Renewable energy stocks have shown underperformance relative to the broader markets for years, even though the long-term outlook remains favourable. High interest rates and inflation have created many headwinds.
The cost of setting up solar or wind projects surged due to the coronavirus crisis because of disruptions in supply chains in late 2021 and 2022. “Due to component shortages, some projects could not go ahead, especially in the wind sector,” Triodos Investment Management analyst Fabian Meijs told Investment Officer.
“Those higher costs could not be passed on to the end customer,” added analyst Emma Hall of Aegon Asset Management. “This put pressure on margins at companies that had already financed many projects with debt.”
Consumers abandoning solar
European residential solar also took a hit after a big rebound during the coronavirus crisis when consumers started DIY projects and bought solar panels for their homes. Higher energy prices following Russia’s invasion of Ukraine also led to increased demand for solar panels. “When energy prices started to fall again, demand for solar panels collapsed,” Hall said. “Parties were left with high and expensive stocks.”
Fund manager Dimitri Willems of Triodos IM further sees a negative correlation between commodities and renewable energy. “Oil and gas prices have done well in recent years, and there is a lot of cash coming out of companies like Shell and BP. This is often somewhat at the expense of enthusiasm around renewable energy stocks,” Willems said.
Some sectors have been hit harder than others, the experts note. Especially companies active in solar panels for the residential market have “gone down the drain,” according to Willems, and have shown little recovery so far.
Hydrogen companies also lagged considerably, mainly because hydrogen is still very expensive as an energy source. “There is still little evidence that hydrogen can be widely used as an alternative energy source,” Meijs said. “Solar and wind energy have proven that already, though.”
US support measures
Utility-scale solar projects, large-scale solar power projects that supply directly to the grid, remained fairly unaffected. “Companies active in this sector have not done badly,” Meijs says. “Especially in the US, these companies benefit from government support, including through the Inflation Reduction Act. Among other things, the act encourages domestic investment in green energy through subsidies and tax breaks.”
The experts cite First Solar as one of the companies that has benefited the most from this. Meijs said, “If the company builds a new factory in the US to make solar panels, the investment can be recouped in as little as a year and a half. This shows how much support the company receives from the US government.” Its shares have already risen over 50 per cent this year.
The rise of AI is also benefiting such companies. Parties like Google, Microsoft, and Nvidia are investing heavily in building data centres to make the most of AI’s capabilities. “They want to run those data centres on renewable energy,” says Triodos’ Willems. “First Solar, for example, supplies the tech giants directly.”
Competition from China
Companies like First Solar are also better protected in the US against competition from China, the experts argue. In the US, there are policies in place to limit Chinese imports and actively encourage domestic production. Hall said, “And where will those Chinese solar panels go if they stop going to the US? Right, to Europe.”
The experts feel that companies in Europe are only marginally protected from Chinese competition. For example, wind turbines from China are available at a third of the price of European models, Hall argues. “That is a problem that European regulators need to address.”
At the same time, it does create a dichotomy for European policymakers, Hall argues. “Brussels wants prices, for example for electric cars, to come down because it wants to achieve its sustainability goals quickly. One way to get that done is by allowing Chinese products. That may be one reason why import tariffs on cars from China are not as high as in the US.”
Doubts about sustainability of US support measures
Yet there are also questions about whether current US support measures are sustainable. Aegon’s Hall sees that higher interest rates are making local governments more inclined to keep a hand on the purse strings. The US election adds further uncertainty. “Trump has already said he wants to scrap all offshore wind projects from day one, partly because of whale deaths, for which there is no evidence, by the way.”
Uncertainty about US support measures combined with higher interest rates and inflation have led to the underperformance of renewable energy stocks this year, Hall said.
Rescue
Triodos’ Meijs argues that some pain may still need to be taken out of the market. Both within wind and solar, he sees necessary companies in trouble. “There have not really been any bankruptcies in that corner yet, but investors do rate some companies as if they are on the verge of bankruptcy.”
Siemens Energy, among others, already had to be bailed out by the German government. The company was struggling with all kinds of defects in its wind turbines and had to make high provisions. “One moment a share like this is spat out, the next it is a big favourite,” Willems said. The share already doubled in value this year after the German government’s bailout, after it halved in value in just six months last year. “It can go fast,” he said.
“It’s boom and bust in wind companies,” Hall argues, pointing to the erratic share price performance of Denmark’s Ørsted, which also had to write off billions and cancel projects.
The experts consulted stress the importance of stock picking. “There are big differences between companies in different sectors. We focus on names with a good balance sheet that can take a hit even in down times,” Triodos experts say. Valuation and competitive position are also important. “We mainly choose market leaders with proven technology at this stage.”
Low valuations
In general, Meijs argues that valuations of renewable energy shares are somewhat on the low side. “Wind shares like Vestas and Nordex seem reasonably fairly priced, although there may be some upside potential in the next two years. The average selling price seems to be going up a bit and input costs down, which could allow margins to recover a bit.”
The sector does suffer from a slow decision-making process in Europe, according to Triodos. “It can now sometimes take up to six or seven years to get the green light to realise a wind turbine project. There is still room for improvement there to encourage renewable energy.”
“With solar, it depends a bit on which company you look at,” Meijs argues. “First Solar has a reasonable valuation, following its recent rise due to optimism about demand for solar panels for data centres. It is possible that the share price has even overshot a bit. Among companies in the residential solar panel inverter market, like Enphase, there is room at the upside. They are companies with a good balance sheet, and if demand picks up and distributors reduce their inventories further, then these kinds of stocks can skyrocket.”
Willems: “The valuations of renewable energy stocks seem somewhat normalised, although with considerable dispersion between subsectors. The long-term picture looks good. Europe also wants to meet its sustainability targets and that still requires substantial investment.”
Hall is especially watching for signs that interest rates are coming down a bit from current levels. “Then there will possibly be a rebound in renewable energy projects. Equities are likely to remain volatile ahead of the US presidential election.”