AM Resorts: Solar-Energized Vacations

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Cloudy Days Ahead

The hospitality and tourism industry in the Caribbean is in a period of unprecedented growth. In 2016, it increased at seven per cent, double the global average. Consequently, numerous competitors have entered the fray, diminishing profit margins in an already low-margin industry. As pressures increase from competition and as customers demand more attractive amenities, resorts will have to shift toward leaner cost structures. Utility expenses are cited as one of the three major challenges to this shift and to Caribbean tourism. AM Resorts is one of the largest and fastest growing resort chains in the region and is quickly expanding by building new properties. By incorporating solar panel installation into its construction, AM Resorts will benefit from a long-term cost advantage relative to its competition.

The Environment

The maturation of the global resorts industry has resulted in investors shifting their investments from fast-growth businesses to incumbent industry giants that optimize the performance of existing assets. Utilities normally account for a relatively small amount of operating expenses of hotels globally; however, this is reversed in the Caribbean region where energy costs are the highest in the world. In comparison to the U.S. average of six per cent, resort utilities in the Caribbean account for 15.6 per cent of total operating costs, on average. The high cost is becoming problematic as energy demands continue to increase. As the trend continues to favour Caribbean resorts with energy-intensive offerings such as universal air conditioning, the need for a sustainable energy solution becomes more evident.

The Caribbean appears to be the ideal location for renewable energy development due to an abundance of renewable resources such as solar, wind, and geothermal. Despite this, Cuba, the largest country in the region, only generates four per cent of its total energy from renewable sources. Consequently, nations in the Caribbean rely almost entirely on imported and expensive fossil fuels, resulting in the region paying some of the highest energy costs in the world. The International Monetary Fund (IMF) theorizes that renewable energy has not been adopted on a wide scale in the region due to lack of financing, political corruption, and unique geographical constraints such as limited land size and hurricanes. In addition, fossil fuel costs are only expected to increase while energy generation costs for renewable energies are expected to decrease.

On the contrary, solar energy has garnered a significant amount of investment and research, and still has ample room for innovation. Given the exponential decrease in solar energy production costs, it appears to be an ideal time to adopt solar panels as these lower prices result in a faster investment payback. In 2017 alone, prices dropped 26 per cent. Further, Swanson’s law observes that the cost of generating energy with solar panels is decreasing at a rate of 20 per cent with each doubling of global manufacturing capacity. For example, in 1977, the cost per watt of power to purchase a solar panel was more than $76, while in 2013, it was a mere 74 cents. This indicates that in sunny regions like the Caribbean, solar panel technology could compete with more expensive and traditional methods of energy generation. Moreover, technological developments that have been proved in theory or in the laboratory, but have not reached mainstream adoption, indicate that solar-generated power will continue to decrease in price while production efficiency increases. However, solar energy generation is dependent on the sun and is thus unable to generate consistent electricity. Consequently, batteries must be installed to store energy for use during the night and energy reserves may need to be supplemented by the main power grid during unfavourable weather conditions. If these conditions are met, solar energy becomes a promising solution to the region’s energy woes.

AM Resorts Graphic 2 - Solar Panel Options

While this plan is reasonable in theory, it prompts the question: what is the best way for companies to develop the infrastructure for solar panels? One option is to purchase large swaths of land and build grids of solar panels to create energy. While this method has the advantage of capturing economies of scale, this is not a viable option in the Caribbean due to the scarcity of land. Another option is to build floating solar farms in the ocean as is being done in some countries, such as China. This option, however, requires significant economic and political cooperation from governments since jurisdiction over the ocean water is usually reserved for large and well-established energy companies. The last option is to build the solar panels on a company’s existing property, by either incorporating them into the design of new construction projects or retrofitting existing ones. The latter is not a feasible option since resorts would have to cease operations on existing properties to accommodate construction. The only off-season for resorts in the region occurs from July to November, mainly due to climate risks, such as tornadoes or hurricanes, which preclude the development of massive projects. Thus, it only makes sense that companies incorporate solar panel designs into the construction of new resorts.

Resorting to a Different Strategy

As one of the fastest-growing luxury resort destinations in the Caribbean, AM Resorts is well-positioned to implement this strategy and install solar panels into its properties currently under development. Owned by Kohlberg Kravis Roberts & Co (KKR), a large U.S. private equity firm, AM Resorts has 20 new locations in its pipeline to be introduced by 2020. By integrating renewable energy into the construction of these new resorts, AM Resorts will be able to offset the growing energy costs for years to come.

The greatest benefit of this venture for AM Resorts is the ability to create a long-term cost-saving advantage relative to its competitors. Countries in the Caribbean pay some of the highest utility costs in the world and such costs are expected to only increase as fossil fuels become more expensive. Generating energy from solar systems, however, is only getting less expensive. If Swanson’s law continues to hold and efficiency in panels continue to grow, the cost per kilowatt-hour for solar panels, excluding labour and other related installation costs, is expected to decrease to four cents by 2030 from nine cents today.
Thus, designing all new resorts with solar panel infrastructure can provide a massive opportunity for AM Resorts to build a competitive cost advantage, even at today’s prices. As new systems are installed going forward, the efficiencies are only expected to increase.

One major opportunity for AM lies with its financial sponsor. In 2015, KKR acquired an 80-per-cent stake in Gestamp Solar, a solar panel manufacturing company with experience manufacturing and installing solar panels in Mexico. KKR will be able to benefit from employing the technical expertise of its solar panel portfolio company to install solar panels on its resorts. Furthermore, by contracting Gestamp Solar for the installation of solar panels on new resorts, KKR will be able to drive revenues in another portfolio company while making this investment.

AM Resorts Graphic 3 - Resort Microgrid System

AM Resorts already makes corporate social responsibility a part of its strategy, pairing resorts with rainforest protection. Solar panels will take this strategy one step forward. With climate change exacerbating weather conditions in the region, AM Resorts’ adoption of solar energy will mark a symbolic start to combating climate change, which will be well-received by the public. This can be used to improve its brand in marketing campaigns targeted towards travellers. Multiple studies indicate consumers are willing to pay a premium price—upwards of 15 per cent—for sustainable hotels that use green energy. Therefore, pursuing this strategy will not only help in cost leadership by lowering operational costs, but also aid in a differentiation strategy.

Daylight Savings

Understanding the financial feasibility of the project requires a comparison of the costs that could be saved to the invested capital required. Under this scenario, the millions of kilowatt-hours of energy new resorts would use and source at more expensive rates, would be entirely generated from the grid of solar panels. The model is driven by each resort’s savings in electricity costs being 33 cents per kilowatt-hour. Installation costs are estimated at a cost of just less than $4 per watt of power, totalling $3.6 million. This includes the cost of labour and construction of supporting infrastructure, such as a power inverter to convert the direct current output to alternating current. Consequently, the investment in solar panels is expected to yield a 15-per-cent rate of return, with a payback period of a little more than six years, significantly below the 25-year useful life of the asset. This is the base case and assumes no change in energy consumption or installation costs throughout the years. As these costs continue to decrease going forward, the attractiveness of this proposal will only grow by the time AM Resorts is ready to install solar panels.

Concerns

In addition, volatile weather conditions in the Caribbean such as wind storms and hurricanes present an opportunity to resorts generating their own power. Following Hurricanes Nate, Maria, Irma, and Harvey at the end of 2017, the U.S. Department of Energy released recommendations for improving the performance and resilience of power grids in Puerto Rico and the wider region. One of its key recommendations is to introduce a system of microgrids and supplementary energy sources to the main grid. Microgrids are small-scale power distribution networks capable of operating independently or in conjunction with the main power grid.As power outages create significant operational complications, avoiding outages through microgrids could be a unique option for AM Resorts.

Finally, KKR, AM Resorts’ financial sponsor, has an average holding period of 6½ years. Although the payback for the installation of solar panels may discourage the implementation of this strategy, it is worth noting that the installation of solar panels would result in margin expansion for the foreseeable future, something that would be recognized upon exit of the investment.

Sunny Days Ahead

Increased global competition in the resort sector will continue to place downward pressure on profit margins into the future, forcing major industry players to minimize costs. Drivers of competitive advantage are evolving, and AM Resorts will be able to lead the sustainable practices movement by using solar panels. This will ensure long-term financial viability while also considering environmental and corporate goals. As the technology continues to evolve, solar energy is expected to become the mainstream standard for energy production.


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