Alternative Energy Stock Outlook - July 2011

Zacks

The growth outlook of alternative energy companies is inversely related to the prices of petroleum products and directly related to the fortunes of the economy.

The recent thaw in oil prices is casting a shadow over this emerging momentum. But even despite the pullback in oil prices, they still remain above historical levels.

Nevertheless, we believe that a temporary oil price thaw will do limited, if any, damage to the emerging positive alternative energy narrative. Per the Energy Information Administration (AMEX:EIA - News) the projected U.S. refiner crude oil average acquisition cost will rise from $102 per barrel in 2011 to $108 per barrel in 2012.

The U.S. economy was not able to completely shake off the negative momentum that plagued the economy in 2010. In the first half of 2011, the economy was affected by unseasonal and harsh weather, a drop in federal defense purchases, and the supply-chain disruptions associated with the Japan quake and ensuing crisis. As a result the U.S. jobless rate rose to 9.2% in June 2011.

However, Zacks expects above-average economic growth to resume in the second half of the year. Driving this growth resumption will be the removal of the temporary restraints that kept the economy in check in the first half. The impact of Japan related supply-chain disruptions, particularly on the U.S. auto sector, has been well documented. As normal industrial operations resume, we should start seeing its impact in manufacturing centric reports.

The macroeconomic improvement should have a beneficial impact on electricity demand. According to the Energy Information Administration (AMEX:EIA - News), U.S. industrial electricity sales are expected to rise year-over-year by 3.6% in 2011 and 2.0% in 2012. This helps improve the operating environment of electricity generators and distributors.

A number of traditional utility companies have growing alternative energy operations. But the fortunes of some of these companies, particularly those with significant fossil-fuel exposures, are less attractive than their peers.

In the utilities space, we are less optimistic about the prospects of The Empire District Electric Company (NYSE:EDE - News), Otter Tail Corporation (NasdaqGS:OTTR - News) and American Electric Power Company Inc. (NYSE:AEP - News).

Conversely, favorable rate cases and stable sales growth in the respective service areas make companies like Ameren Corporation (NYSE:AEE - News), Alliant Energy Corporation (NYSE:LNT - News), Constellation Energy Group Inc. (ceg) and Duke Energy Corporation (NYSE:DUK - News) attractive.

Like everyone else, the Alternative Energy industry was hit hard by the Great Recession and essentially remains in recovery mode. And while the economy is in recovery mode, so is our hope for the industry.

A major growth area in this space is Solar Energy. The U.S. has a lot of catching up to do, despite enormous potential, to get anywhere close to the global leaders. According to the Solar Energy Industries Association (:SEIA) -- the U.S. trade association of close to 1,000 companies in the solar energy industry -- in fiscal 2010, the U.S. installed 887 MW of grid-connected photovoltaics (:PV), representing 104% growth over the 435 MW installed in fiscal 2009.

According to the European Photovoltaic Industry Association (:EPIA) -- the world industry association for solar photovoltaic electricity market -- the cumulative global installed PV capacity stood at almost 16.5 GW at the end of 2010, compared to only 9 GW at the end of 2007. Per EPIA estimates in 2010, Germany ranked first followed by Italy and Spain in terms of cumulative installed solar electric power capacity, as of year-end 2010.

Here we take a look at the Solar Energy space and attempt to identify this nascent industry’s strengths and weaknesses.

OPPORTUNITIES


Environmental advantage: Solar power is one of the most benign electricity resources. Solar cells generate electricity without air or water emissions, noise, vibration, habitat impact or waste generation.

Fuel risk advantage: Unlike fossil and nuclear fuels, solar 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 insure high reliability while providing a long-term, fixed-price electricity supply.

In light of the Fukushima Daichi episode in Japan, the global focus has tilted towards solar in a big way. German plans to phase out nuclear power plants by 2022 will definitely boost solar fortunes in one of its largest global markets.

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 the 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 being a ubiquitous source.

Environmental legislations: Alternative energy companies are increasingly benefiting from new legislation in the U.S. stipulating installation of renewable sources of electricity generation as mandated by Renewal Energy Standards (NYSE:RES - News). At the federal level, Congress has extended the 30% federal investment tax credit (NYSE:ITC - News) to both residential and commercial solar installations until December 31, 2016.

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

Subsidy programs: Governments, most notably in China, Japan, Canada, U.K., Australia, India and the Middle East, have increased their financial support for solar projects. China is aiming at increasing its installed solar power capacity to 50 GW by 2020 from 305 MW capacity at the end of 2009.

In Europe, the European Union's goal of a 20% share of renewable sources in the energy basket by 2020 will keep the flow of new projects going. Specific solar energy stocks under our coverage that stand to benefit from this environment with a Zacks #2 Rank (short-term Buy rating) include Real Goods Solar Inc. (NasdaqGM:RSOL - News).

WEAKNESSES

Excess capacity: In the near-term the solar industry is facing the problem of excess solar cell and module capacity. Buoyed by the recent trends of record shipments, virtually the whole industry is on an expansion spree. The focus on vertical integration may make individual players self-reliant for their solar wafer/cell needs, but on the whole this throws up a lot of unutilized capacity for the industry.

This will significantly affect companies who have substantial solar cell/wafer tolling services revenue exposure. As a result, solar players like JA Solar Holdings Co. Ltd. (NasdaqGS:JASO - News), Canadian Solar Inc. (NasdaqGS:CSIQ - News) and Trina Solar Ltd. (NYSE:TSL - News) may witness headwinds in their margins.

Recent start-ups: A large number of these companies are recent start-ups with limited resources. As such, quite a few depend on their customers’ ability to finance solar projects and remain exposed to continuing near-term losses due to start-up costs. Companies such as Evergreen Solar Inc. (Other OTC:ESLRQ.PK - News) and Westinghouse Solar Inc. (NasdaqCM:WEST - News) would fall in this category.

Subsidy roll-back: Budgetary constraints have caused prime global solar markets like Germany, Italy, Australia, U.K. and Taiwan to roll back a portion of their grants. The recent spike in sales of solar players from the above countries is mainly fueled by the rush to complete projects ahead of subsidy roll-backs. This may affect companies such as First Solar Inc. (NasdaqGS:FSLR - News) and SunPower Corporation (NasdaqGS:SPWR - News), which generate a substantial portion of their sales from markets like Germany.

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.

The improving economic scene, both here in the U.S. as well as worldwide, had been driving oil prices higher even before the Middle Eastern turmoil injected a further element of uncertainty to the market. Following the recent release of reserves by the U.S. and other governments, prices have come down, though they remain above historical levels.

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

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