2012 Strategy: Highly Leveraged to an Upturn

The dreadful decline of alternative energy stocks in 2011 (notably Wilderhill: -52% y/y)

mirrored the dramatic decline in earnings momentum and is proof of just how correlated this sector is to global macroeconomic growth and to tight credit conditions.

 In some ways it wasn’t surprising.  One striking theme throughout last year was the commoditization of PV solar, LED and wind equipment. Barriers to entry have fallen away and consolidation is now beginning (with bankruptcies increasing in number and M&A just beginning). Reduced equipment costs–translating into higher ROIs for projects–is excellent news for those developers fortunate enough to find project funding.

Another theme last year was a new emphasis on maintaining strong balance sheets for management in many companies, particularly towards the end of the year.  Survival is one reason mentioned.  Some companies even wrote off inventories and set aside finished goods to sell to their best customers at attractive prices when demand recovers.

 The volatility of markets in general in 2011, and especially of these characteristically high beta stocks, was enough to take one’s breath away.

 Entering 2012, this industry looks to be significantly leveraged to any hint of positive developments on the global macro front and in credit markets.

 Key focal points for 2012:

 –Macro economic trends:  Sharp falls in share prices are already pricing in poor Q4 earnings and another trying year in 2012.  Better US growth and above all, better Chinese macro statistics would be very positive surprises.  The alternative energy industry is becoming more leveraged to demand from emerging markets.  China alone has positioned itself to become the world’s leading market for renewables.

 –Access to funding:  As solar, LED and wind equipment leaders have repeatedly emphasized since last year, the number of players must diminish.  Bankruptcies – like those of solar players in Germany and the US, and of tier 2/3 LED manufacturers in China– are beginning to multiply.  Recall the Chinese government’s official goal to cut back the number of wind equipment producers.  Cross-border M&A has only just begun.

 Access to project finance became crucial last year when utility-scale projects started to take off.  Solar Millennium was a notable victim, blaming cheap PV, but it was in fact unable to fund the giant Blythe project.  Utility-scale PV will account for over 40% of PV capacity in 2015 with China, US and India best suited for such projects, according to Dupont PV Solutions.  The same goes for wind, especially offshore.  One developer, particularly cautious when choosing wind projects, considers that the scarcity of capital gives his group a competitive advantage, since with fewer people competing, the returns have improved.  Thanks to attractive returns,  PV and wind power installations grew sharply in 2011 and even overshot targets,  +34% and +22.3%, respectively y/y.

 –Company fundamentals :  The market will again reward earnings momentum.  Expectations are low for Q411 and FY 2012 but early 2012 may bring good news.  Solar PV installations may rebound in April, according to an IHS report.  Wind farm installations in China should reach 40GW in early 2012 (according to 12FY Plan).

 ‘Quality’ will again be an important tool for screening.  The winners will be cost leaders with the strongest business models, best cashflow generation, and most attractive valuations (Garp).   Solar, LED, batteries, biofuel, smart grid and wind sectors have all fallen to particularly attractive levels relative to their growth rates (PEGs of less than 1).

 –Politics:  Pessimism already reigns regarding government support in this tough economic environment.  US solar cash grants expired at the end of 2011 and the US incandescent bulb phase-out is now in doubt; Spain’s new government is expected to cut all renewable energy support; import duties for Chinese PV have been introduced in India and in the US; and so on.  With such a bleak backdrop any change to more supportive policies should see a positive ‘over’-reaction.  This was true in the carbon credit market in December.

 In contrast, if China’s incandescent phase-out fails to stimulate LED sales because LEDs are still too expensive, or China’s new solar power tariff regime fails to increase domestic demand, the negative reaction could be similarly exaggerated.

 –Technology issues: While the market is unlikely to be adventurous, it will welcome ‘strategic’ biofuel breakthroughs with readily captive markets (like air transport for Solazyme in 2011), and new technologies that reduce costs such as cheaper and non flammable storage, cheaper LEDs, EVs (reported by the FT as getting to a slow start due to cost issues), and smart grid technologies ($80-160/year of savings for a smart meter doesn’t seem to be enough to motivate consumers).

 And what do we see beyond 2012? Near-term, the renewables industry will grow as costs fall and stimulate demand from emerging economies that have no energy alternatives and from developed economies concerned about energy security.  Long-term, the IEA estimates renewable energy demand will grow 40% by 2035 (from 2011) and will require huge infrastructure investments to meet consumption.



Categories: Biofuels, Economic Indicators, LED, Solar, Wind

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