President Trump’s plans to shift focus to the traditional energy businesses such as coal, oil and gas and his skepticism around global climate change have cast a shadow over the future of solar companies. Trump has promised to call off the landmark Paris deal and boost coal production. Not only has he called climate change a Chinese hoax, but also pledged to repeal former President Obama’s Clean Power Plan.
A comparative analysis of the alternative energy industry’s historical EV/EBITDA ratio reflects a relatively gloomy picture that might be a cause for investor concern. The industry currently has a trailing 12 month EV/EBITDA ratio of 17.38. This level seems unfavorable when compared with what the industry saw in the last 12 months. The ratio is higher than the average level of 15.53 and is near its high end of 17.50 over this period.
Moreover, the industry seems overvalued when compared with its broader industry Â¿Â¿ Oil/Energy sector’s EV/EBITDA ratio of 8.07 in the same time period. This shows that the industry is overvalued when compared to its broader industry.
While the long-term potential of the space is undeniable, the industry is faced with a number of near-term challenges that will likely keep these stocks under pressure. We discuss some of these below.
The Trump Effect: The present administration doesn’t have a friendly stance toward the space. There is nothing concrete in policy terms, but ideas like closing down the EPA, discarding the Clean Power Plan, and pulling out of the Paris Agreement have been talked about in the past. We will see how the policy landscape evolves, but the focus will likely be on incentivizing the coal and natural gas industries.
Since 2014, as utilities closed a large number of aging coal-fired generators, wind and solar have been the two biggest sources of electricity in the U.S. The aforementioned policy changes will likely reverse this trend in the coming years.
China Factor: China’s solar industry is not immune to the ongoing slowdown in its economy. According to theOrganization for Economic Co-operation and Development (OECD), China's economic growth is likely to slow down to 6.5% this year and further decline to 6.3% in 2018.Gross domestic product, or GDP, of the world’s second-largest economy grew 6.7% in 2016 — the weakest in the last 26 years. Considering these numbers, it is clear that the decelerating trend is likely to continue in the near term.
The country’s economic situation has sparked apprehensions that the government could shift asset resources away from investments in renewable energy in order to fuel its stock market. One of the most prominent effects of the economic slowdown in China has been relatively weak demand for electricity.
At the end of 2015, China had set a target of installing 150 GW of solar energy by 2020. But in 2016, the figure was cut by 20% to 110 GW. Though the Asia Europe Clean Energy Advisory (AECEA) raised optimism by stating that the figure could exceed the revised target, uncertainties continue to persist.
In fact, despite being the world’s largest solar market, China is expected to see solar installations to decline to 17.5 GW in 2017, well below its expected number of more than 30 GW.
Trina Solar Ltd. TSL, the largest Chinese manufacturer, derives about two-thirds of its revenues from China. Over the last one year, its share price dropped 99.9%, while Yingli Green Energy Holding Co. Ltd. (YGE - Free Report) saw its shares plummet about 26.1%. Again, shares of JinkoSolar Holding Co., Ltd. (JKS - Free Report) tumbled 22.6% over the same period.
Fed Rate Hike: On Mar 15, the Federal Open Market Committee raised the federal funds rate by 25 basis points to 1%. Fed lifted the key interest rate for the second time in three months, citing an improving labor market and greater confidence in consumers. Future rate hike expectations scaled higher as well and two additional rate hikes are anticipated this year only. Additionally, the Fed expects key interest rate to be around 1.4% by the end of 2017.
The federal funds rate is a benchmark interest rate that determines the rate for financial institutions to lend to each other. A rise in this rate translates to higher borrowing costs for banks that pass on these raised costs to consumers in the form of higher interest rates on loans, mortgages and other financial products. Since financing is an inherent requirement of the alternate energy sector, rising interest rates are a major growth deterrent for this space.
While companies in this space have been benefiting from a low interest rate environment so far, rate hike makes this industry far less appealing. This is because the resulting increase in cost of capital will increase cost of operations for the alternate energy companies, thereby reducing their profitability.
Subsidy Rollback: While the U.S. government provides the Investment Tax Credit and Production Tax Credit to support growth of alternate energy, several other large nations are planning to lower subsidies provided to renewable energy operators.
Per recent media reports, China’s National Development and Reform Commission has hinted at a cut in Feed-in Tariffs (FiT) from the present rates. Though the changes in tariffs are yet to be official, the aim is to reduce FiTs by roughly 3-4% per year so that onshore wind might reach grid parity by 2020.
In Feb 2016, Japan’s Ministry of Economy, Trade and Industry (METI) proposed an 11% cut in solar FiT. Recently, Japan announced plans to cut FiT rates annually to reach the level of household electricity rates of 20.5 cents per kilowatt-hour (“KWh”) by 2019. The FiTs in 2017 will be 23.9 cents per KWh, then reduced to 22.2 cents per KWh in 2018 and finally will reach the target set for 2019.
Similarly, in Aug 2015, the UK government had hinted at an 87% reduction in support for domestic solar and an up to 82% cut in FiTs for commercial rooftops. Again, Germany is expected to cap subsidy payments after the generation capacity reaches a certain target.
Rolling back subsidies will lead to an increase in the cost of energy produced by renewable sources. This surely hurts the prospects of renewable energy across the globe.
Anti-Dumping Duties: The move from the U.S. Department of Commerce (“DOC”) to impose import duties on solar panels and other related products from China and Taiwan could escalate the U.S.-China trade conflict.
The decision addresses one of the main charges in a petition brought by SolarWorld Industries America, a German solar manufacturer with major operations in the U.S. A complaint lodged by SolarWorld brought to the fore a loophole that the Chinese solar product makers were exploiting to evade duties imposed by the Department of Justice in 2012.
The higher tariffs came at a time when the solar industry was on the whole recovering after a two-year supply glut.
The Commerce Department in Dec 2014 set anti-dumping duties at about 52% on most module imports from China and at 19.5% on most imports of Taiwanese cells. It has also slapped 39% anti-subsidy tariffs on most China-made panels.
Imposing of these anti-dumping duties has benefited many U.S. alternate energy companies like Vivint Solar, Inc. (VSLR - Free Report) , Enphase Energy, Inc. (ENPH - Free Report) and First Solar, Inc. (FSLR - Free Report) . While Vivint Solar carries a Zacks Rank #2 (Buy), Enphase Energy and First Solar carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
New Emerging Technologies: The alternative energy industry remains an emerging sector with a steady focus on the lowest-cost technology. This may prove disastrous for existing companies riding the solar boom should a cheaper alternative emerge. The industry also has to deal with cost-competitiveness from traditional means of electricity generation.
Globally, China leads the world in total electricity generation from renewable sources, helped by its increased allegiance in recent times to the alternative path. It is followed closely by the U.S., Brazil and Canada.
All leading solar cell manufacturers are looking for opportunities in the emerging markets. These markets primarily comprise the Asia-Pacific region with China, India and Japan being the key destination for the global solar giants. The long-term outlook on the whole looks bright. This is especially true as global warming and high fuel emission issues have proven how indispensable clean energy sources will be for the future.
However, the global economic turmoil, China's economic slowdown and the consequent subsidy rollback in the prime global solar markets are major headwinds for the renewable energy industry on the whole.
Also, Trump’s focus on reviving the coal industry instead of encouraging alternate energy is a serious concern for all renewable energy companies.
Again, if we are to expand renewable manufacturing infrastructure worldwide to fight the climate crisis, the U.S. as well as the Chinese manufacturers should try to settle their dispute before the industry at large is damaged. Measures to reduce the inflow of Chinese solar panels may hamper the battle against climate change.
Any increase in interest rates is detrimental for the alternative energy space. The recent rate hike thus makes the future prospect of this space quite uncertain.
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