After a meteoric rise in 2020, renewable energy stocks have gone on sale due to valuation concerns and fears of higher interest rates. Two recognizable names that have handily beat the market over the last five years are NextEra Energy (NEE +0.31%) and SolarEdge Technologies (SEDG +2.96%), both of which are negative for the year.
Let's break down both businesses to determine where they're headed, and ultimately decide which one is a better buy now.
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The case for NextEra Energy
NextEra Energy is a large, diversified utility with exposure to both fossil fuel and renewable income streams. The vast majority of its income from both sources is tied to long-term power sales agreements, making NextEra a much safer option than smaller pure-play solar and wind stocks.
NextEra finances and manages massive utility-scale projects. It buys assets from component and equipment manufacturers, works with engineering and construction companies, and is ultimately the company that sells power to the electrical grid.
NextEra has gained a lot of attention from renewable investors recently because it's spending a ton of money to expand its renewable capacity. NextEra's core business is Florida Power & Light (FPL), which is the largest utility in Florida. FPL generates the vast majority of its power from fossil fuels, although it has added renewable capacity, too. FPL's claim to fame is its steady profits and low rates for customers. In a win-win for both NextEra and its customers, FPL's residential customers pay 30% less than the national average.
FPL provides stable inflows and contributes most of NextEra's revenue and earnings. NextEra has been using FPL's extra cash and debt to fund its renewable arm, NextEra Energy Resources (NEER). As a result, NextEra's spending and debt have skyrocketed, but its revenue and net income have yet to take flight because many projects are still in their early stages.
NEE Revenue (Annual) data by YCharts
To put into perspective the sheer scale of this endeavor, consider that NEER had a renewable capacity of roughly 22 gigawatts (GW) at the end of 2019. After adding 5.8 GW of renewable capacity in 2020, NEER plans on adding an additional 23 GW to 30 GW of capacity by 2024, bringing its total renewable capacity to between 50 GW and 60 GW. Most of NEER's existing and planned renewable capacity is wind energy.
Between 2005 and 2020, NextEra grew its adjusted earnings per share (EPS) and dividends per share at compound annual growth rates of 8.7% and 9.6%, respectively. Its shares yield 2.1% at the time of this writing. NextEra's record-high spending is challenging profitability in the short term. However, NextEra is confident that it will be able to grow its adjusted EPS by 6% to 8% in the coming years.
The case for SolarEdge
Unlike NextEra, which generates power for its customers, SolarEdge designs and manufactures optimized inverter solutions for residential, commercial, and small utility-scale customers. Lower renewable power generation costs have led to capacity additions that have helped SolarEdge grow its market share in the U.S. and Europe. SolarEdge has expanded its product offering to include electric vehicle (EV) charging capabilities and battery storage. Even with this expansion, over 80% of its 2020 revenue came from power optimizer and inverter sales.
SolarEdge has been one of the most impressive renewable growth stories, particularly over the last three years. It reported its highest quarterly revenue in history in the first quarter of 2020 -- right before the onset of the pandemic. It was also able to grow revenue and take only a slight hit to gross margins in 2020. All things considered, that's not bad. However, to justify its current valuation, SolarEdge needs to get back to the growth trajectory it was on pre-pandemic.
SEDG Revenue (Annual) data by YCharts
SolarEdge has several advantages over other growth stocks. For starters, it is consistently profitable and has high gross margins. It also has more cash on its balance sheet than debt. As of year-end 2020, its cash and cash equivalents exceeded total debt by over $225 million, which doesn't include over $290 million in bank deposits and investments.
SolarEdge was in its best shape ever leading up to the pandemic. With plenty of new products in the pipeline and plans to expand its focus in the EV charging business, the solar energy stock is poised to further capitalize on the industry's growth.
The better buy
After increasing by more than 230% in 2020, SolarEdge now finds itself in an awkward position: The company is priced to return to the growth it had before the pandemic, and anything less than that will look bad. I trust SolarEdge's management to make the right long-term decisions for the business, but the company could take longer to return to its high-growth trajectory due to factors outside its control, such as rival technology, fierce global competition, rising interest rates, or simply a slower rebound than expected.
With a market cap of $14 billion, SolarEdge is roughly 10 times smaller than NextEra Energy. There's a very good chance that it can grow faster than NextEra, and its stock could very well outperform NextEra's, but there are more risks involved. NextEra Energy is an excellent entry-level renewable energy stock that pays a dividend and has predictable earnings, growth prospects, and exposure to many forms of nonrenewable energy and renewable energy -- not just solar. Therefore, NextEra seems to be the better choice for most investors. However, growth investors that don't mind enduring volatility may prefer the upside potential of SolarEdge over NextEra Energy.
