Traditionally, solar stocks have shown a high correlation with the price of crude oil, i.e. solar stocks move higher when oil prices are stable to moving higher and vice-versa. Even if the underlying business for solar companies may have different catalysts, it is better to look at these stocks when crude oil is holding up well.
Now that crude oil price is back to $40 per barrel range, this is a good time to focus on long-term secular demand story playing in the renewable energy sector in general and solar in particular.
Macro sector dynamics may not look that impressive
From a macro sector standpoint, old investor concerns like building overcapacity, wasting capital, and leading to poor profitability continue to hold back the sector, but stocks usually lead any improvement in fundamental business.
Much of the solar value chain, consisting of polysilicon, ingots, wafers, cells, and module, which is a collection of cells connected, have some amount of overcapacity. The case for consolidation is easy to make, but not going to happen anytime soon, especially in today’s geopolitical environment.
China’s solar installations declined over the last two years, down to 30 GW in 2019 from 53 GW in 2017 and some believe that the Chinese government is finally letting a market-oriented approach to play after years of subsidies.
Some industry consolidation did happen. The five biggest solar cell makers accounted for almost 38% of domestic production in 2019, up 8% from 2018. But recent news flow suggests more expansions on the way.
As per BloombergNEF , Thirteen Chinese firms led by the top suppliers plan to add at least 40 GW of annual capacity in ingots, wafers and cells each, once again raising market concerns about a glut of photovoltaic products and price wars down the road.
U.S. solar industry is already in a weak spot, as evident from the poor health of Tesla’s (Nasdaq: TSLA) subsidiary SolarCity, which was once a leader in residential solar power.
Some bright spots though
Some green shoots are emerging. According to BNEF, Wind and solar are now the cheapest sources of energy across more than two-thirds of the world and these sources will undercut commissioned coal and gas-based energy almost everywhere by 2030.
Companies like First Solar (Nasdaq: FSLR) that sells mostly to utility companies have a large backlog of work that should hold up during the covid-19 related slowdown. First Solar, during the latest conference call talked about good near-term visibility, given a backlog of 12.3 GWs that will fill demand through 2021.
Some of the consumer-facing companies are benefiting from the digital sales models, creative lease programs and discounts during the current slowdown, things that may help over the longer term as well.
Sunrun (Nasdaq: RUN), a residential solar company, is using drones to assess roofs. Both Sunrun and SunPower (Nasdaq: SPWR) are giving consumers six months free and leasing solar panels to customers, with no money up front. Since contracts generally last for 20 years, the deal will make financial sense as well.
Channels business for SunPower was strong during the latest quarter, with help from U.S. residential business, where installs rose 50% year-over-year and strong gross margins even during seasonally weak period.
Chinese players have an advantage that is not going anywhere soon
China is a clear leader in the global solar supply chain, from the production of ingots to wafers, cells and panels. Of the top 10 cell makers, nine are Chinese companies. Even if there is an industry level consolidation, there is little to suggest Chinese domination of the industry will go down.
The scale of solar projects is soaring. Some researchers are still projecting total capacity reaching 500 GW by 2025, double from last year levels. Expansions may act as deterrent smaller firms from adding new capacity.
Additional capacity, especially in newer technology, will also help decrease per-unit costs, required to maintain market share by bigger players. So existing leaders might be better placed than smaller players or newcomers to the industry.
Few interesting names
Scale, technology, margins and capital are important factors to evaluate potential leader stocks for the comeback. Ideally you want them all in a single player, but that is rarely the case.
Besides the fundamental business edge, some of China based players are better positioned to get help from government policies as well, worth keeping in mind while comparing them all.
Enphase Energy (Nasdaq: ENPH) and SolarEdge Technologies (Nasdaq: SEDG) look interesting because of their proprietary technologies, defensible duopoly like market structure and great margins that are expanding. The total available market may be more of a niche but great for small and mid-cap investors.
JinkoSolar Holdings (NYSE: JKS) China based manufacturer of wafers, cells and module has been beaten down for a while and coming back. Recently ITC ruled in favor of the company, related to infringing Hanwha Q CELLS patents. If the company can control its capital expenditure, there can a decent upside from available leverage in the model.
Daqo New Energy Corp (Nasdaq: DQ) One of the major manufacturers of polysilicon used by wafer manufacturers. Market dynamics for polysilicon has been improving for a while now. Improving utilization rates do wonders to the margins and cash flows given most of the costs are fixed in nature for the company.