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What do Costco, Johnson & Johnson, and General Motors have in common? Similar to a number of other iconic brands, these giant companies have deployed solar energy on a massive scale in order to help lower operating costs and increase profits—not to mention the considerable intangible benefits these companies realize by using clean energy.1
To understand how a wide variety of publicly traded companies have found the environmental and financial benefits of solar energy attractive on multiple levels, consider Walmart, the world's largest retailer. With more than 10,000 stores in 27 countries,2 the company aims to be powered entirely by renewable energy, and solar power has become an important part of that mix. Walmart plans to continue its investment in solar energy, expanding the number of its locations powered by the sun, and hopes to use its scale to drive down prices for all renewable technologies, one executive said last year.
Solar Economics Optimize
A growing number of utilities and consumers are following suit, which helps explain why solar energy production rose an astounding 500% in 2012, according to the U.S. Energy Information Administration.3 (See Chart 1.) These users know that increasingly affordable solar energy (thanks to sharply lower polysilicon prices; see Chart 2) allows them to reduce their long-term energy costs.
Source: Energy Information Administration. Data as of April 30, 2013.
Source: Bloomberg New Energy Finance. Data as of May 31, 2013.
And now that the gap between supply and demand has narrowed, investors once skittish about the deteriorating economics of solar energy amid fierce competition have returned to the sector with renewed enthusiasm, convinced that Chinese oversupply is not going to be a problem. Shares of two industry leaders, for example, have nearly tripled in the last six months, according to Bloomberg.
The Smart Money Moves In
A number of respected investors recently have taken big stakes in the industry. This likely shocked the market, considering the dire industry forecasts that have led to massive short positions in the solar names.
MidAmerican Energy Holdings announced plans to acquire two huge solar projects on 3,230 acres in California, which together will form the largest permitted solar photovoltaic (PV) power development in the world.4 MidAmerican (a subsidiary of Warren Buffett's Berkshire Hathaway), will reportedly pay $2.0–2.5 billion for the projects, and the renewable energy they produce will go to Southern California Edison under two long-term power purchase contracts. The deal marked Buffett's third investment in solar energy in a little over a year. Another more recent catalyst was a lease-financing agreement between a leading provider of clean energy and Goldman Sachs, which will help users to install solar panels with no upfront investment and lower electricity bills.5
How Solar Investing Has Run Hot and Cold
In the last several years, there have been a number of initial public offerings (IPOs) in the solar industry, both in the United States and China. In the case of one U.S. company that went public in November 2006, the industry at the time was still healthy and growing. Spain, Italy, and Germany all had programs to fuel the growth of solar energy. The company had gone from a small cap to a large cap stock in just one year. (See Chart 3.)
Source: Bloomberg. Data as of July 24, 2013. For illustrative purposes only and does not reflect any Lord Abbett mutual fund.
But the subsidies would prove unsustainable. As the euro crisis intensified in 2011, the solar subsidies began to disappear. As a result, many investors sold their solar stocks early that year, after which shares of solar companies plunged as Chinese solar companies flooded the market with cheaper alternatives, solar equipment prices tanked, and many industry players fell into red ink.
During this time, the cost of producing solar energy continued to drop at a steady pace, demand rose, and supply started to shrink. By the third quarter of 2012, the company that went public in November 2006 began attracting investors again. Much to their surprise, the company had become a small cap again. The company had rebuilt its business to focus on new markets like South America, where small-scale utility power plants can provide electricity for remote locations like mines in Australia and South Africa, and as a replacement for electricity generated by oil in sun-baked countries such as Saudi Arabia.
Against that backdrop, some analysts began recommending another leading solar company in late 2012, since it appeared to be attractively priced versus its long-term prospects. Nine days later, news that Warren Buffett had chosen that company to build a utility-scale project in Southern California sparked a substantial rally in solar energy stocks as investors refocused on the long-term demand for solar energy in the United States.
During this same time period, a company that makes polysilicon, which is used in the manufacturing of solar panels, also gained favor. The company has also cranked up solar project development, and its shares have more than quintupled in the 52 weeks ended July 31, 2013, according to Bloomberg data.
Solar's Long Shadow
According to the Solar Energy Industries Association (SEIA), the United States has 5,600 solar energy companies across all 50 states and employs more than 100,000 people. In 2012, photovoltaic (PV) installations grew 76% over 2011, with an estimated market value of $11.5 billion as of December 31, 2012. Each market segment (residential, nonresidential, and utility) advanced compared with 2011, while solar markets in most U.S. states also grew.6 (See Chart 4.)
Source: SEIA/GTM Research, "U.S. Solar Market Insight: 2012 Year in Review."
Note: The annual installed figures cover only grid-connected capacity. DC stands for direct current, the type of power output by photovoltaic cells and modules. Data as of December 31, 2012.
The industry remains rather fragmented. However, several weaker companies have gone bust or been acquired, leaving the strongest players in the position to benefit from the significant increases in residential, nonresidential, and utility-scale installations. (See Chart 5.) In fact, leading U.S. solar companies are being contacted to take over projects originally expected to be fulfilled by Chinese module providers.
Source: SEIA/GTM Research. "U.S. Solar Market Insight: 2012 Year in Review."
Residential solar installations have increased in part because one industry player has implemented an innovative financing mechanism whereby buyers can lease systems at attractive rates over, say, a 20-year period, which dramatically lowers the upfront capital investment, which for years was a major hurdle for prospective purchasers. Now some states are providing rebates and tax credits for people who lease. Federal tax credits would still go to the solar leasing companies who purchase the solar energy equipment.
Commercial solar installations have advanced as developers have focused on improving equipment performance, reduced investment costs, increasing government incentives, and the near-certainty of future price hikes for nonrenewable energy. "Solar is a more viable alternative than ever," said Jones Lang LaSalle (JLL), a global commercial real estate services and investment management firm.
According to JLL, there are several different options for commercial real estate developers when considering solar as an energy source. One is to obtain solar power through a power purchase agreement from a third-party provider that owns, installs, and maintains a solar system on a developer's property. (Renting large flat-roof spaces, such as warehouse roofs, to an outside solar developer would be one example.) A second option JLL cites is outright ownership of a solar energy system that can be installed in a variety of locations such as building rooftops, parking lot shade structures, mass transit waiting areas, even unused land.
The recent growth in utility-scale solar projects is especially noteworthy. "This category was all but nonexistent only five years ago, when the residential and commercial sectors accounted for nearly all of the photovoltaic7 [PV] installations," according to the U.S. Energy Information Administration. "While a residential PV system might comprise only a few solar panels and 5 to 20 kilowatts of capacity, utility-scale plants have capacities of 1 megawatt (MW) and above. Utility-scale PV capacity grew from just 70 MW in 2008 to 1,052 MW in 2011. In fact, prior to 2011, the majority of utility-scale solar capacity was concentrating solar technology,8 and not photovoltaic." According to the SEIA, the United States installed 723 megawatts of solar energy in the first quarter of 2013, which accounted for more than 48% of all new electric capacity in the United States the previous quarter. Those installations marked the best first quarter ever for the industry.
Glenn McIsaac, Lord Abbett Research Analyst, U.S. Large and Mid Cap Equity, thinks utility-scale solar (especially PV) will continue to grow in the United States, driven by declining panel prices, a federal tax credit program that remains in place until at least 2016, and state renewable portfolio standards. Even so, solar will likely remain only a small part of the total generation mix, he added.
The Solar Horizon
From an investment perspective, we would caution that the industry remains in the early stages of a recovery, and, therefore, this is still a fragile situation. Demand needs to grow and supply needs not to expand too fast. As concerns the latter, one wild card is the question of how long it will take the Chinese market to rebalance.
The bottom line is that we will continue to own solar companies as the recovery ensues and the economics of the business remain healthy.
F. Thomas O'Halloran, J.D., CFA, Partner & Director, is the lead portfolio manager of the small and multi cap growth equity strategies. Mr. O'Halloran joined Lord Abbett in 2001 as a research analyst for the small cap growth equity strategy and was named Partner in 2003. His prior experience includes Executive Director/Senior Research Analyst at Dillon, Read & Co. and as a trial attorney. Mr. O'Halloran received an AB from Bowdoin College, a JD from Boston College, and an MBA from Columbia University. He is a holder of a Chartered Financial Analyst designation and has been in the investment business since 1987.
Arthur K. Weise, Partner, is a Portfolio Manager of the small and multi cap growth equity strategies, and also contributes as a Research Analyst to the micro cap growth equity strategy. Mr. Weise joined Lord Abbett in 2007, and was named Partner in 2012. His prior experience includes: Managing Director, Portfolio Manager, and Analyst at Bank of New York Institutional Asset Management; Vice President, Director of Research, and Analyst at Trainer Wortham & Co.; and Associate Director at Dillon Read/UBS Warburg. Mr. Weise received a BA from Columbia University. He also is a holder of a Chartered Financial Analyst (CFA) designation, and has been in the investment business since 1993.
Risks to Consider: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. Investments in small-sized companies involve greater risks not associated with investing in more established companies, such as business risk, significant stock price fluctuations, and illiquidity. Investing in international securities generally poses greater risk than investing in domestic securities, including greater price fluctuations and higher transaction costs. Special risks are inherent to international investing, including those related to currency fluctuations and foreign, political, and economic events. These risks can be greater in the case of emerging country securities. No investing strategy can overcome all market volatility or guarantee future results.
There is no guarantee that the solar energy market will perform in a similar manner under similar conditions in the future.
The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.
Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.