated Copenhagen Summit on climate change last December, but the failure of politicians to reach agreement on a new emissions framework to replace Kyoto redoubled the rout. By yesterday you could pick up Climate Exchange shares for just 463p -- at under £225 million, that's less than a quarter of its peak valuation.
The P/E ratio: An inconvenient truth
Chalk one up for the sceptics? Not (quite) so fast!
Today Climate Exchange released its results for the 2009 calendar year, and they're at least going in the right direction.
Revenues grew to £33.6 million, and the company swung into profit. Pre-tax profit was £2.2 million, compared to a loss of £2.5 million last year; profits by the pro-forma pre-tax measure that Climate Exchange prefers to highlight doubled to £6.8 million.
What's more, there's no debt and £19.2 million cash in the bank. But you probably won't be surprised to hear there's no dividend, either.
Still, all these numbers boil down to diluted earnings per share of 1.3p, and while that's a massive improvement on last year's loss per share of 4.3p, with the shares trading at 500p it still equates to an enormous historic P/E of over 380.
Ten years after the dotcom bubble, who says exuberance is dead?
Carbon captured
Alan Greenspan's famous phrase spoke of 'irrational exuberance', of course. The question is whether investors are being rational in paying several hundred times current earnings for what they hope will be a ringside seat in the green economy of the future.
Clearly Climate Exchange seems to have secured a leadership position in the carbon exchange area, and two of its three main business – the European Climate Exchange (ECX), and the Chicago Climate Futures Exchange (CCFE) -- saw overall trading volumes in the year soar, by 80% and 183% respectively.
The odd one out is the Chicago Climate Exchange (CCX), where volumes decline a third in 2009 due to ongoing uncertainty in the US about cap and trade legislation. In the slightly surreal world of carbon emissions trading, CCX customers are now migrating to the CCFE, where the company is striving to support a range of possible outcomes for legislation that hasn't actually been enacted yet!
If you like your acronyms, you'll have a field day looking into this stuff. Will the market for RECs and CCAR-CRT be more significant than the trade in RGGI futures? Your guess is as good as mine.
The ultimate blue sky stock
It's impossible to value Climate Exchange after spending a morning reading its accounts -- this business isn't so much outside most people's 'circle of competence' as on another planet.
Taking a step back, there's definitely something happening here. For instance, Climate Exchange's ECX market now seems to be trading more carbon per week than it did in the whole of 2005.
But it's hard not to be reminded of Internet stocks when looking at the company -- the potential is obvious and the growth is incredible, but revenues are slim.
It's also worth noting that as with the dotcoms there are competitors, such as the Green Exchange, EEX and Bluenext. If carbon trading does grow as big as the oil market, the piddling volumes of carbon emissions being traded so far (less than 5% of the crude oil trade) leaves an enormous amount of headroom for any of these companies to grow into.
And even worse than with the dotcoms, there's the extra headache of substantial political risk that's unique to the carbon trading business.
Currently, volumes at Climate Exchange's European operation are still modestly improving after the Copenhagen shambles, as there's a pretty firm consensus Europe will eventually implement some sort of post-Kyoto replacement.
In contrast, anything could happen in the US -- from national legislation to go-it-alone collectives of states like California, to nothing much at all.
This range of outcomes is daunting. Andrew Shepherd-Barron, an analyst who follows the company for KBC Peel Hunt, says the shares could be worth 800p if US emission trading legislation is passed to as little as 350p under a pessimistic scenario for the EU market.
Jolly green giant
I'd love to invest in Climate Exchange, for the opposite reason to why I don't invest in tobacco companies. The pretty pictures of turtles and forests in the company's financial reports are aimed squarely at soft-hearted capitalists like me.
If you wanted to persuade yourself, you probably could. Consensus forecast earnings per share for 2010 are over 12p, which would represent an incredible growth rate of over 700%, though that's still not enough to justify the price in the near-term, in my view.
More importantly, extrapolating the rising trading volumes of the EXC and CCFE may give analysts confidence in their estimates, but with so much political uncertainty I'm not so sure it's wise.
Who's to say governments won't try some other system entirely, like a flat limit on emissions or direct taxation? Or, more likely, who's to say legislators won't just punt the problem into the future?
As things stand, Climate Exchange is not an investment for me.
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