Alt-Energy Shines on Emerging Market Demand - Zacks Analyst Interviews

Overview

Alternative energy is now an important component in the power generation mix in many developed and developing nations. Although some better-established sources of alternative energy, like hydro, wind, biomass and waste, not to mention solar photovoltaics (PV), are supported extensively, niche renewable energy sources such as geothermal and concentrated solar power CSP are also on the rise, natural conditions permitting. Specifically, 2013 was an excellent year for the U.S. solar market.

Other upcoming alternative sources include the prospect of harnessing sea power. Numerous new ocean power technologies are on the verge of commercial development. Although this form of renewable energy is one of the most notable, it involves technologies with high research and development and startup costs. This has inhibited its all-out adoption so far.

Solar

A major growth area in the renewable space is solar energy. With the increasing need for developing renewable energy in response to stringent environmental regulations, countries worldwide are relying on solar energy for electricity generation.

The solar industry rallied in 2013 following a tough spell since 2011. The U.S. Energy Information Administration EIA estimates that U.S solar demand increased more than 32% in 2013. For 2014, the EIA projects that U.S. solar energy consumption will boom by roughly 35%. The expected increase in demand is likely to fuel top-line growth at the solar manufacturers.

President Obama's new environmental plan, unveiled in Jun 2013, putting further limits on existing coal-fired plants, gave a shot in the arm to the U.S. solar sector. The results were well reflected in the 2013 performance. The president issued directives asking environmental regulators to set up carbon pollution standards for active plants. Coal generates about 40% of U.S. electricity and coal plants are the largest source of carbon emissions in the country.

As a result, the U.S. Environmental Protection Agency is issuing directives to lower carbon emission from newer coal-based power plants while strengthening the existing policies on green-house gas emissions. This development has emerged as a major headwind for coal-fired utility stocks and has proved to be beneficial for renewable energy stocks like First Solar Inc. FSLR.

That said, the U.S. still has a lot of catching up to do, despite enormous potential, to get anywhere close to the global leaders. And the country is working towards that goal. Per the Solar Energy Industries Association (SEIA), the U.S. trade association of approximately 1,000 companies in the solar energy industry, the U.S. solar energy industry grew 41% year over year to reach 4,751 megawatt MW in 2013, the largest year on record. In 2013, 29% of all new electricity generation came from solar energy, up from a trivial 10% in 2012. This made solar the second largest source of new electricity generating capacity after natural gas.

2013 was one of the most happening years in the renewable space driven by a robust level of residential installations and a strong year in the utility segment with 2,847 MW of PV and 410 MW of CSP installed in 2013.

Looking at the cost side, the average cost of a completed PV system dropped by 15% during the fourth quarter 2013 on a year-over-year basis. Again, the average price of a solar panel has dropped by 60% since the beginning of 2011. These price drops will encourage more solar uptake by consumers.

After over 40 years of government investment in renewable energy (the U.S. alone spent $154.7 billion from 1973 to the end of 2013), it appears that solar energy is finally getting a strong foothold in the worldwide energy segment.

Indeed the PV market is gradually becoming global. According to the European Photovoltaic Industry Association (EPIA), a worldwide industry association for the solar photovoltaic electricity market, the cumulative global installed PV capacity stood at almost 136.7 gigawatt (GW) at the end of 2013, up 35% from the prior year. Europe is gradually losing its leading position in the PV market with Asia taking the lead.

As per media reports, China installed a record 12 GW of solar panels in 2013, making it the world's largest solar market in 2013, overtaking longtime leader Germany.

Last September, China's Ministry of Finance announced that local solar manufacturers will receive immediate refunds of 50% of the value-added tax (VAT) for sales taking place from Oct 2013 through Dec 2015. The Chinese government has set a solar installation target of 35 GW by 2015.

While the U.S. and China have been playing a big role in recent years in driving the industry, other nations are also pushing hard to have a home-grown solar generation capacity as a remedial measure to solve their electricity crisis. The latest to join this list is Asia's third largest economy, India. The country recently planned for a $4.4 billion solar plant which could perhaps be the world's largest.

Again, in Japan, companies like First Solar are investing substantially to install emission-free renewable set-ups. The country is expected to become the second largest market for solar products after China. First Solar -- the largest U.S. solar company -- is thus teaming up with Japanese counterparts to develop, build and operate solar power plants.

Wind

The American Wind Energy Association (AWEA) reported that the wind industry grew radically during the first quarter 2014. The U.S. industry installed 214 MW during the first quarter, up significantly from the year-ago installed capacity of 1.6 MW. The reported figure was also more than what the industry installed in the first three quarters of 2013. This brought the total installed capacity to 61,327 MW.

There were more than 8,000 MW of long-term power purchase agreements announced in 2013. EIA expects wind capacity to expand 9.0% in 2014 and 15.5% at the end of 2015. Electricity generation from wind is expected to contribute 4.5% to the total electricity generation basket by the end of 2015.

Hydro

Hydropower is considered the leading renewable energy source in the U.S. With the emergence of new technologies, like marine and hydrokinetics, this industry is likely to continue to generate vast amounts of sustainable energy throughout the country.

Hydropower is the cheapest source of electricity as it has the lowest cost per kilowatt hour compared to all other sources and is independent of the volatile movement in fuel costs. EIA projects that both hydropower and non-hydropower renewables used for electricity and heat generation will grow by approximately 3.3% in 2014.

In 2015, growth in renewables consumption for electric power and heat generation is projected to continue at a rate of 3.2%, as a 0.3% decrease in hydropower is combined with a 5.1% increase in non-hydropower renewables.

On Aug 9, 2013, President Obama signed into law two bills aimed at boosting the development of the nation's largest renewable electricity resource, hydropower. Enactment of laws is a prudent step to uphold hydropower development.

Zacks Industry Rank - Positive Outlook

We rank all the 260-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank.

The way to look at the complete list of 260+ industries is that the outlook for the top one-third of the list (Zacks Industry Rank of #88 and lower) is positive, the middle 1/3rd or industries with Zacks Industry Rank between #89 and #176 is neutral while the outlook for the bottom one-third (Zacks Industry Rank #177 and higher) is negative.

Within the Zacks Industry classification, the Zacks Industry Rank for Solar is #92 out of 260. This corresponds to the middle one-third of the list, implying a neutral outlook.

The Zacks Industry Rank for the Other Alternative industry is #87 out of 260. This puts the industry in the top one-third of all industries.

Among the 15 companies in the solar industry under our coverage, JA Solar Holdings Co., Ltd. JASO holds a Zacks Rank #1 (Strong Buy) while Yingli Green Energy Holding Co. Ltd. YGE carries a Zacks Rank #2 (Buy). For 11 companies under other alternative energy industry, Zacks Ranked #1 (Strong Buy) stock Ormat Technologies Inc. ORA and Zacks Ranked #2 (Buy) stocks Covanta Holding Corp. CVA and U.S. Geothermal Inc. HTM are making the most of the favorable market dynamics.

Please note that the Zacks Rank for stocks, which is at the core of our Industry Outlook, has an impressive track record going back years, verified by outside auditors, to foretell stock prices, particularly over the short term (1 to 3 months).

Here we take a look at the alternative energy space and attempt to identify this nascent industry's strengths and weaknesses.

EARNINGS TRENDS

As far as overall results of the alternative energy industry are concerned, first quarter 2014 was good on the whole. Most of the solar companies came up with first quarter earnings beats. High oil prices also aided solar stocks to reach new highs. Moreover, strong macroeconomic factors have helped this sector to rise above others in the energy space.

For 2014, we expect the solar companies to witness an impressive year with most returning to profit, building on last year's strength.

For more information about earnings for this sector and others, please read our latest Earnings Trends report.

OPPORTUNITIES

Environmental advantage: Solar power is the most benign electricity resource. Solar cells generate electricity without air or water emissions, noise, vibration, habitat impact or waste generation. Over time, rapid population growth, depletion of non-renewable conventional sources and escalating pollution levels will help shape a much more pronounced global focus on renewable projects.

Fuel risk advantage: Unlike fossil and nuclear fuels, alternative energy has no risk of fuel price volatility or delivery risk. Although there is variability in the amount and timing of sunlight in the day, season and year, a properly sized and configured system can be designed to ensure high reliability while providing a long-term, fixed-price electricity supply.

SunPower Corp. SPWR is one of the most forward-integrated solar companies, focused on moving up the value chain. The company once again registered encouraging first-quarter 2014 results, backed by brisk demand for its solar panels in utility, commercial and residential projects. It has also raised its outlook given the strength across regions and end markets.

JinkoSolar Holding Co., Ltd. JKS also seems to be in a strong position with multiple contracts and agreements. The company signed an agreement with PROINSO India for distributing its solar PV modules across India. This agreement comes after the announcement of JinkoSolar signing a $39 million loan agreement with China Development Bank. The deal was to finance two PV solar projects in Xinjiang and Gansu Provinces in China.

Location advantage: Solar power is generally located at a customer's site due to the universal availability of sunlight. As a result, solar power limits the expense and losses associated with transmission and distribution from large-scale electric plants to the end users. For most residential consumers seeking an environment-friendly power alternative, solar power is currently the only viable choice.

Among the renewable energy pack, we would advise investors to look for companies like rooftop solar energy systems provider SolarCity Corp. SCTY with an innovative game plan. The downstream solar company plays on its strength providing renewable power lower than the grid price to residential and commercial markets in the U.S.

The company is now set to grasp the largely untapped abundant solar power resources in one of the sunniest U.S. states: Nevada. This pioneer in residential solar is making a big expansion in Las Vegas.

In Apr 2014, San Jose, CA-based solar manufacturer SunPower and Google Inc. (GOOGL) have teamed up to form a $250 million fund to help homeowners across the U.S. to install solar panels at home. This pact is essentially aimed at financing residential solar system installations that SunPower will then lease out to homeowners.

Residential solar in the U.S. is now a sizzling story. This market even outpaced the commercial and utility segments last year and has already started to attract more conventional electric power companies that produce power mostly from coal and natural gas.

Japan looks bright: We note that Japan has recently been a happy hunting ground for solar companies in search for new markets. The country is going to be a key energy market and the government has set a target to install 28 GW of solar energy power by 2020. With around 6.9 GW, Japan was the second biggest global market in 2013.

Japan's need for electricity is on the rise, particularly after the Fukushima nuclear power plant accident triggered a complete phase out of all nuclear reactors in the country. Presently, the Japanese government is looking for alternate resources to meet the growing need for power in this very industrialized nation.

Recently, Canadian Solar Inc. CSIQ received a contract to supply 43 MW of PV modules for Japan's second-largest solar project.

Environmental legislation: Alternative energy companies are increasingly benefiting from new legislation in the U.S. stipulating installation of renewable sources of electricity generation as mandated by Renewable Energy Standards RES. As of now there are 29 states, the District of Columbia in the U.S. and 2 territories that have RES legislation in place. Another 8 states and 2 territories also have goals for adoption of renewable energy sources.

At the federal level, investment tax credit ITC is currently at 30%, which is set to expire in 2015, and then go to 10% in 2016. The industry will likely see many companies taking advantage of the 30% ITC, and build more panels, storage capacity, and other production items up to the end of 2015. Once the ITC drops to 10%, these companies can also utilize a higher rate of depreciation to protect their profits.  So the cut in ITC for 2016 will not likely dent these companies' profitability.

Also, under the American Reinvestment and Recovery Act (ARRA), the U.S. Treasury Department had earlier implemented a program to issue cash grants in lieu of ITC for renewable energy projects.

The wind sector also benefited significantly from the production tax credit (PTC) over the last few years. It was started in 1992 as a part of the Energy Policy Act of 1992. Subsequent to that it received life extension of half a dozen times. In the first decade of a renewable energy facility's lifespan, the PTC provided 2.3 cents/kilowatt-hour ITC benefit for wind turbines and 1.1 cents for some other renewable energy sources. In early 2013, the renewable electricity PTC was extended for one more year. However, it expired on January 1, 2014 due to Congressional gridlock.

Need for a pollution-free environment: Globally, utilization of renewable energy is rising primarily due to its clean nature and a growing awareness among the masses regarding its benefits. This has influenced utility providers like NRG Energy Inc. (TNRG), Sempra Energy SRE and Duke Energy Corp. DUK to gradually shift their mode of power generation to solar, wind And water.

NRG Energy, a Zacks Rank #1 (Strong Buy) stock, is diversifying its generation mix through the expansion of renewable assets. The company's recent acquisition of the assets of Edison Mission Energy, a subsidiary of Edison International EIX, and Roof Diagnostics Solar will support its renewable asset expansion program.

Duke Energy's business unit, Duke Energy Renewables, is a leader in developing innovative wind and solar energy solutions. Since 2007, Duke Energy has invested more than $3 billion to expand its portfolio of wind and solar power projects.

Currently, the company owns and operates approximately 1,700 MW of renewable energy, which includes 1,600 MW of wind power and 100 MW of solar power. In order to expand the use of renewable energy, the company is also developing an expertise in advanced technologies like the groundbreaking Notrees Battery Storage Project.

In Aug 2013, Duke Energy took over the largest solar generation facility in San Francisco -- the Sunset Reservoir Solar Power Project -- from Recurrent Energy. With a capacity of 4.5 megawatt alternating current (MWAC) this solar power system consists of almost 24,000 solar panels mounted on top of the Sunset Reservoir.

Also, Florida-based utility service provider NextEra Energy Inc. NEE, the major U.S. producer of electricity from wind and sunshine, now plans for an initial public offering of a unit -- NextEra Energy Partners LP -- that will own and operate renewable power plants. This unit will own interests in 10 wind and solar projects in North America with a total output of about 990 MW.

The EIA projects that utility-scale solar capacity will expand by about 56% between year-end 2013 and year-end 2015 in the U.S., in tandem with considerable consumption growth in renewables for electricity and heat generation purpose. California is expected to grab most of the growth with approximately 70% of the new capacity being built in the state.

WEAKNESSES

Subsidy roll-back: Budgetary constraints have caused prime global solar markets like Germany, U.S., Italy, Australia, U.K. and Taiwan to roll back a portion of their grants. Earlier, sales of solar players from the above countries witnessed a sharp rise mainly fueled by the rush to complete projects ahead of subsidy roll-backs.

The alternative energy players may receive another jolt from one of the prime solar markets. Germany is expected to cap subsidy payments after generation capacity reaches a certain target. Germany is consistently evaluating changes to the German Renewable Energy Law, or the EEG. In April 2012 an amendment of the EEG entered into force that introduced a monthly reduction in feed-in tariffs (FiTs) by 1%, which can rise or fall depending on solar growth.

These FiT changes particularly affected the competitiveness of large-scale free field PV systems and modules. Any further policy changes wrought by the German Environment and Economy Ministers and approved by the German Parliament will negatively affect the long-term demand and price levels for PV products in Germany.

New emerging technologies: The alternative energy industry remains an emerging sector with a steady focus on the lowest-cost technology and cost-competitiveness from traditional means of electricity generation. This may prove disastrous for existing companies ruling the solar roost should a cheaper alternative emerge.

Conclusion

Globally, China leads the world in total electricity generation from renewable sources, helped by its increased allegiance in recent times to the alternative path. The dragon is followed closely by the U.S., Brazil and Canada. On the other hand, European PV markets experienced a slowdown in 2013 due to the declining political support for PV. Notably, Italy witnessed a 70% market decline year over year. Germany also experienced a steep PV market decline of 57%.

So, the solar companies are increasingly focusing on the Chinese, Japanese, Indian and U.S. markets to counter the tepid growth in mature markets. Indeed, the long-term outlook seems bright. This is especially true as global warming and high fuel emission issues are leading to rising popularity of clean energy sources.

The demand for renewable energy, in particular solar and wind, is rapidly growing for electricity generation in the U.S. As per EIA, renewable electricity generation in the U.S. would grow by an average of 1.9% per year until 2040 and 69% over 28 years (from 2012-2040).

This boom in the alternative energy sector is also likely to outpace the mounting shale oil and gas business in the years to come. The depletion of fossil fuel reserves, higher oil and gas prices, new and advanced technologies, accompanied with more competent alternative energy applications have made green power more feasible, injecting optimism into the sector.