Solar energy stocks have been hammered over the last month in a broad industry sell-off that may be unnerving to investors. You can see below that SunPower (SPWR 6.81%) has been hit hardest, but SolarEdge (SEDG 5.22%), Sunrun (RUN 10.67%), and Enphase Energy (ENPH 5.69%) have all fallen of late.
What you can also see below is that these stocks have moved together, especially on big down days. That's because there are some forces working against the entire industry. And the residential solar stocks mentioned may have the most uncertain futures when it comes to forces both within and outside of their control.
The curse of rising interest rates
Like it or not, interest rates have always been a big deal to solar companies because of the economics of a solar project. There is a large upfront cost that typically requires debt financing, and then there are small revenue streams, direct or indirect, over the course of 20 years or more. At the end of the installation's useful life, the solar panels no longer have value. So rising interest rates make the value of those long-term cash flows lower because the discount rate investors use to value them is higher.
Let's use an example to explain just how important interest rates are to solar companies. In the table below, I have outlined the cash flows, interest rates, and resulting value of two solar projects. In both examples, we know that the annual cash flows are $1,000 over the course of 20 years. This would be analogous to a power purchase agreement (PPA) for a utility-scale solar power plant, or a lease/PPA payment for a residential solar installation. This example shows how these cash flows are discounted at different interest rates.
|Example||Annual CF||Years||Interest Rate||Value|
Raising the discount rate from 3% to 6% results in a 23% drop in the value of the cash flows. If this were a solar project, it would mean that the cash flows from the project discounted at 6% are worth $3,407 less than the project discounted at 3%.
Now, let's think about this in the case of an installation that Sunrun or SunPower is financing. If the cost of a solar installation that generates $1,000 per year for 20 years is $13,000, then Project 1 would be profitable, but Project 2 would lose money. The company may simply choose not to build Project 2 at all in this case.
As a result of the dynamic between interest rates and solar project values, higher interest rates will slow growth and/or lower margins for solar installers -- and, by extension, suppliers like Enphase and SolarEdge. That's the reality of the market, and it's why investors are concerned about rising interest rates today.
California throws a wrench in growth plans
The other factor impacting solar stocks today is a proposal from California utilities to increase the cost of solar for customers who decide to put solar on their roofs. This would be done by increasing a fixed fee charged to customers with solar on their roofs, and adding a "grid access" charge depending on the size of the solar installation. Utilities would also like to lower what they pay for electricity sent back to the grid through net metering. The net effect of all of these proposals is to make rooftop solar less economical for customers to install.
This isn't the first time utilities have tried to add fees to customers who install their own electricity generation, and all of these fees are out of the traditional utility playbook for fighting rooftop solar. But that doesn't mean they're good for solar companies. Higher fees would make the economics of going solar more difficult in California, which accounts for an outsized portion of the industry's installations.
However, investors should remember that solar companies have spent a decade preparing for this moment. The investment thesis behind solar-plus-energy-storage is that it can reduce the amount of electricity being sent back to the grid, which will improve the economics of a rooftop solar system. It's possible that utility fees will make solar-plus-storage even more popular, which could generate more incremental revenue for solar companies. That's not yet known, but efforts to thwart solar in the past have been met by new innovations that grow the industry, so investors shouldn't be too worried about this California proposal.
Where do solar energy stocks go from here?
Interest rates continue to rise, so that's worth watching. But keep in mind that rates are still historically extremely low, and that's a tailwind for the solar industry.
Concerns about grid access, net metering, and other utility policies will also be worth monitoring in the future. Utilities are defending their turf through the regulators that control their business, and that's understandable. But solar energy is winning long-term because it's cost-effective and providing on-site services that utilities can't. And innovations like energy storage and energy management will be growth industries as these utility policies continue to pressure the industry.
It's worth understanding the threats facing the solar industry and how they're hitting hard so far in 2021. But long-term this is still a disruptive industry that's only scratching the surface of its potential.