What happened
Shares of solar-oriented stocks SunPower (SPWR 5.85%), Sunrun (RUN 5.97%), and Canadian Solar (CSIQ 4.48%) were plunging this week, with these three stocks down 11.7%, 20.3%, and 12.5%, respectively, through Thursday trading, according to data from S&P Global Market Intelligence.
It wasn't particularly difficult to understand why these stocks took it on the chin. Long-term interest rates surged this week, in a continuation from the prior week after the Federal Reserve's latest meeting on Sept. 20. The rate volatility led several Wall Street analysts to downgrade the solar sector broadly and some of these names specifically in recent days.
While these three companies each serve the solar industry in slightly different ways, all are harmed by rising rates, with Sunrun's model especially affected.
So what
Those paying attention to the markets this week probably already know that long-term Treasury bond yields continued to surge, reaching 17-year highs of over 4.8% this week before slightly retreating to 4.71% as of Thursday.
The rapid rise in long-term rates has been especially bad for solar companies. First and foremost, all stock valuations are affected by long-term interest rates. Given that both Sunrun and SunPower lost money both on an earnings and cash flow basis last quarter, they can be especially hard-hit by rising rates since the bulk of their earnings is far out in the future.
But that's true of all high-multiple or unprofitable growth stocks. Yet certain sectors, especially sectors that sell big-ticket items or interest-rate-sensitive products, are doubly affected. And the solar business has elements of all these characteristics.
Residential solar systems are large upfront purchases, which customers usually finance with debt. So, rising interest rates increase costs for systems, narrowing the savings customers get relative to utility bills.
For Sunrun, its main business is leasing systems over long periods at fixed rates. But higher interest actually lowers the net present value of those fixed-rate contracts. In that sense, Sunrun isn't so much like a hardware company as it's like a bank with long-duration assets -- and we've seen how regional banks with lots of low-rate, long-term assets have suffered this year.
Of course, Sunrun doesn't have to pay higher and higher deposits, as banks do -- its assets are also backed by fixed-rate debt, so it's not in as much trouble as banks are. Still, it needs outside capital to grow. So, it's unsurprising that investors are fleeing the stock amid higher rates, lower demand, and Sunrun's complicated accounting.
SunPower is a producer of solar panels and systems. While it doesn't hold leases on its own books, it's a co-investor in a joint venture that does hold some of its long-term solar leases. Additionally, SunPower is dependent upon third-party financing to move its systems, and those partners are also affected by long-term rates.
Canadian Solar is a bit different than the other two names, as it had historically been a panel and battery manufacturer and a project developer for utilities. However, it's also looking to own more recurring-revenue stakes in projects today. Canadian Solar is solidly profitable at the moment, but it is highly cyclical and capital-intensive, so it's vulnerable to capital markets as well. It's also more global and is therefore subject to currency fluctuations.
Image source: Getty Images.
This week, analysts at Raymond James downgraded SunPower -- albeit from "Strong Buy" to a lower-rated "Outperform." It appears the analysts are still bullish in general but cited concerns over SunPower's rising inventories and the potential for a dreaded inventory write-down in the near term amid slowing sales.
Meanwhile, Sunrun also received a downgrade this week from Truist from "Buy" to "Hold," which lowered its price target to $12. The analysts cited the higher costs of financing on the company's ability to grow -- though they seem a little late to the game to be making that call!
Now what
Solar stocks have not only sold off this week but have really been crushed ever since interest rates began taking off in late July. Many have been cut in half in just the span of a few months.
But given the long-term prospects for solar deployment, investors should probably have some names on their watchlists today amid the carnage. Just be careful that you understand each player's differentiation, balance sheet, staying power, and sensitivity to interest rates before you do. While solar has bright long-term prospects, as investors are learning, these businesses can be quite cyclical as well.
