Why solar stocks have returned 14 times the market so far in 2020

0

The Invesco Solar ETF (BRONZER 3.64% ), which contains around 60% of manufacturers and suppliers like Enphase Energy (ENPH 4.52% ) and SolarEdge Technologies (SEDG 5.92% ) and 30% of utilities, is up 235% this year, crushing the market’s 16% return. Solar has been one of the best-known growth stories for years. So why has the industry suddenly taken off?

Let’s take a look at the factors that contributed to one of the hottest sectors of 2020 to better understand what led to the breakout. Ultimately, these themes (and similar lessons) should help you identify future growth trends before the market does.

Image source: Getty Images.

Solar has become much cheaper

One of the most significant developments in power generation over the past five years has been the falling costs of renewables. In the past, renewables needed subsidies to compete with fossil fuels. Renewable energies are now competitive in terms of costs.

The US Energy Information Administration (EIA) estimates the following capacity-weighted discounted cost of electricity (LCOE) for new projects entering service in 2025. Note that solar is the cheapest, followed of onshore wind power.

Type of plant

Total LCOE System (Excluding Tax Credits)

Solar PV

$ 32.80 per MWh

Onshore wind

$ 34.10 per MWh

Hydroelectric

$ 39.54 per MWh

Combined Natural Gas Cycle

$ 36.61 per MWh

Natural Gas Combustion Turbine

$ 68.71 per MWh

Data source: US EIA. Data in 2019 dollars per megawatt hour (MWh).

The LCOE is a uniform way of measuring the cost of producing electricity based on different sources throughout their useful lives. For example, solar and wind have higher fixed operating and maintenance costs than fossil fuels, but do not have variable costs. Keep in mind that this is capacity weighted data, so it represents the new infrastructure that will be brought online, not the cost of the existing infrastructure.

One of the main lessons from this data is that solar and onshore wind are now competitive with combined cycle power plants. In these plants, natural gas powers a gas turbine. The exhaust gases from this turbine power a steam turbine, producing about 50% more electricity than the gas turbine alone (and reducing emissions).

Combined cycle power plants supply most of the baseload electricity to the grid. Gas combustion turbines turn on during peak hours to provide peak power, but at a higher cost. Until battery technology became cheaper, solar power mainly competed with other basic power sources such as wind, hydro and combined cycle power plants.

International growth set to soar over the next 20 years

Cost cuts have been a game-changer, sparking new investments in solar energy. According to the EIA, solar power generation in the United States grew 22% in the first nine months of 2020 compared to the same period in 2019, which was the highest growth rate of any sources. For the future, solar and wind power dominate the list of American projects that will go online between October 2020 and September 2021.

Globally, solar power is expected to shift from the fuel source that added the least capacity from 2000 to 2019 to adding more capacity from 2019 to 2040.

Source

2000 to 2019 (historical) change

2019-2040 (STEPS) planned change

Planned change 2019-2040 (SDS)

Coal

3,854 TWh

(864) TWh

(7,897 TWh)

Gas

3,548 TWh

2,070 TWh

(1,767 TWh)

Other low carbon

2,460 TWh

3,442 TWh

6,709 TWh

Wind

1,391 TWh

4,019 TWh

7,257 TWh

Solar PV

664 TWh

4 813 TWh

8 135 TWh

Data source: International Energy Agency (IEA). STEPS is based on current policy. The SDS is based on goals aligned with the Paris Agreement. TWh = Terawatt-hours.

Solar developed as oil and gas struggled

Cost reductions and global adoption bode well for the solar industry. Leading solar companies of panel and component suppliers, racking manufacturers and developers of power optimizers and inverters increased their revenues and net income during this difficult year for the big oil companies.

SEDG Revenue Graph (TTM)

SEDG Income (TTM) given by YCharts

Surprisingly, 2020 has shown a strong interest in renewable energies. Some oil majors are fed up with a struggling oil and gas industry and are focusing on renewables. Utilities are investing in renewables with the expectation that the high upfront costs will be justified by sustainable assets that generate income for decades to come.

The anatomy of an escape

A variety of factors culminated in causing a breakthrough in the solar industry. But no factor was too surprising. After all, the costs had been going down for years. Solar was well expected to develop in the United States and around the world. For many solar companies, 2019 has seen higher growth than 2020. And even oil, gas and utility companies have been talking about an energy transition for some time.

TAN Total Return Level Graph

Total return level TAN given by YCharts

What was unexpected was that the solar industry proved to be resilient in 2020. It proved that the long-term tailwinds were strong enough to foster growth in a year when few other companies energies can say the same. Oil and gas have suffered the worst recession since 2014. And dramatically, many prominent players have raised their hands and capitulated in favor of renewables.

Where to go from here

Low interest rates and favorable policies have certainly contributed in part to this short-term resilience. It is difficult to justify most of the leader’s valuations at today’s prices based solely on current growth or earnings.

But things start to make more sense once you factor in the discussed tailwinds. Investing in an industry where stock prices are so much higher than a year ago can seem aggressive and even careless at times. In situations like these, it may be better to open a small introductory position with an amount that you don’t want to lose. From there, you can follow some of your favorite companies in the industry to make sure the performance warrants a higher valuation.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

Share.

Comments are closed.