For Immediate Release
Chicago, IL – April 17, 2018 – Today, Zacks Equity Research discusses the Industry: Alternative Energy, Part 3, including Jinko Solar (JKS - Free Report) , Azure Power Global (AZRE - Free Report) , Dominion Midstream (DM - Free Report) , SunPower Corp (SPWR - Free Report) and NextEra Energy Partners (NEP - Free Report) .
Industry: Alternative Energy, Part 3
China’s emergence as a global leader of investment in clean energy projects poses serious threat to U.S based operators for the Alternative Energy industry. China has been a frontrunner in terms of solar module manufacturing and it has made substantial wind power investments in 2017 to expand its renewables footprint worldwide.
While China is vigorously expanding its renewables businesses, the operating environment for the U.S renewable industry has been less than helpful given the Trump administration’s less-than-supportive environment. The current administration’s actions on the Clean Power Plan in March 2017 and unilateral exit from the Paris climate agreement are part of this unhelpful posture. The imposition of a 30% import tariff on solar panel components will also form part of this unfavorable backdrop.
The industry has held up reasonably well so far, but the operating environment in the United States has undoubtedly become far less supportive and helpful, which is essential for a relatively young industry. Stocks in the Zacks Alternative Energy industry are down -5.2% in the year-to-date period, lagging the S&P 500 index’s -0.8% decline.
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.
China’s Clean Energy Leadership: China established itself as a global leader by substantial investments in clean energy projects. Indeed, the nation plays a critical role in the global transition toward a clean energy future in an increasingly carbon-constrained world.
Notably, China installed 50 GW of solar PV in 2017, smashing the 10.6 GW count of the United States. Surely this boosted the prospects of the Chinese solar companies over their American counter parts. Chinese solar module manufacturer Jinko Solar maintained its world-leading solar module shipments position in 2017.
Along with third-quarter results, Jinko Solar issued a guidance that called for full-year shipment of 9.6-9.8 GW, about 10% of global share. When the company reported its full-year result in March 2018, it successfully achieved this target.
Going beyond its obvious dominance in solar, the country has become a pioneer in wind power. China Energy Investment Corporation is now the world’s largest developer of wind energy, post the acquisition of China Guodian. The companies together intend to invest around $3.5 billion in energy projects. In hydro power as well, China is expanding its international footprint in countries like Nepal, Brazil, Philippines and lately Pakistan.
Import Tariff on Solar Modules: In January 2018, the U.S. government announced the levy of 30% tariff on import of solar panel components. In four years’ time, the tax rate is expected to come down to 15%. Following the news, U.S. solar stocks moved up buoyed by hopes that such trade restrictions will create jobs for Americans. However, with the passage of time, the solar industry’s growth was not sustained as investors seemed to have become skeptical over the long-term success of the tariff.
This was part of Trump’s broader protectionist agenda to help U.S. manufacturers against foreign producers who flood the market with cheaper solar modules. The U.S. administration argued that the Chinese government subsidized solar manufacturers and allowed them to sell products in the United States at less than their fair market value. This resulted in increased price competition among the U.S. solar stocks and more than two dozen companies were forced to stall operations.
U.S. solar industry advocates, however, have been raising strong objections against the move. The U.S. Solar Energy Industries Association predicted that the tariff may cut forecasted solar installations in 2018 by nearly 20%, to 9 gigawatts from 11 gigawatts, and lead to the loss of 23,000 jobs in the United States, the world’s fourth-largest solar market after China, Japan and Germany. Research firm Wood Mackenzie also estimated that over the next five years, the tariffs will reduce U.S. solar installation growth by 10-15%.
According to GTM Research, this new tariff is expected to increase solar module costs by 10-12 cents per watt, based on current U.S. import prices of 35 to 40 cents per watt. According to an earlier analysis, a 10 cent per watt tariff is expected to slow the solar market by 8.3%. No doubt this import tariff, if kept over the long term, will weigh on the U.S. solar market that imports more than 80% of its supplies from foreign nations, majorly from China.
Other Import Tariffs: In March 2018, the Trump administration proposed to impose a 24% tariff on steel imports and a 10% tax on aluminum imports. Now, steel and aluminum are important commodities for critical wind, solar and storage components. According to the U.S. Geological Survey, operational aluminum smelters in the United States have declined from 23 in 1993 to five in 2018. So, industries are dependent on imported aluminum and a tariff on the same will have an impact on the renewables industry.
GTM Research, MAKE Consulting and Wood Mackenzie collectively calculate the resulting price increase in commodities could potentially result in a 3-5% increase in the levelized cost of energy for U.S. renewable power plants, leading to slightly lowered forecasts for project deployments. According to the Solar Energy Industries Association (SEIA), steel and aluminum tariffs could add cost of 2 cents per watt to utility-scale solar projects, which is a significant increase on top of what the association sees as "job-killing" solar tariffs. Thus, Trump’s proposal for steel and aluminum import added to the woes of the U.S. alternative energy industry.
The Trump Effect: The present U.S. administration doesn’t have a friendly stance toward alternative energy sources. In June 2017, President Trump had announced his decision to withdraw from the Paris climate agreement. Many fear that whatever progress the United States has made last year toward pollution mitigation and renewable assets expansion in accord with the Paris agreement will now be in vain.
The current administration issued an executive order to roll back the Clean Power Plan – which was the preceding administration’s signature climate policy to curb carbon emissions to 32% below 2005 levels by 2030 at coal-fired power plants. The Clean Power Plan had mandated emission reduction goals for the states in order to ensure that the Environmental Protection Agency’s overall target was achieved.
The annulment of the Clean Power Plan, if approved, will lift the ban on coal leasing on federal lands, scrap regulations to curb methane emissions from oil and gas production, and lead to reconsideration of "social cost" of carbon emissions in all regulatory actions. The move will definitely hurt the clean energy space.
Market Pricing Scenario: In terms of valuation, the industry has always traded at a premium to the broader market, though the magnitude of premium to the market is a lot less than has historically been the case.
The Zacks Alternative Energy industry is currently trading at 24.7X forward 12-month Zacks Consensus EPS estimates. Over the last 5 years, the industry has traded as high as 97.3X and as low as 17.6X, with a median of 29.9X.
The S&P 500 index is currently trading 16.9X forward 12-month EPS estimates. Over the last 5 years, the index has traded as high as 19.1X and as low as 14X, with a median of 17.1X.
As such, the industry’s relative valuation picture remains favorable. But the aforementioned unhelpful government policy posture will likely continue to cause ‘multiple compression’ going forward.
Fed Rate Hike: In March 2018, the Federal Reserve raised rates for the sixth time since the policymaking Federal Open Market Committee began lifting rates off near-zero in December 2015. While long-term interest rates remain low by historical standards, a material rise in long-term interest rates is a key risk for this capital intensive industry that relies heavily on capital markets for access to funds.
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 raise cost of operations for the alternate energy companies, thereby reducing hurting profits.
New Emerging Technologies:The alternative energy industry remains an emerging sector with a steady focus on 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.
Limitation of Quantity: Renewable energy technologies totally depend on the weather to generate energy.
Hydro generators require rains to fill dams to supply flowing water. Wind turbines require strong winds to move the blades, and solar generators have need of clear skies and sunlight to gather heat and generate electricity. When these resources are absent, in the event of weather fluctuations, it hampers the amount of electricity generated. This problem can be solved with energy storage, which leads to additional costs.
It is difficult to generate large volumes of electricity from renewable sources compared with traditional fossil fuel generators. Solely depending on renewables would either require a reduction in consumption or ramping up of energy facilities. In order to tackle current energy problems, it is necessary to strike a balance between different power sources.
Stocks to Avoid
Given the looming headwinds, we advise investors against names that offer little growth/opportunity over the near term. These include companies for which estimate revision trends reflect a bearish sentiment.
We remain skeptical of Azure Power Global and Dominion Midstream which carries a Zacks Rank #4 (Sell). Moreover, SunPower Corp and NextEra Energy Partners have a Zacks Rank #5 (Strong Sell), which investors may avoid investing in.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
China’s leading global position in terms of electricity generation from renewable sources poses competitive threat to the U.S. alternative energy industry. The current scenario, where Trump administration seems to be opposing the rise of the industry as is evident from the imposition of the aforementioned tariff, surely lends China a competitive advantage.
Of course, importing cheap solar modules from China was hampering the industry to some extent. But since the United States has to rely on these imports, levying heavy duty on these items isn’t wise as is evident from the looming trade war tensions.
Instead, we suggest the two nations should settle their dispute if they want to progress with the clean energy environment plans. This is because the countries are dependent on each other in terms of trade and slapping high taxes on Chinese manufacturers may do more harm than good for the U.S. industry.
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