Bloom Energy’s “Time-to-Power” Moat

0:01Matt Frankel: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, Jon 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 guests, Matt Frankel and Rachel Warren. And I'm just going to go right into it. 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?

0:52Matt Frankel: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 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 magic bullet that we need to screen for to find the stocks that are going to make us money over the long term?

1:42Jon Quast: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, ROIC, it's only one piece of the puzzle. It depends whether the company can reinvest those high returns on capital in efficient ways to 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.

2:16Matt Frankel:Yeah, it reminds me of Warren Buffett talking about his Seize Candy business. The returns are great, but there's not a lot of places to reinvest that money into Seize. 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. 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.

2:51And 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 ROIC 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, you know, free cash flow conversion is another very important one. I mean, this tells you really how much of every dollar in revenue turns into cash after a company, you know, addresses its liabilities and continues to maintain its operations.

3:28And 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 ROIC is great, but it should just be one of many tools you use when you're evaluating businesses, in my view.

3:52Matt Frankel: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 you mentioned, SPGI and waste management?

4:05Jon Quast: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. 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 ROIC helps compound the business's intrinsic value over time. That's the big difference here.

4:34Matt Frankel:And of course, then that is actually then supported by the actual returns of the stock over the long term.

4:40Jon Quast:Yeah. 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. 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. And that's been a big percentage of those returns.

5:15Matt Frankel: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, OK, 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? Yeah, I mean, once a business has that cash, another thing I would look at as well is share count reduction. You know, when you have a company that's consistently buying back its own stock, your ownership slice grows automatically.

5:49And, 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.

6:13Matt Frankel:Yeah, I mean, I pushed back on the aggressive framing just a 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 buybacks, 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.

6:54I mean, if you have a company that's, say, reinvesting 80 percent of its earnings at 20 percent returns, you're going to look at a business that's compounding very differently than one reinvesting 20 percent at the same return.

7:06Matt Frankel:I think that 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.

7:18Jon Quast:Yeah. So, I mean, this is the genius of Berkshire Hathaway's business model, which you mentioned sees candy earlier. So I wanted to circle back to that. You know, Seize 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 it owns now, all the returns go into one pool. And then management can decide where the most efficient places to invest.

7:49Jon Quast: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. 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.

8:21Jon Quast: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, but to reinvest that profit. So that's a really, really important thing that you don't want to overlook that as an investor.

8:34Matt Frankel: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 cashflow. 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 that share count for free, but buybacks that are funded by piling on debt, you're really just swapping one form of dilution for financial risk down the road.

9:09This 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.

9:15Matt Frankel: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.

9:23Jon Quast:Yeah, so return on invest to 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. And Coca-Cola, that's its secret sauce, 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. 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.

9:56Jon Quast: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 price valuation. 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 thesis. All right.

10:31Matt Frankel: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 Motley Fool Hidden Gems Investing.

10:57Jon Quast:Support for the show comes from Fundrise. For the past 70 years, there's been a room in finance most people couldn't enter. A room where you could have invested in some of the biggest names in tech, companies like Airbnb and Uber before their multi-billion dollar IPOs. I'm talking about venture capital. Fundrise recently took a sledgehammer to those closed doors by launching a venture capital product that's available to anyone. Their mission is to give everyone the chance to invest in the best tech and AI companies before they go public. You can visit fundrise.com slash fool to check out Fundrise's venture portfolio and get in early today.

11:32Jon Quast:All investments involve risk, including the potential loss of principal. Past performance is not indicative of future results. This is a paid advertisement. Trading at Schwab is now powered by Ameritrade. Unlocking the power of Thinkorswim, the award-winning trading platforms loaded with features that let you dive deeper into the market. Visualize your trades in a new light on Thinkorswim Desktop with robust charting and analysis tools. All while you uncover new opportunities with up-to-the-minute market news and insights. Thinkorswim is available on desktop, web, and mobile to meet you where you are.

12:03Jon Quast:It's built by the trading obsessed to help you trade brilliantly. Learn more at schwab.com slash trading.

12:10Matt Frankel: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 Enphase Energy. And the question here is, AI data centers are creating a rapidly growing need for new sources of electricity and more efficient power infrastructure. Enphase 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.

12:45Matt Frankel:How should investors compare these different approaches to the AI power bottleneck? Specifically, what would need to happen for Enphase'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? 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 the big picture here.

13:16Matt Frankel: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 this 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 investors, 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 queues.

13:54They're spinning up megawatts of capacity immediately. And because the utility grid faces really long delays, Bloom Energy has emerged as a very important player that offers this fast off-grid alternative for data center developers that need the power right now. And Enphase Energy, on the other hand, you know, they target that conversion challenge I was talking about. So they're focusing on stepping voltage down efficiently at the chip level.

14:20Matt Frankel:All right. So since the question did focus a lot on Enphase, we want to put some numbers behind that. Matt, put some numbers behind the Enphase story and what the actual opportunity is here. Yeah.

14:31Jon Quast:So this is not talking about Enphase'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 it can capture a significant part of that addressable market. So the company's core business is contracting. Revenue in the core business was down 20 % year over year. So it's kind of looking to this for a pivot, I guess you would say.

15:12Matt Frankel:Well, and let's ask that. I mean, what does need to go right here, Matt, for Enphase to, for this opportunity to actually become meaningful?

15:20Jon Quast: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 said standard a lot in that sentence. They would need to get a hyperscaler win in 2027. I mentioned they're hoping to ship product to consumers in 2028. 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.

15:51Matt Frankel: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. 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 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 growth story.

16:29Doesn't mean you have a bad business. 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 scales into the 2030s. 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 in the years ahead.

17:01Matt Frankel: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 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 here concern you at all?

17:22Jon Quast:Yeah. So these companies, they're two different animals, really. They both kind of have competitive moats. Bloom has proven its moat. Bloom's moat is providing power quicker than the alternatives. It 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 stock. I mean, 80 times forward earnings. It's up about 500 % in one year. Bloom is monetizing its opportunity today.

17:58Jon Quast:Enphase is a 2028 option on a shrinking company that has a really good market opportunity.