Thursday, January 27, 2011
Strategy Team, Saxo Capital Markets
SINGAPORE, Jan. 27, 2011 /PRNewswire-Asia/ -- Despite the failure to make "progress" on climate change issues at the Cancun climate conference in Mexico, climate change and energy policy are still hot international topics. Saxo Capital Markets Pte Ltd expects the sun will shine on solar stocks in 2011 with a potential upside of at least 30 percent from current levels. The main drivers are strong demand, expansion of valuation multiples, a stable political outlook and lower production costs.
Solar stocks will rise like a Phoenix from the ashes
The latest years have been brutal for the solar and wind industry, as seen in the performance of the Guggenheim Solar ETF and First Trust Global Wind Energy ETF that track the solar and wind industries. The indices are still trading 60-70 percent lower compared to the summer of 2008 and even had a lousy performance for 2010.
Valuations on solar stocks have been held back by concerns that excess supply relative to demand will crush the industry's profits.
Saxo believes the market is far too pessimistic and the latest outlook for 2011 demand from the leading solar companies First Solar and Trina Solar indicate higher demand in 2011 - even in Europe despite concern over subsidies and tighter budgets. As the 2011 quarterly earnings are released; they expect the market will change its mind on solar stocks and send P/E valuations much higher from current levels around 9.6. An industry for which demand is projected to grow 9.6 percent annually until 2030 should not be valued at 9.6 times earnings because earnings growth normally exceeds growth in volume (demand) due to higher operating efficiency and share buy-back programs later in an industry's growth cycle.
Why does Saxo like solar more than wind?
When looking at the market pricing relative to expectations, the solar industry's revenue is expected to grow 22.5 percent in 2011 compared to 15.4 percent for wind. Profits in the solar industry are expected to grow at 28.7 percent compared to 71 percent for wind. The high growth rate expectations for wind are due to the decline in 2010 profits. With 2011 forward P/E for the solar industry at 7.5 compared to 15 for wind, the margin of safety is way larger in solar stocks. The current forward P/E for solar stocks indicates that investors doubt the earnings growth rate in solar stocks; and this is where the upside lies. If the solar industry even gets close to 28.7 percent growth in earnings (anything over 15 percent might even suffice), this could send solar stock valuations way higher. On the other hand, the current forward P/E of 15 for wind on a 71 percent expected earnings growth makes wind stocks unattractive compared to solar stocks. If the wind industry does not deliver there will be pressure on wind stocks throughout 2011 unless expectations for 2012 earnings are revised significantly higher.
From the perspective of industry-profitability, solar energy is also more attractive than wind energy. Solar companies have historically produced slightly lower returns on equity compared to the wind industry with the drag coming from lower leverage and asset utilization. This is about to change as the solar industry is expected to deliver higher return on equity in 2010 and 2011 compared to wind, driven by increasing asset utilization and significantly higher profit margin.
Generally, the solar industry has higher operating (EBITDA) margins and less leverage compared to wind. This signals a healthier competitive situation and if the solar industry is able to increase asset utilization, return on equity could easily pass the 15 percent mark in 2012.
The extended tax grant program (1603) in the U.S. will support solar demand in 2011 and into 2012 and Saxo believes it will compensate the expected slowdown in Spain and Germany due to cutbacks on subsidies there.
With bullish expectations for 2011 from all solar companies, low valuations, increasing asset utilization and stable EBITDA margins, Saxo expects solar stocks are positioned to go much higher in 2011 when valuations multiples are expanding on strong earnings.
Investing in solar stocks provides huge upside but this obviously comes with a couple of risk factors such as political, currency, demand and supply risk.
The political risk in solar investments is high because the industry is still heavily dependent on government subsidies. Germany is talking about cutting the feed-in tariffs for PV solar systems by 16 percent on July 1, 2011; political decisions are obviously an important risk factor. As the industry moves closer to grid parity the political risk will, however, slowly decrease which will lower the risk premium on solar stocks. With Obama's extension of the tax grant program (1603) political stability in the U.S. is secured in the short-term and the road to strong growth in U.S. renewable energy in 2011 is paved.
The biggest risk to their forecast is a significant collapse in the Euro compared to Asian currencies, as 75 percent of global solar sales are in Europe, while production is located in Asia. If this happens then operating margins could be substantially squeezed. According to Bloomberg, the two most respected and accurate currency forecasters, Standard Chartered and Westpac Banking, are both short-term bearish on the Euro and expect it to decline to around $1.20-1.25 by mid-2011. Third quarter statements from solar companies indicate the industry believes U.S. demand will compensate the falling Euro and demand in the Eurozone.
Concerns over low demand in 2011 (particularly in Europe due to declining feed-in tariff environment and tighter budgets) and excess production of solar panels have previously prevented multiples to expand despite increasing aggregate earnings in the solar industry. The latest outlook for orders in 2011 somewhat contradict this concern. The extended tax cuts in the U.S. will also add support for solar demand.
Solar energy is the future
The solar industry has evolved from infancy into a rapidly growing industry with increasingly economics of scale. According to Exxon Mobil's "Outlook for Energy -- A View to 2030" renewable energy including solar is set to grow at 9.6 percent annually until 2030.
General Electric's chief engineer, Jim Lyons, is predicting grid parity in sunny parts of the United States by around 2015 and that solar will eventually be bigger than wind. The biggest driver in achieving grid parity is production costs on solar panels. Renewable Energy Corporation and Q-Cells, the two biggest makers of solar cells expect to continue lowering costs for solar panels next year.
Life insurance companies are also a supporting driver for solar demand because they have entered the market as owners and are providing financing because solar parks provide a relatively stable income stream that is also independent of other assets classes. With internal rates of return on solar projects running around 8-10 percent with fairly low risk, this is a great opportunity for insurance companies to diversify their investment income.
The growth potential is enormous. The largest PV market in Europe is currently Germany and here solar only supplies around 0.3-0.5 percent of the total power production; so there is plenty of room for growth on a global basis.
Drop the ideology and go for performance
Whether global warming is a true trend or not renewable energy is here to stay because governments around the world want a cleaner and more fossil fuel independent energy source.
What Saxo has learned through the financial crisis is that when governments and central banks intervene in the markets it tends to do it forcefully and investors should not underestimate its impact on investment opportunities.
Saxo's message is this: do not underestimate the will of governments to support the solar industry going forward. They do not prefer subsidies to certain sectors, but they have to be realistic about this. Solar is rapidly moving towards grid parity, demand is soaring, governments want this energy source, the solar industry will eventually become competitive without subsidies and its size will eventually dwarf the wind industry. In 2011, the sun may shine on solar energy.
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SOURCE Saxo Capital Markets Pte Ltd