Is the group's recent run-up a solar flare or a sign of bigger things to come?
Solar energy stocks are hot once again, with shares of industry players jumping as much as 58% in the past month. Much of that bounce is due to nearly uniformly positive quarterly earnings reports from some solar outfits. Company executives were able to allay investors' fears about declining demand and lower prices for solar panels and related materials, concerns that were fueled by a sharp reduction of government subsidies in countries such as Spain.
"You've had a lessening of fear in the market of what would happen with Spanish traffic and the U.S. tax credit," says Pavel Molchanov, an analyst who covers solar companies for Raymond James & Co. (RJF). "The visibility hasn't improved, but investors are taking it more in stride and are feeling more confident that, even in the worst case, there will be ample demand in other more early-stage solar markets."
The U.S. investment tax credits for wind and solar power, which currently reimburse property developers 30% of what they spend on installations, would revert to 10% at yearend if no legislative action is taken. "To most developers, that 10% may as well be zero," says Mark Burger, a principal at the Oak Park (Ill.)-based renewable energy consulting firm Kestrel Development.
Stronger Demand Down Under
On earnings conference calls, the management of several solar companies assured shareholders that instead of a decline of more than 10% in the average selling price for solar modules in 2009 that investors had feared, prices would probably fall 5% to 10%. Top executives stressed that despite an expected drop in demand from Spain, which plans to cap the number of solar projects eligible for a form of subsidy known as feed-in tariffs starting next year, they are seeing demand strengthen in countries like France, Italy, and Australia.
Japan's plan to restore its solar subsidies beginning next year after a four-year absence is also contributing to investor optimism. Feed-in tariffs are the renewable energy payments federal governments make to regional or national electric utilities to encourage them to buy solar- or wind-generated electricity at above-market rates set by government.
Positive news from individual companies such as SunPower (SPWR) has given the sector an added boost. The company signed a contract with Pacific Gas & Electric (PCG) in mid-August, under which it will not only sell 250 megawatts worth of solar panels to the utility but serve as the contractor and project developer on a 800-Mw power plant to be built near San Luis Obispo, Calif. SunPower is in a better position than most solar-panel manufacturers due to its in-house expertise as a provider of integrated systems.
Value Investors Intrigued
The project demonstrates the viability of utility scale for photovoltaic technology and for SunPower to win additional contracts, Credit Suisse (CS) analyst Satya Kumar said in an Aug. 15 research note. There could also be announcements of photovoltaic contracts from Southern California Edison, the state's other major utility. One possible glitch: The PG&E contract is contingent on extension of the American investment tax credit.
Another reason stocks have been rallying is their depressed valuation levels, says Molchanov at Raymond James. "The [price-to-earnings] multiples of solar companies had gotten so remarkably low that you had a lot of value investors starting to look at them, where historically solar has been more on the growth part of the spectrum," he says. Even after the rebound in the group, the typical solar company is trading at roughly 15 times 2009 earnings, less than half the annual growth rate in revenue of more than 40%, he adds.
Some accelerated buying of solar panels by residential and small business customers in anticipation of the possible expiration of the tax credit could be contributing to the stocks' gains as well. The tax credits are considered critical to an industry where the costs of solar and wind power generation are still much higher than the cost of conventional power generation.
Depending on Tax Credits
Generation costs from photovoltaic solar panels are falling at a rate of about 5% to 10% a year, depending on location and economy of scale, says Burger. They've begun to reach parity with peak power costs of conventional power sources in areas with higher utility rates like California and the Northeast, he says. At the same time, general electric utility costs based on conventional fuel sources are rising by 10% to 15% a year due to higher oil, natural gas, and coal prices, as well as the costs of environmental compliance. The renewable tax credits are necessary to help solar and wind power compete on a level playing field with other forms of electric generation, says Burger.
Legislation that would extend the tax credits has been defeated multiple times during the current Congress. The easiest way to get the credits extended would be through a stimulus package that President George W. Bush could sign. That would give fiscal conservatives in Congress cover to justify the unreimbursed spending on renewable energy, says Kevin Book, an energy policy analyst at Friedman Billings Ramsey (FBR). The lame-duck session that follows the November elections might also break down the last barriers to Republicans' political resistance, he adds.
The credits stand a much stronger chance of being reinstated next year, with more than 20 ranking Republican members of Congress slated to retire and the prospect of a larger Democratic majority in both houses. A larger Democratic majority in the Senate would lower the odds of a Republican filibuster, which has killed tax credit legislative numerous times before.
Lack of Long-Range Initiatives
"If Barack Obama wins [the November election], you have this Presidential veto that will go away," says Book at FBR. Passing a tax credit as matter of tax policy under a reconciliation bill, which is protected from a filibuster by requiring only 51 votes, not 60, would also be easier, he says. The Democrats already have 51 votes in the Senate. It's also not clear if John McCain were elected whether he would veto funding for alternative energy programs, he adds.
Even if the credit were to disappear for several months, it wouldn't have a meaningful impact on solar demand in the long run, says Molchanov. "We have excellent solar resources in the U.S. We have increasing power prices, plenty of renewable energy incentives even without the [investment tax credit]."
Book says he doesn't expect to see more than a one-year extension for the tax credits for wind and solar power, because influential Democrats in both houses are already looking at a different framework closer to the European regulatory system. The Europeans tie incentives to a new technology's performance rather than to the nameplate capacity of the generation that developers install.
The biggest hindrance to the growth of the solar industry in the U.S. is the lack of long-range policy initiatives, says Burger. Where Japan's residential solar incentive program lasted 12 years and Germany's feed-in tariff program has had a comparable run, national incentives in the U.S. have been limited to two or three years at a time. Spain's decision to back away from government incentives could result in the U.S. becoming the largest solar installer and manufacturer in the world, if it can develop a longer-term policy. Says Burger: "We've got the sun and the real estate and we potentially have the money, but we haven't had long-term policies in place that would give confidence to the industry to do serious business here."