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 remains in place, other macroeconomic uncertainties are weighing on the sector’s fortunes.
According to the Energy Information Administration (EIA), the U.S. generated about 13% of its electricity from renewable energy sources in 2011. 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.
The continuing financial strains in the Eurozone, slow recovery in the unemployment rate and capital goods orders, aftershocks of Hurricane Sandy and ongoing fiscal contraction continue to weigh on the recovery. This otherwise bleak picture is only partly offset by the steadily improving outlook for the U.S. housing sector and a stronger dollar.
The continuing financial strains in the Eurozone remain a headwind for the global economy. The region’s problems are contributing to a flight toward dollar-denominated assets that is resulting in a stronger dollar, lower yields on term Treasury securities, and volatility in major European equity indices. The yield on the 10-year Treasury Note is hovering around a meager 2%. This has kept the spread wider between corporate bonds and the Treasury.
Overall, the outlook for the U.S. economy appears to be slowly improving, with a host of variables showing improvements over the last few months. The Fed’s continuation of bond purchases with no announced end date and the improving housing sector have improved market sentiment. That said, 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.
Oil prices in the near term have strengthened, owing to rising global oil demand keeping oil prices up. Also, in the crude futures markets, money managers reversed course and increased net long positions. This added speculative pressure supported the rise in crude oil prices. A tightening global supply picture in view of the lower supply from the resource-rich Middle East has also helped. Offsetting this favorable view are the high U.S. crude stocks.
In our view, crude oil prices in 2013 are likely to exhibit a sideways trend. With domestic demand relatively soft and the global economy still showing pockets of weakness, the fact that supply will be outpacing consumption appears to be evident. With a slowly improving home front, the question now lies largely upon the growth rate of China and the recovery in Europe and the effect it will have on the U.S. growth momentum.
The apparent ‘decoupling’ between not-so-bad U.S. prospects and a sub-par outlook abroad has nevertheless a bearing on the alternative energy sector, primarily because of restricted government spending levels. This reduced demand environment due to overburdened government finances has come at a particularly inopportune time for alternative energy operators due to the sector’s supply glut.
The gradually emerging solar photovoltaic (PV) industry fortunes are currently on tenterhooks. On the one hand, 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 currently stand, firms without deep pockets may not be able to sustain over the longer run. The situation is made acute by the steady ramping of low-cost China-based players grabbing market share from the U.S. and European contenders who have a higher cost structure.
On the other hand, China’s new solar power tariff regime clearly points to investors to look beyond the near-term earnings horizon for healthier performance. The U.S. Energy Department in its monthly Short-Term Energy Outlook raised its outlook for 2013 oil prices. Consequently, we believe that the oil price upside will boost the emerging positive alternative energy narrative.
A worldwide industry association for the solar photovoltaic electricity market, the European Photovoltaic Industry Association (EPIA), forecasts that the power generated from solar modules in Europe could be competitive in relation to conventional forms of energy by the end of the current decade. The major solar markets under survey were Germany, Italy, France, Spain and Britain.
A number of traditional utility companies are growing their alternative energy operations. But the fortunes of some of these companies, particularly those with significant fossil-fuel exposure, are less attractive than their peers.
In the utilities space, we are less optimistic about the prospects of Atlantic Power Corporation (AT - Snapshot Report) , Cleco Corporation (CNL), El Paso Electric Company (EE - Snapshot Report) , Great Plains Energy Inc. (GXP - Snapshot Report) and UNS Energy Corporation (UNS).
Conversely, favorable rate cases and stable sales growth in their respective service areas make companies like Ameren Corporation (AEE - Analyst Report) , Huaneng Power International, Inc. (HNP - Snapshot Report) , Pike Electric Corporation (PIKE), TransAlta Corporation (TAC - Snapshot Report) and The AES Corporation (AES - Analyst Report) more attractive.
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. Solar Energy Industries Association (SEIA) is the U.S. trade association of approximately 1,100 companies in the solar energy industry. Per the SEIA, in fiscal 2011, the U.S. solar energy industry grew 109% year over year to reach 1,885 MW, which represents 7% of all PV globally, up from 887 MW and 5% of global installations in 2010.
According to the SEIA, this unprecedented growth was spurred in part by declining installed solar photovoltaic (PV) system prices, which fell 20% in 2011 on the heels of lower component costs, improved installation efficiency, expanded financing options, and a shift toward larger systems nationwide.
As per the SEIA, bullishness in the U.S. solar market continued in the first three quarters of 2012 with new installations of 1,992 MW already surpassing 2011’s annual total of 1,885 MW. Going forward SEIA forecasts that close to 1,300 MW of PV capacity will be installed in the fourth quarter of 2012 alone, bringing the total for the year to 3,200 MW.
As for wind energy, per the American Wind Energy Association (AWEA), the U.S. had a total of 60 GW of installed wind power at the end of 2012.
According to EPIA, the cumulative global installed PV capacity stood at almost 67.4 GW at the end of 2011, compared to only 39.7 GW at the end of 2010. The agency reports that almost 21 GW of this growth occurred in Europe. In fiscal 2011, the two biggest markets, Italy and Germany, accounted for nearly 60% of global market growth.
The number of markets reaching more than 1 GW of additional capacity during fiscal 2011 rose from 3 to 6. In 2010, the top 3 markets were Germany, Italy and the Czech Republic; in 2011, Italy led, followed by Germany, China, the U.S., France and Japan, each with over 1 GW of new capacity.
Here we take a look at the alternative energy space and attempt to identify this nascent industry’s strengths and weaknesses.
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.
The long-term bullishness is shared even by oil goliaths like Royal Dutch Shell plc (RDS.A - Analyst Report) and BP plc (BP - Analyst Report) who expect that by fiscal 2050, one-third of the global energy needs will come from renewable sources. And in the near term, Christophe de Margerie, the CEO of another oil company, Total S.A. (TOT - Analyst Report) , expects crude oil prices to average $105–115 per barrel in 2013.
In this space we are bullish on waste management service provider, Covanta Holding Corporation (CVA - Snapshot Report) , which has tied the majority of its service contracts under long-term agreements with inflation escalators.
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.
In this context the one name we are bullish about is Ormat Technologies Inc. (ORA - Snapshot Report) , which engages in the geothermal and recovered energy power business.
In light of the Fukushima Daichi episode in Japan, the global focus has tilted towards solar in a big way. Germany plans to phase out nuclear power plants by 2022. This move will definitely boost solar fortunes in one of its largest global markets.
However among the renewable energy pack we would advise investors to look for companies like rooftop solar energy systems provider SolarCity Corporation (SCTY) 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 production tax credit (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. Our favorite in this space includes Juhl Wind Inc. (JUHL).
Subsidy programs: Governments, most notably in China, Japan, Canada, U.K., Australia, India and the Middle East, have increased their financial support for solar projects. In China, governmental authorities recently adopted a national feed-in tariff (FiT) policy for large scale alternative energy projects. China also expanded the Golden Sun Program, an upfront cost subsidy program, aimed primarily at distributed generation.
In addition, according to the 12th 5-year plan for solar energy, the government intends to raise the 2015 goal for total cumulative solar energy capacity to 21 GW and to 50 GW by 2020. Owing to its Chinese focus we are keeping a close watch on Sino Clean Energy Inc. (SCEI) which operates as a third party commercial producer and distributor of coal-water slurry fuel.
In Europe, the European Union's goal of a 20% share of renewable sources in the energy basket by 2020 will keep the flow of new projects going. Specific solar energy stocks under our coverage that stand to benefit from this environment include Yingli Green Energy Holding Co. Ltd. (YGE), bearing a Zacks Rank #1 (short-term Strong Buy rating).
In Australia, the solar industry is driven by several regulatory initiatives that support the installation of solar PV modules in both rooftop and free-field applications, including the federal government’s nationwide Renewable Energy Target, which has set a renewable energy goal for Australia of 20% by 2020. In India, the National Solar Mission includes a goal of installing 22 GW of solar power by 2022.
In the Middle East and Africa, several countries have announced sizeable solar targets, although policy mechanisms are not yet firmly established. In the Kingdom of Saudi Arabia, there is a renewable energy plan to install 41 GW of solar power by 2032.
In the United Arab Emirates, Abu Dhabi has set a target of sourcing 7% of electricity supply from renewables by 2020. In Morocco, the government has set a 2 GW solar goal by 2020. Other markets such as Algeria, Egypt, Jordan, Kuwait, Oman, Qatar and Tunisia are also actively promoting solar and issuing tenders.
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.
Currently we feel oil price is tied to Europe’s stagnation, high domestic crude stocks along with lower production in Iraq, Iran and Saudi Arabia. This prevents our outlook on oil to be bullish without a sharp spike in domestic GDP growth or at least improvement hitting the Southern European countries.
Per EIA, world crude consumption grew by an estimated 0.9 million barrel per day (bpd) in 2012 to a record-high level of 89.2 million bpd from 88.3 million bpd in 2011. The agency, in its most recent Short-Term Energy Outlook, said that it expects global oil demand growth by another 0.9 million barrels per day in 2013 and by a further 1.4 million barrels per day in 2014. Importantly, EIA’s latest report assumes that world supply is likely to go up by 1.0 million barrels per day this year and by 1.7 million barrels per day in 2014.
Also, the International Energy Agency (IEA) last month raised its demand growth forecast for 2013. In its monthly market report, the Paris-based agency raised its 2013 demand forecast by 240,000 barrels a day to 90.8 million barrels a day. Steady upside in energy price futures suggests that these trends are not likely to be reversed in the near term.
We feel that there is a very small pass-through from sharp changes in energy prices to core inflation. Based on this assumption we feel that the latest slew of energy price rise would not have much effect on core inflation.
Questions about China’s growth outlook remain a key source of uncertainty in demand projections for oil. On the supply side, growing hostilities in the Persian Gulf region due to Iran’s nuclear program remains a key risk factor for the global oil complex. The Iranian threat has been a major contributor to the volatility in oil prices, a trend that is unlikely to abate any time soon.
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.
On the other hand niche players like microinverter producer Enphase Energy, Inc. (ENPH) is insulated by its presence outside the cut-throat commoditized solar module value chain.
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. Solar players like JA Solar Holdings Co., Ltd. (JASO), STR Holdings, Inc. (STRI) and Suntech Power Holdings Co. Ltd. (STP) are in for a difficult near term.
However, seasoned players like Canadian Solar Inc. (CSIQ) are making significant progress even in a difficult environment owing to its rising proportion of project-based revenue.
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 are exposed to continuing near-term losses due to start-up costs.
Companies such as Trina Solar Ltd. (TSL) and Ascent Solar Technologies, Inc. (ASTI) come under this category.
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.
This would not come as welcome news for fringe solar players like JinkoSolar Holding Co., Ltd. (JKS) and LDK Solar Co., Ltd. (LDK) who are already over burdened with discounted product pricing, rising capital costs and shrinking balance sheets.
The Alternative energy players may receive another jolt from one of the prime solar markets. Germany 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. Earlier it reduced feed-in tariffs (FiTs) by 2.2% with plans on the anvil for another round of rate reduction for the FiT in April which will be effective from May 1, 2013.
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.
Going forward, we expect to see a paradigm shift from a market hoisted by growing governmental/institutional support to one of stable growth. This may affect companies which generate a substantial portion of sales from markets like Germany.
A struggling U.S. labor market underlies the high levels of high unemployment expected to persist throughout the forecast horizon, moderating core inflation. In Jan 2013, the U.S. unemployment rate increased to 7.9% from 7.8% in Dec 2012. If this trend continues going forward, the detrimental effect on federal subsidies may be more pronounced.
Also, the 30% grant in lieu of the federal investment tax credit under the ARRA takes into consideration projects which started construction before the end of 2011 and are placed into service before 2013. Unless extended, this concession will not be available for solar installations that begin construction on or after Jan 1, 2012.
If the program is not extended, total tax equity availability could be reduced, which may adversely affect the ability to arrange financing for utility-scale projects and may adversely affect the attractiveness of the U.S. solar market.
Finally, the production tax credit (PTC) for wind powered generation will not be available for turbines that became operational after the end of 2013. If it is not renewed, wind energy installations in the U.S. may take a backseat. As a result, apart from a handful of biggies like General Electric Company (GE) and Siemens AG (SI), we are apprehensive about the performance of the wind pack.
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.
In this area we are keeping a close watch on companies like Ocean Power Technologies Inc. (OPTT). Ocean Power Technologies, Inc. engages in the development and commercialization of proprietary systems that generate electricity by harnessing the renewable energy of ocean waves.
Broader market stocks have pushed to new multi-year highs in recent days on the back of monetary stimulus from the Fed and other central banks. However, since the pulse of the alternative energy industry is closely tied to the swings in the macro-economy, until the picture becomes rosier we won’t find many stand-alone alternative energy companies racing to new highs.
This is evident from the stock price movement of our actively tracked alternative energy stocks. Over the past year, the stock price of solar stocks was down -28.9% in aggregate and other alternative energy stocks were down -24.6%. In comparison, over the same time period, the benchmark S&P 500 index was up by +11.3%.
On the domestic front, although the economy has shown signs of improvement, proper recovery is yet to be seen. Assuming continuation of the ongoing trend we can safely assume we are not going to see any Fed interest rate hikes while U.S. payroll growth is on the borderline of stagnation. This along with the aftershocks of Eurozone 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.
With the fourth quarterly earnings season in full swing, we've seen relatively strong results for the overall market. However the strength is attributed to massive downward revisions earlier in Q4.
As of January-end 2013, total earnings for the 235 S&P 500 companies that have already reported results, was up +1.9% from the same period last year, with 67.2% of the companies beating expectations with a median surprise of +3.2%. However the picture becomes bleaker as we enter the fray of alternative energy.
As of Feb 4, 2013, total earnings for the 276 S&P 500 companies that have already reported results, was up +2.7% from the same period last year, with 67% of the companies beating expectations with a median surprise of +3.1%. However the picture becomes bleaker as we enter the fray of alternative energy.
A look at the Zacks Earnings ESP (Expected Surprise Prediction – read: Zacks Earnings ESP: A Better Method) in the table below shows an overwhelming trend of misses expected for alternative energy players this quarter.
We nonetheless feel alternative energy companies with deep pockets and presence across the value chain will confidently sail through this phase smoothly. In this space we are bullish about First Solar Inc. (FSLR) with its growing utility-scale project business. The company is also in an advantageous position over U.S. Commerce Department taking a strong stance against Chinese solar players through antidumping duties.
Another bullish name on our cards is French oil major Total S.A.’s subsidiary SunPower Corporation (SPWR) owing to its extensive dealer network, systems business, growing leasing footprint and last but not the least the deep pockets of its parent.
To sum up, the fourth quarterly numbers are not going to bring sunshine back to the alternative energy sector. The attractive valuation and the moderate growth prospects notwithstanding, we feel this earnings season will not be the jump-start to higher gears for the sector.