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The Wall Street Flaneur is and has been a solar bull. When we covered the solar sector early last summer, the industry was in dire straits. Major players had seen more than 75% of their market capitalization wither in a year’s time, Solyndra had nearly made solar a bad word, and with fiscal crises roaring in Europe and a highly polarized political race impending at home, the solar industry’s future seemed anything but certain. Fast forward eight months and market capitalizations of players, such as our pick SunPower, are at or near 52-week highs having more than doubled since our analysis, 2012 saw record solar capacity installed, and if the President’s State of the Union address was any indicator: renewable energy, alongside the oil and gas renaissance, will play an important role in this country’s and the world’s energy future.
- 2013 will be another record year in the US: More than three gigawatts were installed in the US in 2012, a record. That amount represented a more than 75% increase over 2011, which itself increased 109% over 2010. Favorable policy and continued cost improvements ensure continued, rapid growth in 2013.
- China will become a bigger source of demand: China’s major panel manufacturers, Yingli, Trina, and Suntech, were in the hottest water. But the Chinese government has stepped in with bailout loans and perhaps more importantly, set aggressive domestic renewable energy goals, of which solar will be a major part. Expect solar to follow the broader theme taking place in China right now: growth driven by domestic demand.
- Technology – thin film and crystalline – will co-exist: the long running debate between thin film manufacturers, such as First Solar, and crystalline, such as SunPower, will not be decided this year, if ever. There is room for both technologies foreseeably. First Solar’s lowest cost/low efficiency dynamic makes its panels a good choice when land is abundant and cheap. First Solar will continue to thrive as utility plant developer and pseudo independent power producer. SunPower’s efficiency edge gives it a competitive advantage where space is limited, such as roof tops. But SunPower, backed by energy giant TOTAL SA, has significant expertise in utility scale project development as well. Expect both to grow.
- Cost structures will continue to stabilize, improve: margins were crushed by a supply/demand imbalance, which led to poor asset utilization industry wide. Most players overbuilt production capacity and when the slowdown in the European markets hit, competitive pressures had players undercutting each other on price, even to the negative gross margin territory in the case of some of the Chinese players. However since the lows, SunPower has posted steadily improving gross margins. We expect increased scale and identified but yet-to-be-realized manufacturing efficiencies to drive the return to profitability.
- Panel manufacturer landscape – some consolidation but still fragmented: expect some of the weaker players to be picked off or to fail. Last year, we would have said expect a consolidation among the Chinese firms, but the government lifeline makes the future less certain. For now, we expect a largely fragmented market to remain as such.
- Heightened consumer interest, adoption: we touched on this in our SolarCity analysis. Innovative financial structures that allow for home and business owners to put zero dollars down in exchange for a commitment to purchase below utility-rate solar-generated power and costs that continue to fall will collectively drive market growth. As the market grows, solar energy becomes more visible and thus more sticky.
Why we’re long. Reiterating our case from last year:
- Favorable federal and state policy – the Investment Tax Credit, a tax credit that covers 30% of the cost of solar energy equipment, is in place through 2016 at which time it steps down to 10%. This has been a major driver to date and its four-year horizon adds needed certainty to the industry’s future. Furthermore, state-level renewable energy programs (typically referred to as Renewable Portfolio Standards) mandate electricity suppliers source a certain percentage of their electricity from renewables (17 + Washington, DC include specific provisions for solar). This effectively ensures a multi-billion opportunity each year. Let’s take Pennsylvania as an example: for compliance year 2013 (ending May 31), electric distribution companies and electric generation suppliers must supply 0.051% of electricity from solar resources. That is 56.9% more than compliance year 2012. Compliance year 2014 mandates 0.084%, a 64.7% increase over 2013. In 2011, when the requirement was considerably lower, Pennsylvania installed nearly 90 megawatts of solar capacity, which at the time represented more than $500 million of installed cost. This is just one state and the other 16 in addition to DC are structured in much the same way, some with an even more aggressive ramp.
- Declining costs and cost visibility – panel costs have fallen by more than 50% since 2009. Equally importantly, costs are declining following a predictable pattern.
- International competitive pressures – we’re not calling this the Space Race of our day. But major countries around the world have announced significant commitments to solar. And with eyes toward a secure, independent energy future, we don’t see any of the major names bowing out of the renewables race.
- Bipartisan friendly landscape – on the surface, a head scratcher. The political process in Washington is at a near stalemate. Still, we think the US oil and gas boom that has narrowed trade deficits will go on undeterred. And so long as it does, and is not excessively tampered with, we believe it creates a significant opportunity for renewables and fossil fuels to co-exist.
- Increased visibility for end users – solar roof tops and solar fields are proliferating. SolarCity more than doubled its 2006-2011 cumulative customer count in 2012 alone. We think there’s a certain got-to-have-it factor, not unlike Apple’s products enjoyed in the last decade that will boost solar adoption, particularly as costs continue to fall.
- Innovative financing and return of tax equity – innovative financial models, such as SolarCity’s, that enable home and business owners to put $0 down, and purchase on site-generated solar power at rates lower than prevailing utility rates is pretty close to can’t-miss. These models are predicated on tax equity financing, and we expect dollars to continue to pour into this market as major banks and other financial players return to profitability and look for attractive tax planning options. We’re also curious to see if oil and gas-heavy MLP structures are put to use in the solar industry.
So where’s the risk? Potential disruptions:
- Major change of policy – solar returns are driven by the sun, yes, but they are also driven to attractive levels by policy. A return to recession or ongoing fiscal brinksmanship may ultimately significantly hamper solar-friendly policy. But given the thousands-strong solar workforce in the country, we see this as politically daring and probably messy.
- Inability to generate consistent profit – panel manufacturers are still running at losses. The industry remains in oversupply mode, with production capacity outstripping demand. But again looking at our SunPower pick – the company has steadily improved gross margins and we expect additional scale will drive future profitability. Management has also identified further cost efficiencies it expects to drive out of the manufacturing process. Some players will fail, no doubt, but we expect the strong to survive.
- Precipitously falling electricity rates – an abundance of cheap natural gas, which utilities are increasingly turning to for power generation, could put downward pressure on utility rates. As these act as a sort of cap for solar rates, any decline hampers solar’s competitiveness. But for 40 years, electricity inflation rates have significantly outpaced the broader CPI. Cheaper natural gas may help, but already enjoying some of the world’s cheapest energy, we don’t see much room.
- Irrational valuations – the valuation highs of 2007 – 2008 never made sense. The market did see the growth that has taken place, but failed to account for competitive pressures that would push panel costs downward and the concentration risk that the European market presented. The market is more mature now and more diversified, but be wary of unreasonable growth expectations. We think the US will continue to grow rapidly over the near and intermediate term, with likewise rapid growth in the emerging economies, and growth albeit less certain in the more mature European markets.
Solar will continue to grow. Its cost has fallen rapidly, it enjoys favorable policy, it employs more than 100,000 people in the country and more than one million around the world, and major economies are making major commitments to a renewable energy future. We’re not here to say whether we agree, or whether it’s the right technology. We are here to say: solar is here to stay.
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