No one said investing was easy, and that's definitely the case with the renewable energy sector right now. The long-term outlook remains very positive, but I think investors should be stock selective and prepared for potential disappointments along the way. It's not going to be smooth sailing.
That said, there are ways to play the renewable energy theme, and I think investors should be looking at some of the less touted names, such as General Electric (GE 1.23%) and Siemens Energy (SMEG.F -4.08%). Let's take a closer look at why.
The key points
The argument centers on renewable energy (solar and wind power) to produce electricity. It's a somewhat complicated set of industry dynamics.
- Solar and wind power are forecast to be the cheapest stand-alone ways of producing electricity in the future, so the long-term outlook remains very positive.
- Solar and wind power in the U.S. is a better value proposition than combined cycle plants (gas and steam turbines) right now in part because of tax credits.
- The leading wind power players, Siemens Gamesa, Vestas, and GE, are forecasting flat or low growth in onshore wind installation in the medium term.
- Offshore wind installations are forecast to grow slowly for the next few years and then pick up strongly in 2025.
- Even if the average cost is cheaper, renewable energy will not always be the most optimal solution in every geography.
- Gas turbines will remain a major feature of global electricity production, and lower gas prices will also make gas turbines more attractive.
Putting all of these points together, it's clear that the industry dynamics are somewhat nuanced in the medium term, and it's definitely not the case that investors should pile into the renewable energy sector indiscriminately.
The following chart outlines the relatively tepid nature of growth in new installations as forecast by leading consultancy Wood Mackenzie. GE, Vestas, and Siemens Gamesa all use Wood Mackenzie data, so presumably, their internal forecasts are based on the consultancy's data.
Buyer beware: TPI Composites and Hexcel
Investors can see an example of volatility produced in such dynamic market conditions with wind blade manufacturer TPI Composites (TPIC -10.71%) and advanced materials and composites manufacturer Hexcel (HXL -0.27%). TPI's stock had a great 2020 as investors bought into the long-term theme and the stock was buoyed by hopes that the Biden administration would lead to a surge in renewable energy investment. However, the stock sold off heavily in February on the news that there were "short term" overcapacity issues in the industry, and management expects to operate its production lines with lower utilization toward the end of 2021.
Meanwhile, Vestas has been forced to lay off 450 workers in wind turbine plants in Colorado in 2021, in response to overcapacity issues. Also, Hexcel closed a plant in Colorado as its wind energy customers are shifting to outsourcing wind blade production rather than producing in house and buying composites from Hexcel.
How to invest in the industry
In this context, it makes sense to look at GE and Siemens Energy (a company comprised of a 67% share in Siemens Gamesa and the former gas and power business of Siemens).
- GE and Siemens Energy both have an earnings growth opportunity to expand margin to the high-single-digit level achieved by Vestas.
- GE and Siemens Energy are also the leading players in gas turbines and combined cycle plants, which will act as a hedge if that market comes back after an extended period of weakness.
- GE and Siemens can also grow their repowering revenues while new installation growth plateaus.
- GE is growing its offshore wind business from minimal revenue in 2020 toward a $3 billion business by 2024.
While power and renewable energy are not the most important earnings generators at GE, margin expansion in both segments is a key part of the investment case for the stock. Similarly, Siemens Energy expects to expand its profit margin to high-single digits by 2023 -- in both Siemens Gamesa and the gas and power business.
Time to invest in renewable energy stocks?
The answer has to be "yes," but it comes with qualifications. The industry has a bright future, but don't expect a linear growth pattern. Indeed, the leading players expect onshore wind growth to be tepid until the 2024/2025 timeframe. In such conditions, it makes sense to discriminate in the stocks you select in the sector. GE and Siemens Energy are good options on a risk/reward basis given the medium-term wind power installation outlook.