Bright Spots in the Solar Storm

Back in 2007 I had an epiphany when I was working on my first book, Power Plays. I was doing some calculations to estimate the effect biofuel mandates might have on global oil demand. My conclusion was that because of the low efficiency of photosynthesis in converting solar energy to biomass, and considering the amount of available arable land on the earth, biofuels would never contribute more than perhaps 10% to our global liquid fuel supply. In 2007, the contribution of biofuels was 0.9% of the global liquid fuel supply. By 2014 that number had reached 1.7%.

But I came to a very different conclusion when I studied the potential of solar power. In contrast with photosynthesis, which generally operates at an efficiency of less than 1%, solar

photovoltaic (PV) cells convert solar radiation into usable energy at efficiencies ranging from 10% to 15%. Experimental cells have been developed with efficiencies above 40%. At that time solar power still wasn’t cost competitive, but costs were falling rapidly. I reasoned that in a world with a growing population, efficiency would be at a premium. Thus, I concluded that The Future Is Solar.

Solar Goes Supernova

It would be putting it mildly to say that growth in solar power has exploded since 2007. That year, the world consumed 6.8 terawatt-hours (TWh) of solar power. By 2014, that number had grown to 185.9 TWh — a 30-fold increase thanks to a compounded annual growth rate of about 60% over that period.

Germany was the largest national consumer of solar PV power in 2014, with 35.9 TWh. It was followed by China (29.1 TWh), Italy (23.7 TWh), Japan (19.4 TWh) and the U.S. (18.5 TWh). China is in second place globally for installed solar PV capacity, and if it maintains its recent growth rate it will surpass all countries sometime this year.

Solar power still has plenty of room to grow. Installed global capacity at the end of 2014 was almost 180 GW, but the 185.9 TWh consumed in 2014 still amounted to only 0.79% of global electricity consumption, up from a 0.034% share in 2007.


Until recently, the U.S. outlook for solar growth had been clouded by the expected expiration at the end of this year of the solar Investment Tax Credit (ITC), a 30% federal tax credit for the capital cost of solar systems on residential and commercial properties. As a result, growth was expected to slow from the explosive pace of recent years.

Research firm IHS previously predicted global installations of new solar PV would peak at 70 GW in 2016 – a 20% increase over 2015 driven largely by a push in the U.S. to beat the ITC sunset. IHS forecast that expiration of the tax credits at the end of 2016 would have led to a projected global decline of 10% in 2017, with installations falling back to 63 GW.

But the $1.15 trillion Consolidated Appropriations Act, 2016, passed in December, extended the ITC at the current 30% level for both commercial and residential systems through 2018. At that point the tax subsidy begins to diminish, settling at 10% in 2022. This has huge implications for the continued growth of the solar PV industry.

The Solar Energy Industries Association projects that that extension of the ITC will lead to more than $125 billion in new private investment in solar projects. IHS called the extension “one of the most significant stimulus policies for the renewable sector in the past 10 years,” and now forecasts that global solar capacity additions will increase from about 59 GW this year to 66-68 GW in 2016 and 70-73 GW in 2017.

These federal subsidies are now due to sunset just before the first set of state compliance deadlines for the EPA’s Clean Power Plan (CPP) in 2022. The CPP, which has just been put on hold by the U.S. Supreme Court while lower courts adjudicate a legal challenge from 29 states and the affected industries, would require a 32% cut in utility-sector carbon emissions from 2005 levels by 2030.

States Lead the Charge

But even if the CPP is ultimately overturned, utilities have other good reasons to invest in solar power — many are required to do so by their states’ alternative energy mandates.

For instance, California, which already derives more than 20% of its electricity from renewable sources, last year upped its mandated renewables share in electricity sales from 33% by 2020 to 50% by 2030.

New York, on order from Gov. Andrew Cuomo, is in the process of raising its renewables mandate from 30% as of 2015 to 50% by 2030 as well. Hawaii has legislated 100% reliance on renewable power sources by 2045.

Such mandates are not just a blue-state phenomenon. Texas required a minimum of 5,880 megawatts (MW) of renewable generating capacity by 2015, and had more than twice as much by 2013, mostly as a result of rapid investment in wind turbines. Nevada law requires 25% of the state’s energy consumption to come from renewable sources by 2025. In all, 29 states and the District of Columbia imposed renewable portfolio standards (RPS) as of last year:


Source: U.S. Department of Energy study

In the aggregate, such mandates will require 106 GW of domestic renewable capacity other than hydro-electric by 2025, accounting for 8% of the U.S. power supply. Renewables other than hydro accounted for 6.4% of the power generated by commercial U.S. suppliers during the first 10 months of 2015.

But this is not just about the government mandates, in the long run. It’s about steady technological advances driving a rapid decline in the cost of solar power, to the point where large utility-scale arrays in the right place can generate electricity as cheaply as the lowest-cost gas-powered plants.

Thi is a very different revolution from shale one, in which increasingly expensive chemical cocktails need to be injected one multi-million well at a time to coax the oil and gas from unyielding rock. In solar, incremental improvements in the efficiency of photovoltaic cells or control systems are quickly replicated across a dynamic and ultra-competitive industry at ever lower cost.

Investment Implications

The cutthroat competition makes solar investments risky, especially in this year’s panicky stock market. The Guggenheim Solar ETF (NYSE: TAN) is nursing a 34% loss year-to-date and has shed 59% since topping out last April. Worries about key solar market China have certainly played their part, along with lower prices on competing fossil fuels and a downturn in sales of residential rooftop panels.

But even in an environment as harsh as this one, there are companies that are winning more than their share of battles. One in particular has been in our portfolios for the nearly three years and now joins the short list of current Buy recommendations. The other is a more recent addition as a deeply discounted yieldco weighed down by its ailing sponsor.

The industry leader is First Solar (NASDAQ: FSLR), which just as we predicted it would back in 2013, has successfully transformed itself from a loss-making modules maker into a leading, and profitable utility-scale project developer.

Over the last four quarters, First Solar has produced $328 million in free cash flow — cash earnings less investments in its business.

Sales have been brisk and cost savings steady amid improvements in the company’s proprietary cadmium-telluride thin-film technology for photovoltaic cells, leading First Solar to increase its 2015 profit guidance in October. In December, the company forecast sales growth of approximately 13% for 2016 and an ending net cash balance of $2 billion to $2.3 billion, up from an expected $1.3 billion in net cash at the end of 2015.


Source: First Solar presentation

Management plans to run its plants at 96% capacity to deliver a 20% year-over-year modules increase, yet is no hurry to add capacity ahead of contracted demand. This conservative bent is reflected in the industry’s strongest balance sheet.  

Although the stock boasts one of the market’s few healthy-looking charts, with the share price up 50% from its September low, it is not fundamentally expensive with an enterprise value at 5.6 times trailing EBITDA and forward price/earnings ratio of 14.4 based on the midpoint of the company’s 2016 guidance.

The 8point3 Energy Partners (NASDAQ: CAFD) yieldco (dividend-paying affiliate) launched last summer in a joint venture with SunPower (NASDAQ: SPWR) has also fared better of late, giving First Solar an affiliated buyer for some of its completed projects.

We’re upgrading Growth Portfolio recommendation FSLR to a Buy with a tight initial limit of $65. Subscribers looking to capitalize on the stock’s traditionally high volatility might wait to see if it goes on sale following the fourth-quarter results due the last week of February.

Our second recommendation comes from the bottom of the deep discount bin. TerraForm Power (NASDAQ: TERP) is the yieldco sponsored by the troubled Aggressive Portfolio holding SunEdison (NYSE: SUNE). As recently as last summer SunEdison was seen as an industry leader rivaling FirstSolar, until it ruinously overreached by overpaying for a marketer of residential rooftop panels.

Because SunEdison relied heavily on debt financing in contrast with FirstSolar’s prudence, the subsequent collapse in the value of its own stock and those of its yieldcos left it struggling for survival.

The silver lining in this whirlwind for TerraForm Power is that it should see immediate significant appreciation in the increasingly likely scenario of ending up with a different sponsor, whether through a sale or a restructuring.

Right now, TERP shares yield 18% annualizing the most recent dividend, vs. 6% to 8% for the more popular yieldcos.

Some of the spread is justifiable given the credit crunch at SunEdison, which has leaned financially on its affiliates to make ends meet. Further, TERP’s strong current portfolio of renewable assets with 1.918 MW of generating capacity selling power to investment-grade offtakers under long-term agreements could be diluted with the higher-risk 470 MW portfolio of residential rooftop assets it has agreed to buy as part of SunEdison’s pending acquisition of Vivint Solar (NYSE: VSLR).

But there are grave doubts as to whether that acquisition will go through, and TerraForm will be be an immediate winner if it doesn’t. But even if it does, the current discount looks excessive for the added risk especially given the long-term likelihood of a new affiliation with a healthier project developer than SunEdison. We’re adding TerraForm Power to the Aggressive Portfolio. Buy TERP below $10.    


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