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Industry Outlook

The growth outlook of alternative energy companies is directly related to the fortunes of the economy and inversely to the prices of petroleum products. Trends on both fronts appear be favoring the alternative energy industry at present.

The U.S. economy has shaken off the negative momentum that appeared to be taking hold in the middle of 2010. The fourth quarter GDP report, despite the subsequent negative revision, is showing the resumption of sustainable economic growth. Importantly, the drivers of economic growth appear to have shifted the more stable consumer spending side.

Major economic reports, such as the ISM Indices, leading indicators and consumer confidence are all showing signs of renewed strength. Even the labor market appears to have turned the corner as the weekly jobless claims numbers and the February nonfarm payroll report showed.

The recent spike in oil prices in the wake of unrest in the Middle East has been casting a negative shadow over this emerging positive economic momentum. But we believe that a temporary oil spike will do limited, if any, damage to this emerging positive economic narrative. And we think that the fear premium in oil prices will come down as the situation in Libya improves.

This improving macroeconomic environment should have favorable impact on electricity demand. According to the Energy Information Administration (EIA), U.S. industrial electricity sales are expected to rise year-over-year by 1.7% in 2011 and 2.3% in 2012. This helps improve the operating environment of electricity generators and distributors.

A number of traditional utility companies have growing alternative energy operations. But the fortunes of some of these companies, particularly those with significant fossil-fuel exposures, are less attractive than their peers.

In the utilities space, we are less optimistic about the prospects of CenterPoint Energy Inc. (CNP - Analyst Report), DPL Inc. (DPL), DTE Energy Company (DTE - Analyst Report) and Public Service Enterprise Group Inc. (PEG - Analyst Report). Conversely, favorable rate cases and stable sales growth in the respective service areas make companies like Cleco Corporation (CNL), Companhia Paranaense de Energia (ELP - Analyst Report), El Paso Electric Company (EE - Snapshot Report), Enersis S.A. (ENI - Snapshot Report) and Pike Electric Corporation (PIKE - Snapshot Report) attractive in the near-term.

Like everyone else, the Alternative Energy industry was hit hard by the Great Recession and essentially remains in recovery mode. And while the economy is in recovery mode, so is our hope for the industry.

A major growth area in this space is Solar Energy. The U.S. has a lot of catching up to do, despite enormous potential, to get anywhere close to the global leaders. According to the Solar Energy Industries Association (SEIA) -- the U.S. trade association of close to 500 companies in the solar energy industry -- the U.S. solar industry is a significant net exporter of solar energy products, with net exports totaling $723 million in 2009. Additionally, U.S. solar installations created $2.6 billion in direct value to support the U.S. economy.

According to the European Photovoltaic Industry Association (EPIA) -- the world industry association for solar photovoltaic electricity market -- the cumulative global installed PV capacity stood at almost 16.5 GW at the end of 2010, compared to only 9 GW at the end of 2007. Per EPIA estimates in 2010, Germany ranked first followed by Italy and Spain in terms of cumulative installed solar electric power capacity, as of year-end 2010.

Here we take a look at the Solar Energy space and attempt to identify this nascent industry’s strengths and weaknesses.

OPPORTUNITIES

Environmental Advantage: Solar power is one of the most benign electricity resources. Solar cells generate electricity without air or water emissions, noise, vibration, habitat impact or waste generation.

Fuel Risk Advantage: Unlike fossil and nuclear fuels, solar energy has no risk of fuel price volatility or delivery risk. Although there is variability in the amount and timing of sunlight in the day, season and year, a properly sized and configured system can be designed to insure high reliability while providing a long-term, fixed-price electricity supply. With fuel prices going up following the crude oil spike of the last few weeks, this advantage has become very pronounced.

Location Advantage: Unlike other renewable resources such as hydroelectric and wind power, solar power is generally located at a customer’s site due to the universal availability of sunlight. As a result, solar power limits the expense and energy losses associated with the transmission and distribution from large-scale electric plants to the end-users. For most residential consumers seeking an environment-friendly power alternative, solar power is currently the only viable choice being a ubiquitous source.

Environmental Legislations: Alternative energy companies are increasingly benefiting from new legislation in the U.S. stipulating installation of renewable sources of electricity generation as mandated by Renewal Energy Standards (RES). At the federal level, Congress has extended the 30% federal investment tax credit (ITC) to both residential and commercial solar installations until December 31, 2016.

Also, under the American Reinvestment and Recovery Act (ARRA), the U.S. Treasury Department implemented a program to issue cash grants in lieu of investment tax credit for renewable energy projects.

Subsidy Programs: Governments, most notably China, Japan, Canada, U.K., Australia, India and the Middle East, have increased their financial support for solar projects. China is aiming at increasing its installed solar power capacity to 20 GW by 2020 from 305 MW capacity at the end of 2009.

In Europe, the European Union directive's goal of a 20% share of energy from renewable sources by 2020 will keep the flow of new projects going. Specific solar energy stocks under our coverage that stand to benefit from this environment with a Zacks #1 Rank (short-term Strong Buy rating) include LDK Solar Co. Ltd. and Akeena Solar Inc. .

WEAKNESSES


Excess capacity: In the near-term the solar industry is facing the problem of excess solar cell and module capacity. Buoyed by the recent trends of record shipments, virtually the whole industry is on an expansion spree. The focus on vertical integration may make individual players self-reliant for their solar wafer/cell needs, but on the whole this brings a lot of unutilized capacity to the forefront for the industry.

This will significantly affect companies who have substantial solar cell/wafer tolling services revenue exposure. As a result, solar players like JA Solar Holdings Co., Ltd. (JASO - Analyst Report), Canadian Solar Inc. (CSIQ - Analyst Report) and Trina Solar Ltd. (TSL - Snapshot Report) may witness headwinds in their margins.

Recent Start-ups: A large number of these companies are recent start-ups with limited resources. As such, quite a few depend on their customers’ ability to finance solar projects and remain exposed to continuing near-term losses due to start-up costs. Companies such as Evergreen Solar Inc. (ESLR) and Ascent Solar Technologies Inc. (ASTI) would fall in this category.

Subsidy Roll-back: Budgetary constraints have caused prime solar markets in Europe like Germany , Italy , Spain and U.K. to roll back a portion of their grants. The recent spike in sales of solar players from the above countries is mainly fuelled by the rush to complete projects ahead of subsidy roll-backs. This may affect companies such as First Solar Inc. (FSLR) and SunPower Corporation (SPWRA), which generate a substantial portion of their sales from markets like Germany.

Fortunes Tied to Crude: Alternative energy stock prices generally rise and fall in direct proportion to the price of crude oil. While in times of high oil prices this may present an opportunity, it also increases volatility in the sector. The improving economic scene, both here in the U.S. as well as worldwide, had been driving oil prices higher even before the current spate of unrest in the Middle East took it to new levels.

We expect, however, the current spike to be temporary phenomenon that will unwind once the situation in Libya stabilizes. However, the new sources of uncertainty in this all-important oil producing region will add volatility to oil prices for a long time.

New technologies are emerging:
The alternative energy industry remains an emerging sector with a consistent focus on the lowest cost technology to be cost competitive with traditional means of electricity generation. This may prove disastrous for existing companies ruling the solar roost should a cheaper alternative emerge.

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