Over the past fifteen years, there has been a marked shift in the world’s most valuable industry. Oil dominated the top 10 in the prior decade and technology dominates in the current decade. However, what will happen when these two dominant industries merge into renewables and combine the addressable market of fossil fuels with the disruptive nature of technology?
It’s a big question to ask as many renewables companies look like moonshots, or they’ve operated for some time and have cyclical financials. There are many highs and lows in their financials due to the level of infrastructure required for renewables and the dependency on cyclical supply chains. To put it plainly, the financials in the renewables sector are what most growth investors try to avoid. First Solar is a great example as the company rotates between 100% growth in some quarters and negative growth in others. Cyclical issues are the norm and not the exception. We discuss this more towards the end of the report as we identify a handful of companies we are keeping a close eye on.
You can reference our previous renewables report here.
The Bull Thesis:
Our first report on renewables highlighted a study from the College of UC Berkeley claiming that by 2035 the U.S. could see up to 90% of U.S. energy consumption come from renewable energy sources. This report assumes favorable subsidies and legislation that should facilitate this transition and acknowledges that government assistance is not a guarantee. Without government support, the report claims the U.S. could see up to 55% of its energy consumption come from renewable sources by 2035.
Since year-end 2020, we’ve seen even higher growth reported than previously estimated with worldwide capacity growing by 45%. This is the largest annual growth rate since 1999. The growth was driven by a 90% rise in wind power and a 23% expansion in new solar power installations. Most importantly, the IEA is predicting that large capacity gains in renewable energy becomes the “new normal” in 2021 and 2022 with gains in capacity similar to 2020.
The key point to renewables is that the levelized cost of energy (LCOE) for utility-scale solar photovoltaic (PV) has plummeted 400% in the past five years. I covered this for MarketWatch with the image below to depict how competitive solar has become compared to other energy sources. This is important because the industry has seen a change in the story and (generally speaking) is why the renewables’ financials were deep in the red over the last couple of years.
This has led to hockey stick growth. According to the report, wind is growing the fastest (50%) within the renewables category yet solar (26%) is expected to overtake wind power.
The reason for this growth is that the technology is being developed for and marketed to individual consumers whereas wind is designed primarily for a region’s electricity grid. As the efficiency and storage continue to increase, and the cost continues to go down, more people will likely migrate to having a home that is independent of the grid predominantly due to a reduction in personal expenditures, which will also align with the desire to become greener.
More importantly, the cost to produce 1 kilowatt of solar electricity is now competitive with wind, and is the cheapest form of electricity available when taking into account utility-scale systems installed in locations that receive full sun.
If we use the metric of levelized cost of energy (LCOE), solar is more expensive to build upfront, but much cheaper to maintain, compared to a natural gas power plant that is less costly to build but has significant and on-going costs to maintain. As stated, the LCOE for solar has plummeted as much as 400% in the past five years, making the economic incentive a real driver for municipalities and business to develop on a large scale.
Global Addressable Market
Renewable energy companies have global addressable markets, which makes it an attractive industry for investment. In any given region – China, the United States or Europe, energy accounts for 15-18% of the country’s GDP. According to Brookfield Renewable Partners, one of the world’s largest investors in renewable energy, $5 to $10 trillion will be invested in renewable energy worldwide by 2030.
We’ve covered why we are keen on China for electric vehicles specifically. In a similar vein to the country having a need for electric vehicles due to a lack of oil, China is also the biggest manufacturer of solar photovoltaics and the largest producer of solar-generated electricity. According to Wood Mackenzie, China will exceed the United States on solar power through 2024.
Last year, China accounted for 50% of the world’s growth in renewable energy capacity. In Q4 of 2020, China added 3X gigawatts in capacity compared to Q4 2019.
The country’s global share is at 22.9% with a 10-year annual growth rate of 33.4%. Compare that to the United States with a similar global share of 20.1% yet with a 10-year annual growth rate of 10.1%.
India is forecast to become a growth market, as well, with ambitions to reach 225 gigawatts of power by 2022 compared to 10 gigawatts of power in 2019.
India and the United Kingdom are tied for the second highest 10-year annual growth rate in the 17% range after China’s 33%.
With that said, the United States is a key market with 5% of the world’s population yet accounts for 17% of the world’s energy. The daily per capita energy consumption in the United States is 2.6 gallons of oil, 9.7 pounds of coal, and 255 cubic feet of natural gas. Residential consumption is 11.8 kilowatts (KWh) per person.
Even though the growth rate is much lower in the United States, on a per capita basis, the country is in a wide lead for both fossil fuels and renewables. In Q4 of 2020, the United States added 19 gigawatts compared to 13.7 in the year-ago quarter compared to the 3X growth China reported.
Constraints to Renewables:
Renewable energy’s capacity factor is more fixed due to the elements. Solar has a capacity factor of 25%, while wind has a capacity factor of 35%. These numbers are based on the rotation of the sun and other weather patterns. Advancements within this field must come from an acceleration of efficiency during the restricted time that it can produce energy.
The average size of natural gas power plants in the U.S. is 820 megawatts. The average current capacity factor for natural gas in the U.S. is 58%. This means that the average natural gas power plant produces 4,166,256 MWh/year.
Compare this with one of the more advanced on-shore wind turbines, which is about 810 ft high with a blade diameter with a 518 ft diameter. One turbine has a 5 MW size, with a capacity factor of 35%. Therefore, one turbine equals 15,330 MWh/year. In order to have the equivalent energy output of the average natural gas power plant, you would need 272 of these turbines.
There are now off shore wind farms where the capacity factor is an impressive 63%. Furthermore, General Electric has developed an off shore turbine called the Haliade-X that can produce 12 MW. So, one of these turbines produces 66,225 MWh/year. Even with such improvements, you would still need 63 of these turbines, which seems more plausible.
The scalability issue becomes even more exacerbated with solar. For example, the United States is in the process of beginning to build one of the more advanced solar farms in the world, called the Gemini Solar Project in Nevada. When completed, the generation facility will have a size of 690 MWs, and the total land mass it will take to build this array is roughly 7100 acres. For perspective, Central Park in NYC is about 840 acres. So, the size of the Gemini Solar Project is the size of about 8.5 Central Parks.
With a capacity factor of 25%, the total MWh/year comes out to 1,511,100 MWh/year. Thus, you would need nearly three Gemini Solar Projects to equal the average energy output of the average natural gas power plant.
We have seen huge improvements in renewable energy tech; however, total scalability of the U.S. energy grid is not feasible (yet).
Impact from Covid
Due to COVID-19, the energy sector as a whole saw the largest drop in investments in history. The sector as a whole experienced a roughly 20% decline in investments, which includes renewable energy projects. Many believe this is a temporary setback, and preliminary earnings reports seem to agree in some cases while other companies are still reporting negative revenue growth.
Stocks We are Watching
Renewable energy companies that generate free cash flow and have strong balance sheets have a competitive advantage over financially weaker rivals, since they have greater access to the capital needed to finance growth. That's why investors should focus their attention on financially strong clean energy companies.
Although this is not an extensive list, we spell out our thoughts on why a couple of names make our watchlist and why others don’t. We are providing this in case it’s helpful as renewables often have quarters with negative revenue growth, etcetera, so more depth into why we ignore this in some cases and not others may be helpful.
Plug Power:
Plug Power is a high growth company within renewables, and thus has attracted a very high valuation. As we covered before, management is expecting high growth over the next several years, believing that in 2024 it will earn $200 million in operating profit and record gross billings of $1.2 billion (gross billings will be $325M-$330M in FY’20).
Per our previous coverage, HC Wainwright projected Plug's revenues in 2024 will be about $1.1 billion — more than four times the company's trailing revenues currently. Current consensus is projecting Plug to grow revenue 40% next year in FY 2021.
In Plug’s most recent earnings report, the company “reaffirm(ed) the recently raised gross billings targets for 2021 and 2024.” Plug Power’s accounting issues have also been cleared up with minimal impact on the overall financial outlook of the company. The company reported 76% growth in revenue year-over-year for $72 million in revenue which was less than analyst expectations at $77 million. There was also a EPS miss at ($0.12) compared to ($0.08) expected.
Why has the stock done well despite a weaker-than-expected earnings report? My guess is because Plug Power is the fastest growing company within the renewables sector and the underlying key metrics are stronger than the surface-level ER reveals. Although profitability is an issue, Plug Power’s fuel cell systems segment is growing rapidly and this is the company’s most profitable segment.
Gross billings are also very healthy. Here is what the CEO said in the last earnings call:
“Investors should expect $115 million to $120 million of gross billings for the quarter. This is approximately 40% of our target revenue of $475 million for the year. Usually, at this point in the second quarter, […] 33% of our annual revenue will have been achieved. We are at a run rate that is higher from both a revenue and growth rate level than we have experienced in the past.”
Plug Power is at the top of our list right now for renewables.
Enphase:
Enphase has done well because it’s a safer choice than many other renewables as the company has been consistently profitable for many quarters (9 out of the last 10). The company has an adjusted gross margin of 41% with adjusted EPS in the most recent quarter of $0.56.
Not only is Enphase consistently profitable yet the company has maintained industry-leading growth. The most recent quarter reported 46% growth year-over-year and 14% sequentially. In 2019, Enphase was in the 75%-100% growth range. This is important because the company is very consistent where other solar stocks are not.
During Covid, there was a brief pause in revenue growth in Q3 and Q2 of 2020. The company reported flat growth in Q3 2020 and -6% growth in Q2 2020. For this industry, that is not bad at all and is actually a sign of strength that Enphase bounced back faster than it’s peers.
The company has a cash balance of $1.48 billion. In March, the company issued convertible notes due 2024 and 2025 for net proceeds of $1.19 billion.
For the second quarter, Enphase management guided for $300 million to $320 million, or 140% growth. Again, this is due to the weaker quarters the company had last year during Covid, which were flat to negative. It’s better to look at the growth on an annual basis, which is expected to be 70% growth for FY 2021 with analysts expecting $1.32 billion this year, up from $774.4 million.
Enphase is at the top of our list for renewables.
SolarEdge:
SolarEdge competes with Enphase yet does not have the same consistency as the company has reported flat to negative growth for four quarters. The company reported revenue of $405.5 million, or (6%) year-over-year yet up 13% sequentially.
Adjusted gross margins are at 36.5%. The company has $515 million in cash.
Looking forward, SolarEdge is expecting $445 million to $465 million in revenue, or an increase of 37% for the upcoming quarter. The annual growth for FY2021 is expected to be around 29% with the year after at 25.3%.
We will keep an eye on SolarEdge for improving financials.
Blink and ChargePoint:
ChargePoint operates the largest online network of independently owned EV charging stations operating in 14 countries. The adjusted gross margins are in the 20-25% range.
We like this company for its strong cash position and steady forward growth. Revenue increased 24% year-over-year to $40.5 million with management guiding for $46 to $51 million in revenue next quarter. The company also confirmed its revenue outlook of $195 to $205 million for FY 2022 ending in January. This represents 37% growth year-over-year. The company has cash and cash equivalents of $610 million after exercising warrants worth $73.8 million.
Blink is a fast-growing company with revenue growing 72% year-over-year and charging stations growing 370% year-over-year. However, the company has very little revenue to speak of with $2.2 million in the first quarter. It’s easier to put up triple digit numbers with a low revenue base. The company also losses of $7.4 million that have gotten steeper as the company grows, up from losses of $3 million in the previous year.
We wanted to highlight these two to show why we prefer Stem as our high beta play. Not only is Stem growing faster but plans to be profitable this year. Notably, we also have exposure to EVs through Xpeng and Nio. We’ve owned Tesla and Lucid Motors in the past.
Stem:
Stem has over 900 systems operating on its Athena AI software in over 200 cities worldwide. Athena AI optimizes time-of-use and demand charges, resulting in 10% – 30% monthly electricity bill reductions.
The company is still in its infancy with $33M in net revenue for the FY 2020. Revenue is projected to grow 348% YoY in 2021 to $147M. With the way the company recognizes its sales, 88% of its forecasted 2021 revenues are from contracts that have already been executed. This means there is minimal risk that the company will fall short of its 2021 revenue target of $147M. Notably, the company has a pipeline of $1.43 billion.
The company reaffirmed its 2021 financial guidance for $147 million in the latest earnings report on May 17th. The company also outlined they expect nearly half of the annual revenue to come in Q4.
Revenue came in at $15.4 million in revenue compared to $4 million in the year, up nearly 275%. Adjusted gross margins were at 19% compared to 1% a year ago.
The company expects to reach adjusted EBITDA profitability in 2022 and turn FCF positive in 2023. Gross margins are expected to improve to 38% by 2025. The gross margin improvement will be driven by Stem’s increasing software revenue, which is the highest margin portion of their business (~80%)
Stem is a newer company that must prove itself. On that note, we are very bullish on this company for the exposure to software within the renewables sector that this particular investment provides. Notably, Stem is the one renewables stock and the only SPAC we remained with during the sell-off. Please reference our Stem position on the portfolio and our past research here.
iSun:
iSun offers solar, energy and data solutions. The company is a “deSPAC” or basically SPAC post-merger that has very low gross margins. In the most recent quarter, the company reported $7.26 million in revenue yet had only $119,000 in gross profit. This nearly $0 in gross profit is a pattern in previous quarters, as well. We see this company as too high risk for an entry at this time. The margins would need to improve substantially for consideration.
Bloom Energy:
Bloom Energy has revenue of $194 million per quarter, an increase of 23.8% year-over-year. The adjusted gross margins are at 29% with adjusted EPS of ($0.07). The company has negative operating margins of (7.4%) in the first quarter of 2021 which is an improvement from the (29.6%) operating margin in the first quarter of 2020.
The company has cash of $365.7 million and debt of $522.2 million.
Management guided for forward revenue of $950 million to $1 billion for FY 2021, or 25.7% growth. The company was flat last year and saw very low growth the year prior.
Overall, this company is not high growth enough for our portfolio.
Conclusion:
One reason why the renewables sector is at a starting point (and we are not seeing the full picture yet in terms of financials) is that Moore’s Law applies to renewable tech. For example, the cost per watt in solar has gone from $22 in the 1980s, to $3 in 2011, and is now about $2.90 per watt. In fact, MIT released a report explaining how close we are to $0.20 per watt, which will make the economic benefit of transitioning to solar a real driver for both individuals, businesses and municipalities.
Right now, we rate Plug Power slightly higher than Enphase in terms of positions we want to build. We are also reiterating our conviction on Stem compared to other high beta plays in this sector. We believe these are the top three choices – Plug Power for growth, Enphase as a market leader and Stem for its position with the Athena AI software and strong revenue growth out the gate.