Once in a Lifetime Buy in Clean Energy (Part I)

Paul is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Yes, we are the characters last spring that made a $500 call for crude oil in coming years.  You can read our unchanged views and reasoning on the high odds of skyrocketing oil and gas prices here.  Today investors underestimate the impact that rising prices for energy globally will have on the existing structure and foundation of the economy going forward.  Our basic argument is that record high levels of money printing will combine with the Peak Oil supply situation to force the price (and value) of oil vs. other assets and commodities to zig-zag higher at a 20%+ annual clip the next 5-7 years.

In early 2013, we may have reached a fabled, “Be careful what you wish for” moment in the economy, for investors, consumers, businesses and central bankers.  Even a small uptick in sentiment regarding economic activity has translated into a decent +15% upmove in crude oil.  If the global economy actually expands some in 2013, honest crude oil shortages on the planet may develop, mathematically requiring a large 30%-50% rise in the price of this universally important energy input. 

We could be on the verge of a spike in oil and gas prices, “without” any significant supply shock from a new war with Iran this year, or continuing social tumult in a number of oil producing regions.  Given a 5% CPI rate from $150 crude oil, the Federal Reserve and U.S. Treasury would see serious issues develop in the capital markets, if they choose to continue with money printing schemes and debt funding dreams.  Sharply HIGHER interest rates would be required to keep Uncle Sam solvent, and this would crush any deficit-cutting hopes.

In the end, a doubling and tripling in crude oil prices globally over time will have far-reaching ramifications on the economy, our day to day lives, and honestly may rewrite the playbook on all aspects of energy supply and demand. 

A boom for clean energy

The biggest beneficiary of continued rises in coal, oil and gas pricing will be, in our opinion, clean energy – mainly solar and wind resources.  Not only will the real world “cost” of clean energy production cross BELOW the expense of burning brick, liquid, and gas fossil fuel, but their renewable and available-everywhere aspects will generate a sea change in demand for clean energy.

Already, in many areas of the world, large-scale solar energy projects are nearing the total cost aspects of traditional natural gas or coal-powered electricity generation.  A major solar cost advantage for utilities vs. natural gas and coal alternatives revolves around their “fixed” cost nature during a rising and unpredictable energy price future. 

While natural gas and coal prices today in America are quite low (natural gas prices in 2012 were actually at record lows when compared to the relative price of other commodities), in five or 10 years this critical input price for a utility could be multiples of the present number.  On the contrary, a fixed price for budgeting an entire solar project can be attained before the project is started for a 20-plus-year lifespan.  Inflation generally, and the fear of future price gains in natural gas and coal, will soon be a major benefit for large project designs, like what First Solar (NASDAQ: FSLR) builds and maintains.

Solar as utility

First Solar is our favorite company in the solar field.  It has a strong balance sheet, significant long-term owners in the Walton family (Wal-Mart money with great political connections), a wonderful management team, and a prudent focus on utility-scale electricity generation.  It's also uniquely profitable in the industry, even at a major bottom in the business cycle.  One of our favorite investment themes is to buy the strongest competitor in an industry after a prolonged downturn or bust phase.  First Solar fits this formula best in solar.

Quantemonics is excited about both the value proposition for FSLR shares today against its existing asset and cash flow base, and its growth outlook in a rising energy price environment.  If the crude oil, natural gas and coal price background rises sharply, the demand for First Solar's products could grow exponentially starting in 2014.  We view our First Solar investment as part high technology, part solar panel manufacturer, and part utility in our valuation model. 

Not many analysts are presently using the “utility” idea in their forecasts for First Solar’s earnings and cash flow down the road.  In reality, First Solar already has existing long-term contracts on its solar projects to run and maintain them.  This residual revenue and cash flow stream is making a difference in the quality and consistency of its financials, and we can easily envision the number of utility workers under First Solar's umbrella growing from hundreds of employees to thousands the next 5 years.  A big part of the business model will be a more regular, consistent and conservative revenue stream, than the average solar panel maker. 

Using this logic, and growth in its solar plant portfolio, a much higher multiple of earnings and cash flows seems warranted by Wall Street than the ultra-low valuation of today.  Based on First Solar’s current asset and liability structure, its present revenue and cash flow stream in 2013, and a conservative estimate of growth in new utility-scale solar farms, we feel a fair value for FSLR is closer to $50 a share, than the sub-$20 prices last summer, or $33 market price today.  Please review the latest 2011 10-K filing and September 2012 10-Q with the SEC for additional research.

<img src="/media/images/user_2224/fslr_large.png" />

Charts courtesy of StockCharts.com

With governments cutting back clean energy incentives for new solar projects, mainly in Europe the last several years, the initial gold rush in solar ended in 2008.  Not coincidentally, the rise and peak in the last upcycle in solar demand and investor valuations closely mirrored the rise in other energy pricing, namely oil, gas and coal products. 

Looking to bounce back

Anyone owning a solar stock can testify to how poorly they have performed the last 3 years, as the stock market generally has risen strongly.  Looking back, the average solar stock fell 80% to 90% in price between 2008 and 2012.  However, in our estimation, the bust phase in solar is nearing completion in 2013, after a huge oversupply situation problem led to bankruptcies, shuttered capacity, mergers and reorganizations (likely to continue throughout the year).

Believe it or not, measured from the solar stock bottom in the second half of 2012, many have already doubled off their low prices.  Using the Guggenheim Solar ETF (NYSEMKT: TAN) as a proxy for the industry, solar stocks are up roughly +50% since November 2012!  Typical of past supply/demand cycles, the respectable rise in solar supply stocks may be signaling the industry is reaching for a bottom, or at least more stability in pricing. 

For investors, quick exposure to the sector can be achieved by putting money to work in TAN.  We currently have a BUY rating on TAN, as a stand-alone idea for investors looking at solar, and a diversification proposition with low expenses in the ETF arena.  You can review the latest data and a complete list of TAN’s stock ownership at the Guggenheim website.

<img src="/media/images/user_2224/tan_large.png" />

A similar but much smaller ETF product compared to the TAN creation is Market Vectors Solar Energy (NYSEMKT: KWT).  While both ETFs have related focus and stock holdings, minor differences exist, with KWT actually performing slightly better the last 6-month period for investors.  Do your own due diligence and weigh the pros and cons for yourself by reviewing the Market Vectors webpage for their focused solar ETF entry.  We currently have a BUY rating on KWT.

<img src="/media/images/user_2224/kwt_large.png" />

Overall, we feel U.S. solar stocks represent much better value than overseas based ones.  The Obama administration has wisely decided to protect the burgeoning industry from unfair Chinese competition, and their decision to add tariffs on imported solar panels in May 2012 will help support a quicker recovery in pricing and sales than otherwise would have taken place. 

Without a serious long-range energy policy for decades in America, the decision to retain American know-how and production in solar will pay big dividends after a spike in oil and gas prices becomes reality.  Several American-based solar manufacturers have strong upside potential, if we are at an inflection point for the industry, and above average growth trends are about to resume.

Sun also rises

SunPower (NASDAQ: SPWR) ranks with First Solar as one of the largest solar energy manufacturing concerns on the planet, and is based in California.  It is a fully integrated solar inventor, designer, producer, installer and service company.  Helping both commercial and residential solar customers, SunPower has the largest installed base in America, and arguably the most “efficient” panels at converting light to electricity. 

In 2011, the company took a large investment from the Total SA (TOT) oil conglomerate to help pay down debt and deliver future growth options.  Today Total owns approximately 66% of the company, with the other 34% owned by the investing public.  More than half of revenues come from utility-scale solar farms and big business roof development, a huge plus from our point of view.  SunPower is one of a handful of solar related stocks that has actually RISEN in price the last 12 months.  Start your own research with their 2011 annual 10-K filing here.

After several years of restructuring operations, focus and assets, First Solar, SunPower, and other stocks we will mention in Part 2 of this blog entry are projected to have solid earnings growth during 2013 and beyond.  Citibank and Credit Suisse analysts have taken notice of the changing solar production and pricing conditions in February, initiating new coverage and Buys on many in the sector.

<img src="/media/images/user_2224/spwr_large.png" />

MEMC Electronic Materials (NYSE: SUNE) just reported much better than expected results for the last quarter of 2012, and is based in Missouri.  MEMC develops and manufactures silicon wafers worldwide for the semiconductor and solar industries, and develops large solar projects.  On the plus side, the company is a leading name and well established in the markets it serves, with the bottom line projected by Wall Street to be profitable in 2013; on the negative side, it has become extremely leveraged and is quite susceptible to a downturn in the industry or global economy.  If you invest in MEMC, think about retaining a 20% or 30% stop-sell order on your position, in case things start to move in the wrong direction.  Quantemonics Investing has a Neutral rating on WFR currently.  You can review their September 2012 10-Q here

<img src="/media/images/user_2224/wfr_1_large.png" />

 (Part 2 will discuss more investment ideas in Solar and Wind Energy.)

FULL DISCLOSURE: We hold First Solar (FSLR) shares long in our mirror portfolios on Covestor http://covestor.com/quantemonics-investing and unrelated personal accounts. We do not currently hold positions in any other stock mentioned in this article. Quantemonics Investing, LLC is paid as a general publication information and data provider. All contents of the Quantemonics Investing service and blogs on the Motley Fool website are provided for information and education purposes only. You agree that the service is not to be interpreted as investment advice, as an endorsement of any security or investment, or as an offer or solicitation to buy or sell any security. Quantemonics, www.quantemonicsinvesting.com and the owners and officers of Quantemonics Investing, LLC do not provide specific and personalized investment advice, and are not registered as investment advisors or a broker/dealer. The trading of securities or investments may not be suitable for all users of the service. It should not be assumed that future results will be profitable or will equal past performance, and all readers should understand each security investment involves a degree of risk. Investors should not assume that profits or gains will be realized by any security or investment mentioned by the service or related blogs. Readers accept any and all potential liability, loss, expense and cost when making trades or investments in their own account. We recommend readers consult with a registered financial adviser before making any investment decision. Investors should not hold more than 5% of their portfolio capital in any single equity position, as a general rule of diversification. No compensation of any kind has been paid to Quantemonics Investing, LLC or related parties for company participation in our data service. The facts and information presented have been obtained from original or recognized statistical sources believed to be reliable, but their accuracy and completeness cannot be guaranteed. All opinions expressed on the service are subject to change without notice.

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