Alternative Energy Stock Outlook - Oct 2013 - Industry Outlook

In June, President Obama unveiled a fresh environmental plan that puts further limits existing coal-fired power plants. He 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 U.S.

As a result, the U.S. Environmental Protection Agency is getting ready 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 beneficial for renewable energy stocks like First Solar Inc. (FSLR).

The U.S. in fact has a lot of catching up to do, despite enormous potential, to get anywhere close to the global leaders. The Solar Energy Industries Association (SEIA), the U.S. trade association of approximately 1,000 companies in the solar energy industry, said that in 2012 the U.S. solar energy industry grew 76% year over year to reach 3,313 megawatt (MW), which represents 11% of all PV globally, up from 1,887 MW in 2011.

The second quarter of 2013 was one of the most happening quarters on record in the renewable space. As much as 832 MW of solar energy came on stream during the quarter, representing 15% growth over the last quarter thanks to unmatched installation levels in the utility market. Going forward, SEIA forecasts that 4,400 MW of PV (30% growth over 2012 level) and over 900 MW of CSP will be installed this year.

Looking at the cost side, the average cost of a completed PV system dropped by 11% during the second 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.

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 102.2 gigawatt (GW) at the end of 2012, compared to only 71.1 GW at the end of 2011. Europe took the lead with over 70.0 GW of installed PV capacity during the year.

In 2012, the next three big markets were China, U.S. and Japan. Besides the three countries, Australia and India will be a part of the major solar industry powerhouse in the near future.

In 2012, though Europe led the list in terms of total installed PV capacity, it accounted for 70% of the world's new PV installations, down from 75% in 2011. This can be attributed to a tepid European economy and a distinct downswing in the PV market, particularly in new connected capacity, seen for the first time in 12 years.

It is believed that in 2013 the majority of new PV capacity in the world will come from outside the Europe. China and India are expected to be the forerunners, followed by countries in Southeast Asia, Latin America and MENA.

Wind

The American Wind Energy Association (AWEA) reported that the wind industry slowed radically during the first half of 2013 following a record fourth quarter 2012 installations. U.S. wind growth has stagnated this year, with no new installations completed in the second quarter of 2013 compared to 1.6 MW in the preceding quarter. Hence, the total installed capacity currently stands at 60,009 MW.

The recent stalemate notwithstanding, the U.S. wind industry is now gradually picking up. There are more than 3,950 MW of long-term power purchase agreements signed. As of Jun 30, over 1,280 MW of projects were under construction spreading across eight states: Alaska, California, Colorado, Kansas, Michigan, Nebraska, New York and Texas.

Hydro

Hydropower is considered as 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.

In 2012, hydropower provided 100,000 MW of installed capacity -- the highest from a renewable source. Hydropower is the cheapest source of electricity as it has the lowest cost per kilowatt hour compared to all other sources and it remains independent of the volatile movement in fuel costs.

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 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 #42 out of 260. This corresponds to the top one-third of the list, corresponding to a positive outlook.

However, the Zacks Industry Rank for the Other Alternative industry is #218 out of 260. This puts the industry in the bottom one-third of all industries.

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, 2013 has been a good year so far. Specially, most of the solar companies have come up with second quarter earnings beat. High oil prices have also aided solar stocks to make new highs. Moreover, strong macroeconomic factors have helped this sector rise above others in the energy space.

For 2013, we expect the solar companies to witness an overall impressive year with most returning to profit following a year of downturn.

For more information about earnings for this sector and others, please read our '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.

Among the renewable energy pack, we would advise investors to look for companies like rooftop solar energy systems provider SolarCity Corporation (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.

Again, Zacks Ranked #1 (Strong Buy) company SunPower Corp. (SPWR) is one of the most forward-integrated solar companies, focused on moving up the value chain. The company delivered strong second quarter results, swinging to profit from the loss incurred in the year-ago quarter. Its stellar results were backed by strong demand for its solar panels in utility, commercial and residential projects. During the quarter, the company's total production improved 42.3% sequentially while utilization reached 100%.

Location advantage: Unlike other renewable resources such as hydroelectricity and wind power, 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.

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, Congress has extended the 30% federal investment tax credit (ITC) to both residential and commercial solar installations until Dec 31, 2016. 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 investment tax credit for renewable energy projects.

The wind sector has 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 has received life extension of half a dozen times. In the first decade of a renewable energy facility's lifespan, the PTC provides a $0.022/kilowatt-hour investment tax credit benefit.

Earlier this year, the renewable electricity PTC was extended for one year. This extension would ensure significant wind capacity additions over the next three years, thereby leading to higher generation from wind.

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 Sempra Energy (SRE) and Duke Energy Corporation (DUK), to gradually shift their mode of power generation to solar, wind and water.

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 August, 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.

Another utility, DTE Energy Company (DTE) recently received approval from the Michigan Public Service Commission to purchase 20 megawatt (MW) of wind power from a subsidiary of Heritage Sustainable Energy, a Michigan wind energy producer.

Also, Florida-based utility service provider NextEra Energy Inc. (NEE) also has plans to add about 500-1,500 MW of U.S. wind assets in the period 2013 to 2014. NextEra is a premier utility service provider that has been aggressively expanding its renewable assets across North America. The company recently expanded its operations to Hawaii to develop underground cable infrastructure connecting the grids between the islands of Oahu, Maui and the Big Island.

WEAKNESSES

Excess capacity: In the near term, the solar industry is faced with the problem of excess solar cell and module capacity. The solar industry continues to witness a difficult business scenario, categorized by intense pricing competition, both at the module and system level. Most of the solar companies are now incurring operating losses or modest to no operating income. The earlier rush in vertical integration by individual players for self-reliance in their solar wafer/cell needs has created a lot of unutilized capacity for the industry.

We believe this supply glut situation between supply and demand will likely continue to put pressure on pricing through the remainder of 2013 and at least into 2014. Specifically, this structural imbalance will prove unfavorable primarily for module manufacturers. However, companies with well-known proficiency and meaningful PV generation solutions in different regions of the solar value chain (like project development, EPC capabilities and O&M services) are more likely to sustain their business in this scenario.

Hence, the near-term solar module industry outlook is clouded by unnecessary inventory that has led to industry-wide sharply falling Average Selling Prices. Industry-wide module average selling prices have continued to experience downward pressure, although the rate of declines in some markets over the last two years has begun to ease.

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. The feed-in tariffs (FiTs) agency informed that solar feed-in tariffs for the rest of the year are subject to a 1.8% monthly decrease.

These FiT changes particularly impacted the competitiveness in Germany of large-scale free field PV systems and modules to be installed in such systems. 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 consistent 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.

Fortunes tied to crude: Alternative energy stock prices generally rise and fall in direct proportion to the price of crude oil. While in times of high oil prices this may present an opportunity, it also increases volatility in the sector.

As per Energy Information Administration (EIA), world crude consumption grew by an estimated 0.7 million barrels per day (MMBPD) in 2012 to a record high of 89.0 MMBPD. The agency, in its most recent Short-Term Energy Outlook, said that it expects global oil demand to grow by another 1.1 million barrels per day in 2013 and by a further 1.2 million barrels per day in 2014. Importantly, EIA's latest report assumes that world supply is likely to go up by 0.8 million barrels per day this year and by 1.2 million barrels per day in 2014.

The immediate outlook for oil remains positive given the commodity's constrained supply picture. In particular, while the western economies exhibit sluggish growth prospects, global oil consumption is expected to get a boost from sustained strength in China, the Middle East, Central and South America that continue to expand at a healthy rate.

Chinese Companies' Response to U.S. Import Duties: In 2012, the U.S. Department of Commerce (DoC) implemented anti-dumping duties of effectively 25.96% and countervailing duties of 15.24%. The U.S. DoC rolled out these tariffs to tighten supply of Chinese solar products in the U.S. and simultaneously encourage local players to tap the growing renewable domestic market. These steps have made the North American solar power market increasingly competitive for the Chinese solar power product manufacturers.

However, in response to the U.S. DoC's decision, China's Ministry of Commerce is now set to impose anti-subsidy duties of an additional 6.5% on polysilicon imports from the U.S. In July, China imposed anti-dumping duties of 53.3% to 57% on U.S. polysilicon and claimed that the imports were being sold below market value. Hence, the U.S. polysilicon suppliers will now face at least 60.2% tariffs, depending on the company.

This move is expected to intensify trade tensions between the world's two largest economies. On the other hand, South Korean imports will face rates ranging from 2.4% to 48.7%.

The European Union has settled its solar panel antidumping dispute with China as tariffs were set to rise in two steps: initially by 11.8% starting Jun 6 and then 47.6% on average from Aug 6, 2013. This will make international expansion for Chinese solar manufacturers difficult. Indeed, increasing order flows will not sufficiently offset the headwind from anti-dumping duties in Europe as well as the U.S.

However, China's Ministry of Finance has recently 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 subsidy offered by the Chinese government, which has already set a solar installation target of 35 GW by 2015, lifted Chinese solar stocks across the board.

Conclusion

Since the pulse of the alternative energy industry is closely tied to the swings in the macro-economy, until the picture becomes rosier we do not expect to witness many stand-alone alternative energy companies.

The continuing financial strains in the Eurozone, slow recovery in the labor market, and ongoing fiscal contraction continue to weigh on the economic picture. This otherwise bleak picture is only partly offset by the steadily improving outlook for the U.S. housing sector and a stronger dollar.

Overall, the outlook for the U.S. economy appears to be gradually improving, with a host of variables showing positive trends over the last few months. The no-taper policy of the Fed continues to support a favorable and expansive monetary stance.

According to EIA, the U.S. generated about 12% of its electricity from renewable energy sources in 2012. Most of this generation comprised hydroelectric power (56%), followed by: wind (28%), biomass wood (8%), biomass waste (4%), geothermal (3%) and solar (1%). Globally, however, 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.

As per the EIA, renewable generating capacity will account for nearly one-fifth of total capacity in 2040. Of this, solar generation will be the primary contributor to renewable capacity growth, with wind capacity occupying the second spot.

The fortunes of the gradually emerging solar PV industry are currently uncertain. The core European markets of Germany, Italy and Spain -- historically accounting for the lion's share of solar products -- are fast nearing maturity. To counter this tepid growth, the companies are increasingly focusing on the Chinese, Indian and U.S. markets. However, as things stand now, firms without deep pockets may not be able to sustain over the longer run.

With most of its solar peers in trouble due to an oversupply of solar panels, ReneSola Ltd (SOL) seems to be in a better position with multiple contracts and agreements. Again, JinkoSolar Holding Co. Ltd. (JKS) reported impressive second quarter 2013 results, returning to profit following seven quarters of losses buoyed by higher demand from new solar markets. This makes JinkoSolar the first Chinese module manufacturer to return to net profitability since the downturn.

Solar companies like SunPower and Trina Solar Limited (TSL) with a Zacks Rank #1 (Strong Buy) and Zacks Ranked #2 (Buy) companies like Quantum Fuel Systems Technologies Worldwide Inc. (QTWW), JA Solar Holdings Co., Ltd. (JASO), JinkoSolar, LDK Solar Co. Ltd. (LDK), ReneSola and Yingli Green Energy Holding Co. Ltd. (YGE) are making the most of the favorable market dynamics.
 
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