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),
Cleco Corporation (CNL), El Paso Electric
Company (EE), Great Plains Energy Inc.
(GXP) and UNS Energy Corporation (UNS).
Conversely, favorable rate cases and stable sales growth in
their respective service areas make companies like Ameren
Corporation (AEE), Huaneng Power International,
Inc. (HNP), Pike Electric Corporation
(PIKE), TransAlta Corporation (TAC) and
The AES Corporation (AES) 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.
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.
The long-term bullishness is shared even by oil goliaths like
Royal Dutch Shell plc (RDS.A) and BP
plc (BP) 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), 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), 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), 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.
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.
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.
Conclusion
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.
AMEREN CORP (AEE): Free Stock Analysis Report
AES CORP (AES): Free Stock Analysis Report
ATLANTIC PWR CP (AT): Free Stock Analysis Report
BP PLC (BP): Free Stock Analysis Report
CLECO CORP (CNL): Free Stock Analysis Report
COVANTA HOLDING (CVA): Free Stock Analysis Report
EL PASO ELEC CO (EE): Free Stock Analysis Report
GREAT PLAINS EN (GXP): Free Stock Analysis Report
HUANENG POWER (HNP): Free Stock Analysis Report
ORMAT TECH INC (ORA): Free Stock Analysis Report
PIKE ELECTRIC (PIKE): Free Stock Analysis Report
ROYAL DTCH SH-A (RDS.A): Free Stock Analysis Report
TRANSALTA CORP (TAC): Free Stock Analysis Report
TOTAL FINA SA (TOT): Free Stock Analysis Report
UNS ENERGY CORP (UNS): Free Stock Analysis Report
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