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Zacks Analyst Interviews

Overview

Alternative energy sources are gradually making inroads into the global energy mix. Growing population, economic growth, regulations as well as new technologies are transforming the energy landscape.

Historically, the growth outlook of alternative energy companies has been directly related to the state of the economy and inversely related to the prices of petroleum products. While that relationship still remains in place, other macroeconomic uncertainties are weighing on the sector’s fortunes.

The continuing financial strains in the Eurozone, slow recovery in the labor market, and ongoing fiscal contraction continue to weigh on the economic picture. This otherwise bleak picture is only partly offset by the steadily improving outlook for the U.S. housing sector and a stronger dollar.

Overall, the outlook for the U.S. economy appears to be gradually improving, with a host of variables showing positive trends over the last few months. While the market has started sizing up the odds of ‘tapering’ in the Fed’s QE program, the fact remains that overall stance of monetary policy continues to be very favorable and expansive.

The expectation is that the U.S. economy will continue to expand at a moderate pace, which given the problems in Europe and questions about China, is considered a favorable outlook. This morning’s modestly better than expected May non-farm jobs report provides further confirmation that there is plenty of underlying momentum in the U.S. economy.

Crude oil prices are likely to exhibit a sideways-to-bearish trend in the second half of 2013. With domestic demand relatively soft and the global economy still showing signs of weakness, keeping prices on the weak side.

The fortunes of the gradually emerging solar photovoltaic (PV) industry are currently uncertain. The core European markets of Germany, Italy and Spain -- historically accounting for the lion’s share of solar products -- are fast nearing maturity. To counter this tepid growth, the companies are increasingly focusing on the Chinese, Indian and U.S. markets. However, as things stand now, firms without deep pockets may not be able to sustain over the longer run.

According to the Energy Information Administration (“EIA”), the U.S. generated about 12% of its electricity from renewable energy sources in 2012. The lion’s share came from hydroelectric power (56%), followed by wind (28%), biomass wood (8%), biomass waste (4%), geothermal (3%) and solar (1%). Globally, however, China leads the world in total electricity generation from renewable sources, helped by its increased allegiance in recent times to the alternative path. The dragon is followed closely by the U.S., Brazil and Canada.

Solar

A major growth area in the renewable space is solar energy. With the increasing need to develop renewable energy in response to stringent environmental regulations, countries worldwide are relying on solar energy for generating electricity.

The U.S. has a lot of catching up to do, despite enormous potential, to get anywhere close to the global leaders. Solar Energy Industries Association (SEIA) is the U.S. trade association of approximately 1,000 companies in the solar energy industry. Per the SEIA, in 2012, the U.S. solar energy industry grew 76% year over year to reach 3,313 megawatt (MW), which represents 11% of all PV globally, up from 1,887 MW in 2011.

According to SEIA, this unprecedented growth was spurred by solid contribution in the fourth quarter of 2012. As much as 1,300 MW of solar energy came on stream during the quarter, thanks to unmatched installation levels in the residential and utility markets. Going forward, SEIA forecasts that over 4,200 MW of PV and 940 MW of concentrating solar power (CSP) will be installed this year.

The PV market is gradually becoming global. According to the European Photovoltaic Industry Association (EPIA), a worldwide industry association for the solar photovoltaic electricity market, the cumulative global installed PV capacity stood at almost 102.2 gigawatt (GW) at the end of 2012, compared to only 71.1 GW at the end of 2011. Europe took the lead with over 70.0 GW of installed PV capacity during the year.

In 2012, the next three big markets were China, U.S. and Japan. Besides the three countries, Australia and India will be a part of the major solar powerhouse in the near future.

In 2012, though Europe led the list in terms of total installed PV capacity, it accounted for 70% of the world’s new PV installations, down from 75% in 2011. This can be attributed to a tepid European economy and a distinct downswing in the PV market, particularly in new connected capacity, seen for the first time in 12 years.

It is believed that in 2013 the majority of new PV capacity in the world will come from outside the Europe. China and India are expected to be the forerunners, followed by countries in Southeast Asia, Latin America and MENA.

Wind

As for wind energy, the American Wind Energy Association (AWEA) reported the total installed wind power at the end of the first quarter of 2013 was 60,009 MW. The extension of the Production Tax Credit (PTC) and the record fourth quarter of 2012 installations acted as a catalyst to capacity growth.

On Apr 15, renewable electricity production tax credit (PTC) was extended. This extension would ensure significant wind capacity additions over the next three years, thereby leading to higher generation from wind.

Zacks Rank

Within the Zacks Industry classification, the Zacks Industry Rank for Solar is #192 out of 261. This corresponds to the bottom one-third of the list.

However, the Zacks Industry Rank for the Other Alternative industry is #34 out of 261. This puts the industry in the top one-third of all industries, corresponding to a positive outlook.

The way to look at the complete list of 260+ industries is that the outlook for the top one-third of the list (Zacks Industry Rank of #85 and lower) is positive, while the outlook for the bottom one-third (Zacks Industry Rank #170 and higher) is negative.

Please note that the Zacks Rank for stocks, which is at the core of our Industry Outlook, has an impressive track record going back years, verified by outside auditors, to foretell stock prices, particularly over the short term (1 to 3 months).

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

OPPORTUNITIES

Environmental advantage: Solar power is the most benign electricity resource. Solar cells generate electricity without air or water emissions, noise, vibration, habitat impact or waste generation. Over time, rapid population growth, depletion of non-renewable conventional sources, and escalating pollution levels will help shape a much more pronounced global focus on renewable projects.

Fuel risk advantage: Unlike fossil and nuclear fuels, alternative 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 ensure high reliability while providing a long-term, fixed-price electricity supply.

Among the renewable energy pack, we would advise investors to look for companies like rooftop solar energy systems provider SolarCity Corporation (SCTY - Snapshot Report) with an innovative game plan. The downstream solar company plays on its strength providing renewable power lower than the grid price to residential and commercial markets in the U.S.

Location advantage: Unlike other renewable resources such as hydroelectricity 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 losses associated with 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.

Environmental legislation: Alternative energy companies are increasingly benefiting from new legislation in the U.S. stipulating installation of renewable sources of electricity generation as mandated by Renewable Energy Standards (RES). As of now there are 30 states and the District of Columbia in the U.S. that have RES legislation in place. Another 7 states also have nonbinding goals for adoption of renewable energy sources.

At the federal level, Congress has extended the 30% federal investment tax credit (ITC) to both residential and commercial solar installations until Dec 31, 2016. Also, under the American Reinvestment and Recovery Act (ARRA), the U.S. Treasury Department had earlier implemented a program to issue cash grants in lieu of investment tax credit for renewable energy projects.

The wind sector has also benefited significantly from the PTC over the last few years. It was started in 1992 as a part of the Energy Policy Act of 1992. Subsequent to that it has received life extension of half a dozen times. In the first decade of a renewable energy facility’s lifespan, the PTC provides a $0.022/kilowatt-hour investment tax credit benefit.

Need for a pollution-free environment: Globally, utilization of renewable energy is rising primarily due to its clean nature and a growing awareness among the masses regarding its benefits. This has influenced utility providers, like Sempra Energy (SRE - Analyst Report) and Duke Energy Corporation (DUK - Analyst Report), to shift their mode of power generation to solar, wind and water.

Recently, a Duke Energy Corporation unit − Duke Energy Renewables − has completed the acquisition of two commercial solar power projects from SolarWorld for an undisclosed amount. Since 2007, Duke Energy has invested more than $2.5 billion to grow its commercial wind and solar business.

WEAKNESSES

Excess capacity: In the near term, the solar industry is faced with the problem of excess solar cell and module capacity. Going by the trend of solar companies citing sluggish demand and high inventory levels, affecting margins, virtually the whole industry is in a pause. The earlier rush in vertical integration by individual players for self-reliance in their solar wafer/cell needs has created a lot of unutilized capacity for the industry.

The near-term solar module industry outlook is thus clouded by unnecessary inventory arising from a supply glut and a corresponding underutilization of capacity. This has led to industry-wide sharply falling Average Selling Prices.

Subsidy roll-back: Budgetary constraints have caused prime global solar markets like Germany, U.S., Italy, Australia, U.K. and Taiwan to roll back a portion of their grants. Earlier, sales of solar players from the above countries witnessed a sharp rise mainly fueled by the rush to complete projects ahead of subsidy roll-backs.

The Alternative energy players may receive another jolt from one of the prime solar markets. Germany is expected to cap subsidy payments after generation capacity reaches a certain target. Germany is consistently evaluating changes to the German Renewable Energy Law, or the EEG. The feed-in tariffs (FiTs) agency informed that solar feed-in tariffs for May to Jul 2013 are subject to a 1.8% monthly decrease.

These FiT changes particularly impacted the competitiveness in Germany of large-scale free field PV systems and modules to be installed in such systems. Any further policy changes wrought by the German Environment and Economy Ministers and approved by the German Parliament will negatively affect the long-term demand and price levels for PV products in Germany.

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

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.

As per EIA, world crude consumption grew by an estimated 0.7 million barrels per day (MMBPD) in 2012 to a record high of 89.0 MMBPD. The agency, in its most recent Short-Term Energy Outlook, said that it expects global oil demand to grow by another 0.9 million barrels per day in 2013 and by a further 1.2 million barrels per day in 2014. Importantly, EIA’s latest report assumes that world supply is likely to go up by 0.6 million barrels per day this year and by 1.8 million barrels per day in 2014.

The immediate outlook for oil, however, remains tepid given the commodity’s fairly positive supply picture. On the other hand, the growth in global liquids fuel demand will be relatively soft in the absence of a strong global recovery.

Chinese companies under pressure: In 2012, the U.S. Department of Commerce (DoC) implemented anti-dumping duties of effectively 25.96% and countervailing duties of 15.24%. The U.S. DoC rolled out these tariffs to tighten supply of Chinese solar products in the U.S. and simultaneously encourage local players to tap the growing renewable domestic market. These steps have made the North American solar power market increasingly competitive for the Chinese solar power product manufacturers.

International expansion for Chinese solar manufacturing companies are no longer an easy task. Indeed, increasing order flows do not sufficiently offset the headwind from anti-dumping duties in Europe as well as the U.S.

Recently, the European Commission (EU) approved a phased introduction of punitive anti-dumping tariffs on Chinese PV imports to Europe. The duty will be set at 11.8% initially until Aug 6, following which it will be increased to 47.6%. The Commission reiterated its willingness for further discussions with Chinese exporters and with the Chinese Chamber of Commerce.

Conclusion

Since the pulse of the alternative energy industry is closely tied to the swings in the macro-economy, until the picture becomes rosier we do not expect to witness many stand-alone alternative energy companies.

On the domestic front, although the economy has shown signs of improvement, proper recovery is yet to be seen. Again, the aftershocks of the Euro zone debt crisis would keep Europe stagnant. Given such a scenario in the international arena, we expect the cloud of uncertainty to persist in the near term.

Moreover, the first quarterly earnings season revealed weak results for the overall market. To sum up, the 1Q numbers are not going to bring sunshine back to the alternative energy sector. We nonetheless feel that well-capitalized alternative energy companies with a presence across the value chain will confidently sail through this phase smoothly. Growing economies and steady demand from the U.S. and the world will continue to drive the alternative energy industry in the future.

With most of its solar peers in trouble due to an oversupply of solar panels, ReneSola Ltd (SOL - Analyst Report), however, seems to be in a better position with multiple contracts and agreements. Again, First Solar Inc. (FSLR - Analyst Report) is continuously receiving orders from domestic as well as international clients for solar modules and other allied services. In 2012, the company inked several deals with Chinese, Indian and Indonesian organizations.

Again, companies like a Zacks Ranked #1 (Strong Buy) Ormat Technologies Inc. (ORA - Snapshot Report) and Zacks Ranked #2 (Buy) JA Solar Holdings Co., Ltd. (JASO - Analyst Report), Yingli Green Energy Holding Co. Ltd. (YGE - Snapshot Report), Hydrogenics Corporation (HYGS - Snapshot Report), Gevo, Inc. (GEVO - Snapshot Report) are making the most of the favorable market dynamics.

As per EIA, renewable generating capacity will account for nearly one-fifth of total capacity in 2040. Of this, solar generation will be the primary contributor to renewable capacity growth, with wind capacity occupying the second spot.

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