Image Source: Chuck Coker
Clean or renewable energy sources will undoubtedly be a part of how we generate power in the future, but how investible is the space? The answer is largely dependent on your risk tolerance.
Key Takeaways:
The success of the solar industry at this point in time is dependent on public policy, specifically investment tax credits, which allow participants to compete with traditional energy sources.
The wind power industry is more developed than the solar industry, though many of the largest players in the industry are large utility holding companies.
There are a wide range of ideas ancillary to the renewable energy movement in the areas of emissions reduction, power storage, and energy efficiency.
By Kris Rosemann
“The dependence of the solar industry on tax credits to be competitive keeps us on the sidelines for the foreseeable future, and we suspect it may be several years before the industry can be considered stable.” — Kris Rosemann
Demand for clean energy does not exist in a bubble. Clearly there are certain factors that make it irreplaceable to some and unusable for others, but at this point in time renewable energy demand falls under the umbrella of energy demand, which continues to be dominated by traditional fossil fuel energy generation. The recent rout in energy resource pricing impacted demand for substitutes such as solar or wind power, showcasing their interrelatedness, but both solar and wind continue to grow as a percentage of energy generating capacity in the US.
The solar industry in particular has felt the pressure of a supply glut in the energy markets, as the aforementioned commodity price pressures has somewhat coincided with a run-up in production capacity. Recent restructuring initiatives within the space, such as the workforce and capital spending reduction plan at SunPower (SPWR), indicate that industry participants may be battening down the hatches for an extended period of time. Despite the strong growth in solar photovoltaic (PV) production capacity in recent years–solar made up nearly 30% of all additions to electrical generating capacity in the US from 2013-2015–it only makes up ~2% of total capacity in the country, indicating a long potential runway for growth.
However, the deployment of solar PV systems has been and continues to be dependent on the support of public policy. Even the least expensive systems today, which include utility-scale systems in areas of high insolation, require federal tax incentives to compete economically with traditional energy sources. On a positive note, the Energy Policy Act of 2005 created a 30% investment tax credit (ITC) for residential purchasers of PV systems and raised the same credit for businesses to 30% from 20%, and the ITC was recently extended through 2023, though gradual annual reductions are planned for 2020-2022 and thereafter. It is worth noting that Congress and the President could reduce or eliminate the ITC before that time, which may not be out of the realm of possibility given some of the commitments the Trump administration has made to traditional energy generation across the US.
We continue to be wary of any business that is overly dependent on regulatory or other outside forces to compete effectively, even if recent reports suggest Trump will leave the renewable energy tax incentive plans untouched. Whether it is the federal-grant funded for-profit education or the heavily regulated utilities sector, we think it makes sense to seek out businesses that are able to generate economic profits without government incentives, particularly in a time of such uncertainty surrounding a wide variety of policies in the US. There will likely be a time in the perhaps not-so-distant future where this is the case for the solar industry, but until the technology of the space is at a point that it is able to be a “true” economic (standalone) substitute for other forms of non-renewable power, we see it as a speculative market that could easily eat up overzealous investor capital.
Tax incentives for wind power are lower than that of the solar industry, and the phase-out of said incentives is scheduled to occur sooner. The final year of a 30% production tax credit (PTC) for large wind was 2016, with the PTC decreasing to 24%, 18%, and 12% in 2017, 2018, and 2019, respectively. The benefit for small wind turbines ceased at the end of 2016. Wind energy appears much closer to being economically competitive with traditional power sources across much of the US, and it accounted for nearly 5% of total US electricity generated in 2015. Some market observers estimate wind power will account for 20% of US electricity by 2030.
However, one issue that arises within the investment thesis of wind power in the US is the ownership of wind farms across the country. Many of the largest owners of wind farms are large utility holding companies such as NextEra Energy (NEE), whose subsidiary Nextera Energy Resources is one of the world’s largest generators of wind power and generates roughly 70% of its total capacity via wind. While large entities such as NextEra may be able to more rapidly facilitate the expansion of wind power via their access to large amounts of capital and relationships with regulators, the consolidation of new and old energy sources in this way caps the potential for alpha generation for investors. However, such a scenario does help mitigate risk associated with potential boom and bust cycles in an up and coming industry in which smaller players may be more likely to overextend themselves. ‘Greener utilities’ such as NextEra may be of interest to investors looking for exposure to wind power technology.
There are a wide range of companies participating in the clean energy movement in avenues other than the generation of renewable energy. Changing energy supply and demand dynamics are forcing innovation in a number of ways, from emissions reduction to power storage to energy efficiency. Those focused on emissions control include the likes of Ceco Environmental (CECE) and Corning (GLW), and many investors are likely to recognize Tesla Motors (TSLA) as a potential market leader in next-generation power storage. Rapidly advancing Internet of Things technology will undoubtedly play a role in the expansion of renewable energy generation capacity, “The Next Industrial Revolution – Internet of Things.”
We view the energy efficiency-focused space as one that may have the most potential in its current state. The upside potential may not be as great as that of a long-term winner in solar–something we warn against attempting to predict at this point in time–but evolving industrial companies such as Emerson Electric (EMR) or Eaton (ETN) offer solid income generation along with the potential for upside surprise as they are related to high-growth industries–neither offers an attractive value opportunity at current price levels, however. Emerson Electric’s dividend track record is second to none at more than 60 consecutive years of annual dividend increases, and its Dividend Cushion ratio is solid, but it is important for investors to be cognizant of these firms’ ties to the cyclicality of industrial- and energy-based end markets.
The future of clean energy certainly is bright, but whether it is worthy of investment dollars is another thing. The dependence of the solar industry on tax credits to be competitive keeps us on the sidelines for the foreseeable future, and we suspect it may be several years before the industry can be considered stable. Furthermore, we generally prefer to avoid the regulatory risk that comes with exposure to any one specific utility via including the Utilities Select Sector SPDR ETF (XLU), which happens to include a 9%+ stake (the largest in the ETF) in NextEra Energy. Ancillary ideas exist in established players within the areas of emissions control, power storage, and energy efficiency, among others, but a deeper dive in those areas goes beyond the scope of this article. Please check out our reports on industries such as Pollution Controls, Electrical Equipment, Industrial Electric Equipment, Electronic Component Suppliers, and Environmental Services for other potential ideas related to the clean energy movement.
There are also a number of clean or renewable energy ETFs available to investors that may be considering exposure to the space such as the PowerShares WilderHill Clean Energy Portfolio (PBW) or the iShares Global Clean Energy ETF (ICLN), or even a “pure-play” solar ETF, the Guggenheim Solar ETF (TAN), but these more speculative-idea filled ETFs often come with higher expense ratios than we are accustomed to. For example, the PBW’s net expense ratio checks in at 0.7% compared to 0.14% for the XLU. For the time being, we are satisfied with our exposure to wind energy via the XLU, not to mention the exposure to the evolution of the broader energy arena via General Electric’s (GE) expanding manufacturing capabilities and Internet of Things technology, in both newsletter portfolios. We’ll let readers know if our thoughts change in the future.
Solar: CSIQ, FSLR, JKS, SPWR, TSL
Article tickerized for stocks in the Guggenheim Solar ETF.