After a seemingly unstoppable ride higher, renewable energy stocks are getting battered over fears of higher interest rates, among other things. TPI Composites (TPIC 5.64%), an independent wind blade manufacturer, has seen its shares crash over 30% in one month, much more than other solar and wind energy stocks. Part of the reason is due to the company's 2021 guidance, which indicated slowing top-line growth but more profit.
Here's how interest rates affect the wind energy industry -- and why they could impact TPI's business down the road.
How rising interest rates affect the wind industry as a whole
Ten-year treasury rates are at their highest point in over a year. However, they are still at the low end of their three-year range, and quite low by historical standards. So yes, interest rates are rising but that doesn't mean they are unreasonable.
Typical wind energy projects have a lot of moving parts. They can take years, involve coordination between several different companies, have complex supply chains and permitting, and are incredibly capital intensive. Rising interest rates are just one more reason to call off an operation. They make it more expensive to borrow money, which dissuades developers from pursuing certain projects. Fewer projects mean less business for original equipment manufacturers (OEMs). In addition to managing the project, these companies make their own components and contract players like TPI for a fair share of that business, too. Therefore, less business for the OEMs can mean less business for TPI.
The good news is that TPI's supply agreements add a level of predictability to its orders. Between now and 2024, it has contracted minimum commitments of $2.8 billion and potential revenue up to $4.6 billion. Higher interest rates could mean that OEMs decide to order closer to the minimum amount on their contracts, which would impact TPI's revenue. If OEMs sense that the market is weakening or just aren't getting business like they used to, they may decide not to renew contracts with TPI -- or, at the very least, restructure the terms of future contracts.
Digging into utilization rates
A great way to monitor how much business TPI is receiving is by looking at its utilization rate. The utilization rate tells you how much production TPI is generating relative to its capacity. The renewable energy stock had over 92% utilization in the second half of 2020.
Even during the second quarter, the height of the pandemic, management noted that its plants were operating at or above planned capacity. Fewer orders weren't the reason for TPI's weak 69% second-quarter utilization rate. Rather, its facilities in Mexico and India suffered a labor shortage due to pandemic-related safety concerns. This is a great example of why it's not worth obsessing over quarterly utilization rates. They can pop or drop for one-off reasons, which has happened from time to time over the last few years.
As for full-year 2021, TPI is guiding for a utilization rate between 80% and 85% (it averaged 80% over the past two years). TPI has been in growth mode, adding a lot of capacity over the last few years. A high utilization rate shows that the added capacity isn't going to waste. However, that growth has made TPI into a bigger company with more moving parts and higher debt -- leaving it more vulnerable to an industry slowdown.
What to watch
Rising interest rates could mean less growth for the wind industry as a whole. TPI's contracts should do a good job at protecting its downside risk for now. However, a declining utilization rate could signal that customers are ordering on the lower end of supply agreements. In addition to monitoring utilization rate trends, investors could gain an edge by keeping track of what TPI's customers are saying. Over 90% of its business comes from Vestas, GE, Nordex, Siemens Gamesa, and Enercon. Following their comments on interest rate risk, as well as wind business performance and guidance, could provide a nice leading indicator to gauge TPI's future order volume.