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Solar stocks are simmering – a major achievement for the simplest and most mature green energy technologies. Finding companies that can continue to shine may require a search in less obvious places.
The MAC Global Solar Energy Index generated a 233% return, including dividends for dollar investors over the past year. This is well ahead of the returns from wind turbine manufacturers Vestas and Siemens Gamesa, not to mention the 15% S&P 500.
As public and political support for green energy expands, markets expect decades-long renewable energy launches. It is hard to see any catalyst for a change in sentiment, says Sam Arie, a veteran public service analyst at UBS. Solar panels may be the cheapest way to generate electricity in many parts of the world. “In some cases, it is even cheaper to build a new solar farm than to operate the existing coal plants,” says Alex Monk, portfolio manager at asset manager Schroders.
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The problem is that the switch to renewable energy does not guarantee the return of shareholders. To justify high valuations, investors need to ensure that companies have a defensible business, as well as growth prospects.
Solar energy investors have already experienced at least two stomach-turning cycles. An important lesson was that making the panels themselves is a hypercompetitive low-margin market that is best avoided. But other parts of the value chain offer better prospects.
For example, SolarEdge and Enphase make energy inverters, which convert the energy from a solar panel into alternating current and adjust performance to maximize production. Its Nasdaq-listed shares returned 179% and 444%, respectively, over the past year and are now traded at 72 and 93 times future earnings. This is a lot of growth with prices. However, the technologies are patent protected and can also be central to managing the energy of a smart home between electric vehicles, solar panels, batteries and the like – a potentially vast market.
Developers are another option. They bid, build and manage solar parks. While installing the panels is not complex, experience is valuable in setting bid prices and navigating the licensing process, and scale is crucial to obtaining panels effectively.
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NextEra Energy, NEE -1.93% Enel ENEL -2.50% and Iberdrola IBDRY -1.86% built huge renewable energy farms as part of the broader utility business and have ambitious deployment plans for solar and wind energy . Its shares have given investors total returns of between 16% and 28% over the course of a year and now change hands 15 to 32 times future earnings. Barclays utilities analyst Dominic Nash credits part of the increase to general growth investors entering the industry for the first time.
Then there are the US residential developers, who offer homeowners solar panels on roofs combined with battery storage. The products provide additional reliability and monthly payments for the cost of batteries and solar panels that are generally less than existing utility bills. “It’s a very easy sale,” says Stephen Byrd, an analyst at Morgan Stanley.
The shares of SunPower SPWR 2.12% and Sunrun, two of these developers, are traded in Tesla-type multiples, 118 times and 360 times future earnings, respectively. Revenue will grow – solar penetration in the United States will increase from 3% now to 14% in 2030, says Byrd – but margins will also come under pressure, as installers compete head-to-head instead of traditional utilities.
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Investors need to choose carefully while the stock market’s solar roller coaster accelerates again. The general direction of the trip may be upward, but it probably still has many twists and turns reserved.