MorningWord 8/11/16: Star Wars – SCTY, TSLA, SPWR, FSLR

by Dan August 11, 2016 12:57 pm • FREE ACCESS

Wall Street has a habit of grouping stocks into sectors. For example, almost every trading day we hear market participants refer to sector performance in areas like semiconductors, retail, energy, banks, etc. This keeps things easy when there’s so much to absorb by the gyrations of the market on any given day. In fact, we have entire indices and etf’s to trade these groupings. But just as the metonym Wall Street glosses over the many differences within the financial industry  (much of the financial industry isn’t even in NYC, nor in the downtown financial district, nor on Wall Street itself) the names we give sectors don’t often capture the major differences between the companies in that sector.

One sector I want to talk about today because it’s been in the news a lot lately is Solar. First, let’s start from 30 thousand feet and look at it as a sector. The Guggenheim Solar etf (TAN) is the most tradeable vehicle for exposure to the industry as a whole. Here’s its 2 year chart:

Screen Shot 2016-08-11 at 9.34.01 AM
2 yr TAN from LiveVol Pro

As you can see, 2015 was a pretty volatile year for these stocks with the etf going from 34 to 50 and then roundtripping and then some down to 30 by year end. 2016 has seen mostly downward volatility, as the etf sold off hard to start the year before spending most of the time since in a range from about 24 to just below 20. Currently it’s 21.30.

Now let’s look at some of the holdings to get a sense of what makes up this sector ETF. As of 8/10:

Screen Shot 2016-08-11 at 9.41.30 AM

You’ll notice some names that get talked about in major financial media like Solar City (SCTY) SunPower (SPWR) First Solar (FSLR) and Trina (TSL). You’ll probably also spot a bunch of names you never even heard of, many of them manufacturers in China. Because it’s such a mix of manufacturers, installers, leasing companies etc. overall its most important input is as a proxy versus the price of oil and natural gas. You’ll see this relationship play out on a day to day basis when you see big moves in the fossil fuels. This is the “anticipating demand” knee jerk reaction. Another major factor over the past few years has been supply side with gluts and shortages of panels causing price fluctuations and affecting earnings. It makes for a complicated where sometimes correlation to fossil fuel prices in close to 1 and other times, closer to zero when comparing Crude to TAN:


But stepping away from the TAN etf and looking within the sector there’s another interesting divide and it may the one that determines some of the winners and losers in the industry. That’s because even though solar has been around for a long time, what happens next is still anyone’s guess, and the different players are making very different make or break bets on how it all shakes out as far as implementation.

The most famous name in the industry is none other than Elon Musk, founder of Tesla (TSLA) and soon to be head of Solar City (SCTY) after this announcement:

Tesla announced last month that it had made an all-stock offer for SolarCity worth $2.8 billion. It argued that by acquiring SolarCity, the two companies would form a one-stop clean energy shop, offering consumers solar panels, home battery storage and electric cars under a single trusted brand.

Musk was already a major shareholder and on the board of SCTY so some are calling this a bailout. But it’s also a major bet on exactly how solar is implemented. And one that if Musk is wrong about could have major implications.

There are two ways that solar implementation can go, they are not mutually exclusive but it’s possible that one ‘wins’ in a larger sense. The implementation question is whether 10 years from now we look at solar energy like we did coal fired power plants, something that happens across your city or state, and that feeds into the grid, eventually reaching your house. Or whether your house (or store, or factory) is itself a mini power plant, generating your electric needs from your roof. In other words, will the industry be centralized or de-centralized?

Musk has a vested interest in how this plays out since he’s made major bets on in house battery systems and now rooftop solar. Most recently:

Solar installer SolarCity, which is in the process of being acquired by electric car maker Tesla, plans to develop and sell a roof integrated with solar panels. Currently the company installs solar panels on top of its customer’s roofs.

Musk pointed to the new planned solar roof product as an example of why SolarCity needs to make its own solar panels. We “need to do manufacturing in house to control the aesthetics,” said Musk.

Musk says his goal is for SolarCity to sell solar roof and battery products that make homeowners so excited that they want to show their neighbors. SolarCity plans to launch two new products before the end of the year, and presumably the solar roof will be one of them.

That’s a massive bet. Not only is Musk taking SCTY (and now TSLA) into the solar manufacturing business but he’s doubling down on TSLA’s exposure to the idea that the future of power is decentralized. Rooftop solar shingles, powering in garage battery systems, that power your car and your house.

That’s in contrast to some of the other bets in the industry like SPWR who are involved with massive solar array projects meant to act as centralized power plants. SPWR stock recently fell 30% following its most recent earnings report:

SunPower Corp. also announced that it will be laying off 1,200 employees and take a restructuring charge between $30 million and $45 million. The company lowered its full-year guidance for revenue as well, saying it now expects revenue between $2.8 billion and $3.0 billion.

As SunPower CEO Tom Werner put it, “Certainly 2017 will be a difficult year in power plants. The power plant market is unlikely to improve in America in the next few quarters. It will in time.”

One of the culprits in the slowdown of solar power plants is the renewal of a tax credit:

The culprit is the federal investment tax credit, which for years has been one of the biggest drivers of the U.S. solar industry. It was scheduled to expire at the end of this year, but got an unexpected five-year extension in December. To qualify, construction must begin before the deadline, so developers need to line up a power-purchase agreement, or PPA, many months before that.

While the solar industry was pleased, the timing made things tricky. There was a surge of contracts signed in 2015 as companies rushed to meet the earlier deadline. Now there’s no rush, and developers’ pipelines have been depleted.

About 8 gigawatts of big solar farms will go into operation in the U.S. this year, almost double the 4.4 gigawatts in 2015, according to Bloomberg New Energy Finance. That’s the legacy of deals signed in the past. And with utility contracts scarce now, that will slip 11 percent to 7.1 gigawatts in 2017.

“Because the tax credit got extended — which of course was a good thing — there’s less of an urgency for utility customers to sign contracts,” Pavel Molchanov, an analyst at Raymond James Financial Inc., said in an interview.

The utility solar market will eventually recover, driven by state clean-energy requirements, global efforts to curb carbon emissions and in the U.S., the investment tax credit.

“What is currently a headwind could well become a tailwind in the not-so-distant future,” Molchanov said.

First Solar is another company with huge bets on the utility side of the business:

With utilities holding off on power contracts, prices are coming down, according to First Solar CEO Mark Widmar, who was elevated from chief financial officer July 1.

The company gets about 70 percent of its sales from developing big solar farms for utilities, with the rest coming from providing panels to other developers. By 2019 that ratio will be reversed, former CEO Jim Hughes said in April.“Utilities seem to be in a wait-and-see mode,” said Hugh Bromley, a solar analyst with New Energy Finance.

So within the solar industry, you have a ton of factors affecting stock prices. There’s fossil fuel pricing, manufacturing shortages and gluts, tax policy, and most importantly for long term holdings, bets on whether the industry looks more centralized or decentralized. Elon Musk and Tesla and betting big on a specific version of the future. Other companies are seeing the effects of a bet a few years ago that just got turned on its head. It’s possible both bets are eventually proven right.

Both implementations have their pluses and minuses. Solar on your own home is more efficient in some ways because some power is lost traveling across the grid from a solar array to your house. But solar arrays combine costs of upgrades and offer efficiencies in that regard. One of the biggest problems with rooftop solar has been customers fears of spending money for something that will eventually become outdated. (Companies have attempted to address this with leasing) But buying solar power from the grid for your Tesla and your air conditioning doesn’t have that issue as the upgrades are someone else’s issue.

It’s impossible to know how this all plays out, but when investing or trading within the sector, it’s important to know the massive differences on the long term visions of the companies themselves. And the headlines like TSLA and SPWR recently are easier to frame in the bigger picture.