In this episode of Industry Focus: Energy, Fool contributor Jason Hall joins host Nick Sciple to discuss the Department of Energy's Solar Futures Study. The duo chat about ways to invest in solar energy's future, as well as some companies that have a lot of opportunities ahead of them.

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This video was recorded on Sept. 16, 2021.

Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. Earlier this month, the U.S. Department of Energy released its vision of a future where solar power provides 40% of the nation's electricity. This week, Jason Hall returns to the show to take a look at the report and its implications for solar investors. Jason, welcome back on the podcast, man, I can't talk today.

Jason Hall: Nathaniel, Nick, it's nice to be on, this is a fun topic. I'm looking forward to peeling back some layers here.

Sciple: I'm excited to have you back on, my misspeaking your name notwithstanding, always great to be on with Jason. Jason is one of the first, I think, the first guest I ever had on Industry Focus podcast when I started hosting it. We share a love of college football. This is our prime season right now, but we're not going to go down the Nick Saban rabbit hole. We're not going to talk about rat poison, we're going to talk about solar energy today. Jason, what did you see in this DOE Solar Future Study report?

Hall: There's a couple of things, so the obvious part is you have to look at the politics of it, so we went four years and we heard very little out of the administration about renewables, during the Trump administration. Five or six years ago, we were still hearing a lot during the Obama administration, and I think the key thing there for me is this isn't a partisan take, it's just a reminder. Don't invest based on either your politics or what is specifically coming out of the administration. But with that said, Nick, even the more conservative cases here make it pretty clear that the renewables train, solar, in particular, it's left the station.

Sciple: Yeah, I think to a certain extent, the fact this document is coming out now is a reflection of government policy and the government is very involved in the energy industry, when you think about the most regulated industry probably on the face of the planet is the utility industry. But part of this is a reflection of government policy. You see some of that in the report, so some of the assumptions you look at to get to this 40% energy, solar being 40% of the energy by 2035, you make some aggressive assumptions. One of those is that you're going to have some policy intervention, that the government is going to put their thumb on the scale to a certain extent to help fund research and development and those things. We have some assumptions in there that I'm a little skeptical of, such as we'll have the government spend some money here, we're going to accelerate innovation and maybe that has played out in some industries and others we have the big public examples of Solyndra and things such as that. There's also some assumptions around, we can snap our fingers and get access to the land we need to solve all these problems and the markets will evolve without any of the human factors that take place anytime you're totally taking a system and changing it over to a new system. 

But to your point though, Jason, even the reference scenario, this is the scenario that assumes that there's no policy intervention and "Market forces and technology will drive significant deployment of solar and other clean energy technology, as well as substantial de-carbonization." To put the numbers on that. Even under the base case, you're looking at installed solar capacity increasing by a factor of seven by the year 2050 and grid emissions declining 45% by 2035, and 61% by 2050, both relative to 2005 levels. What that means is, snap your fingers and say none of the political stuff is involved. Market forces are going to 7X this industry at least based on what the Department of Energy is projecting over the next 30 years, and that's a heck of a growth trend if you can find some companies to invest in. Thoughts, Jason?

Hall: Yeah, no. I think all you have to do is look back five, 10, 15 years, and you can see that path being really a reasonable expectation. It's not one that necessarily requires, unlike the far more optimistic case here, doesn't require the development of technologies that just don't exist today. As a starting point, it doesn't require the same decline on the cost curve to make it work. It doesn't require a lot of government funding directly to drive it. I think it's a reasonable expectation, like that lower case. The key though, Nick, and this is something we've talked about, we'll get into, is as an investor, finding the places within this where there's opportunity to profit.

Sciple: Absolutely. That's another thing I would pull out of this report. I think government reports for me are one of the most interesting places to find ideas. You can read railroad administration, or Department of Energy, or any of these other sorts of things. They can give you clues on where an industry is going and maybe where there's some places to invest. As I said earlier, there's some assumptions you have to make about where technology goes in order to accomplish the government's goals. There's a few things that pop out. No. 1, you have to make more solar. Solar energy, you need continued innovation and production of solar panels. That's an obvious take when you're looking at growth in solar. Another takeaway that's here all over this report is indeed advances on technology and inverters. We've talked about inverters previously here on the show. This is technology, so whenever you make energy on a solar panel, it comes out as direct current. The grid uses alternating current, is what the inverter does, is it takes that direct current that the solar panel produces, and it puts it into the type of electricity that the grid uses to transmit. They talked about it in the report. 

We need continued advancements in inverters in order to allow solar to thrive, as we've talked about on the show in the past, there's intermittency when it comes to solar production and you can't always match production with the grid. What these advanced inverters would do is allow solar to play a little bit more nicely with the grid, adjust production based on voltage, things like that. Then lastly, storage. We've heard this a bunch also with intermittency. If you're going to a universe where you're going to have the grid being 40% solar, well, listen, the sun's only up half the day, and in the winter maybe even less than that, so you have to find a way to take this energy that the sun is producing and be able to use it when the sun isn't out and things aren't shining. These are trends, some areas where there has to be investment in order for this solar future to be realized, and maybe these are some buckets we should look in as potential investors.

Hall: Yeah, absolutely. Again, we'll talk a little bit more about this. But you mentioned it with the government reports, I think it's easy to miss a few things. There are a few organizations that have access to as much data about as many things as the U.S. federal government does. Guys, you already paid for it. It's free, it's there, it's public, it's in the public domain. If you're not using it, it's the Mark Twain, "The man who does not read has no advantage over the man who cannot read." It's right there and it's certainly powerful to look at these really large systems and start thinking about that data like you were saying, Nick. I agree, I just wanted to emphasize that.

Sciple: We've talked about the reports, some big trends to pull out of it. No. 1, solar getting a lot bigger. No. 2, we need new technologies to make that happen. As you go from there --

Hall: Multiple technologies.

Sciple: Multiple technologies, correct.

Hall: It's improving the efficiency of the panels, inverter technology that can move power in multiple ways. They can't do it right now. Better battery storage technology, better chemistry, cheaper batteries. The depth and breadth and the scale is immense.

Sciple: Let's talk about maybe a couple of companies that could give us some shots on the goal of these trends. We group them into two buckets. You've got the Rule Breaker-y, growth-y companies, and then the companies that maybe just get you some exposure to this industry in a way that there's less technology risk, much more just playing into the trends. Let's start out with the Rule Breaker-y, growther-y, that's a word, we're going to make that word up, growthery.

Hall: I like it.

Sciple: Companies. Let's start with solar panel manufacturers, Jason. What's the company that comes to mind for you for investors?

Hall: You think about this report and the data, this is heavily focused on utility scale, most of the heavy lifting. That's already the case, if you think about global solar deployments, two-thirds of it or so is utility scale. These are the large solar farms you see. You're driving through Arizona, or even in the Southeast, you're starting to see, here in Southern California, they're all over the place, with tens of acres of giant solar panels. A company that has consistently remained in a very good position in this area is First Solar (FSLR 0.43%). First Solar, it's a U.S.-based company, they manufacture a lot of solar panels here in the U.S. They also manufacture a lot in Southeast Asia, Malaysia, I think. Nick, is that what we --

Sciple: Correct.

Hall: For some reason, I can never remember, but so it has a large international presence. But it really has a good presence here in the U.S. and North America. The thin-film technology, and I think they are on their fifth or sixth generation. It has a couple of advantages. Now, there are other panels out there that might be a little more efficient in terms of the percentage of sun that it's able to convert to electricity. But thin film has a couple of other advantages. One is that extreme temperatures tend to consistently generate more electricity, so the efficiency tends to hold better at the extreme ranges of the energy conditions. That's really important in terms of flexibility for deployment and the fact that a lot of solar deployment happens in places that get super-duper hot and there's growingly in places where it might get colder, so that thin-film technology is an advantage. This is also a company that has consistently had what is the best balance sheet across the solar panel manufacturing industry, has always kept a substantial amount of cash, far more cash than debt, only has a few $100 million in debt and about $1.7 million in cash and investments. If you look back, that number has come down from over $3 billion a couple of years ago because the company has the cash that they can spend on improving its technology, lots of R&D spend, and then they have deployed that capital to retool factories and to expand output. 

Having that strong balance sheet is a competitive advantage because, Nick, this is a really cyclical industry, particularly when your customers are utility-scale customers. The deployments from one year to the next can shift pretty dramatically even though this is a secular growth industry from year over year, you can see big ups and downs based on regulatory changes, based on capital spending, based on the economic environment it can have some impacts on it, so all of those things together, that cash-rich balance sheet means that this company doesn't have to massively change their strategy in terms of development, in terms of deployment of technology based on a change in the cycle.

Sciple: You mentioned cycles being driven by government action, maybe that's what we're seeing here when we have this big policy document coming up. But always something you have to keep in mind with this business, in any cyclical business, the ability to survive the bottom part of the cycle is much more important than how big of a home run you can hit in the top part of the cycle because it's inevitable, it will turn one time or the other, and First Solar has proven over time its ability to survive. The solar panel industry, there's not a lot of companies that have that to go for them if you look at the past there.

Hall: Yeah, there's only two or three that have consistently been in the shape. The other part of that, too, Nick, I think is important to talk about is a lot of times, stocks in this space, they tend to trade at some of their highest prices late in the cycle, which means that buying a lot of these companies, overexposing yourself to a lot late in each of those cycles, you pay a premium price, and that can really make it harder to generate meaningful long-term returns. I think I just want to highlight that it's important for a stock like First Solar. If you're interested, and I own some, and it's one that I've added to over time, is that this is a great company to build out your position over time, really over multiple years. Because the stock can be very volatile and it often moves based on rumors about changes in regulation one way or the other. A lot of times, it gets detached from the key drivers of what's actually going on in the industry. Then sales fall, and then the forecast starts to change, and then the stock plummets really, really quickly, so you just have to be careful and think about building a position over time.

Sciple: You mentioned premium valuation, companies that move based on regulatory change, which I guess brings us to the inverter companies here, we mentioned earlier, advanced inverters being important to the thesis. You hear in this government write-up, we've talked in the past about Enphase and SolarEdge (SEDG -2.77%), the two big public companies playing in this space. Enphase, 20 times price to sales, I'm looking here. SolarEdge, nine times price to sales. It's one of these where it looks like the market knows that we need inverters just as much as the DOE does.

Hall: Yeah, there's actually a little bit of irony here in terms of the specific report because Enphase and SolarEdge, neither one really play much in utility scale at this point. They both have initiatives to expand that, but they're really heavily focused on distributed solar. You think about rooftops, all around houses, maybe like a Walmart (WMT 0.46%) distribution center. That's solar that's being produced by a private entity for their own consumption, and then they're taking the excess and sending it back to the grid, they're not producing it and selling it to the utility. It's a different scale. Here's the edge for these two companies, Enphase and SolarEdge. They've been the leaders in panel-level electronics here in North America, in the U.S., code actually requires the use of panel-level electronics, meaning that on the solar panel itself, each individual solar panel, if you have 30 of those on your roof each individual panel has to have its own power management and ability to cut off power to the grid directly at that. Historically, it's been string inverters, meaning there's one inverter that handles your house so all the panels run through that single inverter. The panel-level electronics do a couple of things. 

No. 1, by controlling it at the individual panel it reduces things like fire risk, improves safety, improves safety for grid workers, making sure that every panel is disconnected also can improve efficiency, managing the power better. This is something these two companies have done and they command between the two of them, I think somewhere around 90%-plus of the North American distributed solar inverter market, inverters and power optimizers, because nobody else is really focused on it. They established it early and they got in a great position and everybody else just backed away. They've also expanded their technologies overseas, both have grown pretty well in Europe as well as distributed solar becomes more prevalent. But in terms of this report, honestly, their exposure is not significant. This is just more being driven by the tailwinds.

They both also have some interesting optionality with energy storage. They're both rolling out energy storage, Enphase actually has a pretty good storage for residential storage already. SolarEdge is working on bringing their products to markets. I think there's an interesting edge that they above have. They both work with a lot of manufacturers like the solar panel manufacturers, they work with a lot of large installers, they work with regional installers. So they're right in the middle of that distribution mix. That is a bit of a competitive advantage in terms of energy storage because they are known entities. They're known quantities, they have existing relationships, and it seems like energy storage at the distributor level is becoming like a bolt-on. It just happens where we're seeing in a lot of places the majority of solar deployments, residential solar deployments, it's getting to a point where the majority are including storage along with the solar panels. Totally, we're moving into a new house in Massachusetts and we will be deploying solar with storage. We're not even looking at it as separate things, it's just going to be together. I think that's becoming more and more true. 

The other thing, too, with SolarEdge is it seems like it has even a little more optionality because of some focus they have with the acquisition they made a few years ago to develop powertrain components for electric vehicles. This is an industry that we know is going through just bananas-level growth. More and more companies are looking for more and more suppliers. It's adjacent to what they already do so it fits within their core competencies, is a good position to be in right now. I want to hit it again, you mentioned the valuations here again, 21 times sales for Enphase, almost 9.5 times trailing sales for SolarEdge. Very high multiple risks. To earn those valuations, these companies have to continue to grow at very high rates. Also, and I think this might be the more challenging thing, is to continue to command the margins that they've been able to command, which frankly, I've never seen anybody else's supplying inverters or any of this other in between equipment been able to do. Generally, suppliers that are middle suppliers that are not the end-products manufacturers, don't get the margins that these companies are getting. Can they continue to command those margins while also growing? It remains to be seen. I love those businesses, I own both, kind of like First Solar a little bit. I think this is a good stock to dip your toes in, if you're interested, and then build out a position over time.

Sciple: Yeah. We'll see what happens as the industry grows. If we do get to 40% of energy grid, it is hard to see an industry that matures at that rate that maintains these types of supernormal margins. But hey, maybe we can make it up on volume in that way you don't need as high margins if you're pushing through massive amounts of more throughput. We've talked about a couple of Rule Breaker-y companies here with First Solar and then Enphase and SolarEdge. Do you want to build more of an all-weather portfolio, you're going to get less shaken around maybe by some of these governmental headlines or by the cycle. What are some companies that come to mind for you, for investors?

Hall: Yes, these are tried and true. If anybody is listening, if you've heard me on here with Nick before talking about renewables, these are not going to be unfamiliar names. These are the yieldcos, independent power producers. These are the companies that have either developed or acquired and now operate renewable energy facilities. They are not just doing utility-scale solar, they're also doing utility-scale wind. Generally they own some transmission as well, that connects their projects to the grid. Some of them also own hydroelectric, so that's like the OG of renewable energies. Hydroelectric has been around for a long time. Three, I want to highlight really quickly that I like a lot. The first one is Clearway Energy (CWEN 1.29%), ticker CWEN, and then there's non-voting shares. CWEN.A economic equivalent of what you own pays the same dividend. I tend to buy from one at the time that I'm deploying money pays a higher yield, because you own essentially the same thing. Clearway Energy again, is an independent power producer, and has pretty large exposure to the Western U.S. Went through some challenges with its cash flows because of the bankruptcy of, Nick, you're going to help me out here.

Sciple: PG&E?

Hall: PG&E, yes. Short version. Bankruptcy judge froze some cash that was at a subsidiary that came through from PG&E. Management said the whole time, "Hey, this is going to be fine, it's going to get released, our contracts are good." It proved to be right, the company was able to reestablish its dividend, has grown substantially, and is working to steadily decrease its exposure to single individual utility customers. That's helping reduce that risk. But the big thing here is this is exactly the kind of company that is positioned to continue to deliver long-term growth in this area. Whether there's government intervention or not, this is where the puck is moving right at the companies that are doing this. Clearway is a play on growing their footprint, acquiring and developing more of these assets, growing their cash flows that are stable over the long term, like 20-year agreements typically, and then growing a dividend that it pays to investors. I believe yield's around 4% right now, maybe a little above that. Starting at a 4% yield and then growing that payout over time, it really lowers the bar for the growth you need to see to deliver meaningful returns. 

Two others that I like, that I'm going to highlight I won't dig into too much, one is Brookfield Renewable, which is the largest of these independent power producers. Still the majority of its business comes from hydroelectric, but it's deploying far more capital into solar and into wind than anything else. Part of that Brookfield Asset Management group of entities, lots of capital that comes into this business. It's international. They're really good at capital deployment no matter where in the cycle things are. The thing that I like the most is they have really good optionality depending on where the market is, geographically, which asset class to deploy where they think they can get the best returns. NextEra Energy Partners (NEP 0.26%) is a similar version of this because it's the limited partnership of NextEra Energy, which is the largest solar utility in the world, I think, actually. Has big assets down in Florida with its regulated business. But NextEra Energy Partners is a big part of the way it's growing its independent power business. Because again, the tailwinds are pushing so much utility-scale power toward renewables so they are able to leverage this subsidiary business to do that. It's their yield growth business. I really like those three a lot in that space because not only can you capture a good yield and have that income stream grow because the above-average growth of the dividend but these can be market-beating investments. You don't have to buy these growth-y names to outperform the market. You can do that with these yieldcos.

Sciple: These are the companies that would be helping carry out this huge deployment that we're calling for over these next several decades. There's nothing wrong with taking the companies that know how to do this and know how to squeeze blood from the stone when it comes to renewable energy.

Hall: They're driven by the tailwinds. The large secular growth in this industry, they benefit from the decline in the cost curve, because they're buying and operating the equipment. They really benefit from all of that. They're not exposed to the same cyclical aspects that the manufacturers are. They benefit when the cycle turns and all of a sudden all these manufacturers have excess inventory and start fighting for market share and cutting costs. If you're the guy that's buying that equipment, you benefit. That's another thing about these yieldcos that's really exciting to me.

Sciple: Jason, it's about time for us. We've talked about this Department of Energy, reported some big takeaways, and shared a few companies folks should have on their radar. That's First Solar, FSLR, Enphase, ENPH, SolarEdge, SEDG, Clearway Energy, CWEN, there's A and B shares. There's CWEN.A and there's just CWEN, Brookfield Renewable, which is BEP, or if you want the corporate shares, which are a little bit easier. If you're in a tax-free account, there's BEPC. Then I think you mentioned NextEra Energy Partners, which is NEP. Any last thoughts, Jason, here on solar stocks and just this big broad trend before we send it home?

Hall: Just the conclusions. We talked about it earlier, use this government data. It's massively informative, it's free. Don't get caught up in the partisan aspects of it. Just take it with a grain of salt with the administration that it's coming from. With that said, the train's left the station. Solar is real, this is happening. There's something here for everybody, whatever kind of investor you are, super conservative, really focused on growth, willing to take on that risk of high volatility, every investor can profit from this and probably should have some exposure to it because it's real.

Sciple: Jason, always love having you on the podcast. Looking forward to next time.

Hall: Me, too. Thanks, Nick.

Sciple: As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against the stocks assessed, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the virtual glass. For Jason Hall, I'm Nick Sciple, thanks for listening and Fool on!