Solar power has distinguished itself as the most reliable source of renewable energy, when it was most needed in the summer months of peak electricity demand. Here, I’ll look at how investors can efficiently wire up an investment in this promising sector.
As the effects of climate change become more stark, the solar industry will see a continued ramp up in demand from all regions of the world. Solar has proved especially critical as China, the western United States, and Europe were hit by mega-droughts that dried up hydro power output. In addition, tailwinds for solar demand abound: We have skyrocketing natural gas prices in Europe, grid unreliability from excessive summertime heat, government incentives from the Inflation Reduction Act, the electrification of transportation, and vast improvements in battery storage. Solar is proving a vital source of carbon-free energy.
I believe the best way to play the solar sector is through the Invesco Solar ETF (TAN) — as I wrote last November. Remarkably, the amount of capital invested in this exchange-traded fund has gone down to $3 billion from $4 billion last November, even as the TAN is up 8% year-to-date. Considering all the capital supposedly buying into climate change mitigation and green initiatives, the industry is not crowded with investors. Instead, the fossil fuel sector has seen a renaissance of investments as capital chases performance.
When investing in this critical sector, many idiosyncratic issues emerge when analyzing individual solar-related stocks. Buying TAN eliminates the difficulty of picking winners and losers within the sector.
Sunrun (RUN) , one of the top rooftop solar installers, is particularly enigmatic. Domestic homes will add rooftop solar at a record clip this year, expected to increase by about 20% to 5.6 gigawatts. The demand is spurred by high energy costs and the solar tax credits in the Inflation Reduction Act. On the one hand, demand is strong for Sunrun; on the other hand, the company may never outrun the problematic aggressive accounting treatment. Short sellers, like Muddy Water and Jim Chanos, have targeted Sunrun’s questionable accounting assumptions. Yet, most analysts have a highly favorable view of the company, including as a top pick at Morgan Stanley. It’s a battle where I’d rather not have direct exposure.
The top component in TAN, Enphase (ENPH) , is a powerhouse in solar components for energy conversion efficiency and battery storage. Enphase is one of the few highly valued growth stocks that has retained its premium valuation even as growth stocks in general have declined significantly. At a 70 multiple to earnings, having direct exposure in a volatile bear market can seem imprudent, but some exposure through TAN is far more palatable.
I’ve never recommended owning a company domiciled in China due in part to accounting opaqueness and ownership structure uncertainties. TAN has about a 20% exposure to Chinese companies, including panel maker JinkoSolar (JKS) and polysilicon supplier Daqo New Energy (DQ) . These stocks have, at times, suffered China-specific pullbacks related to governance, audit requirements, and production utilizing the forced labor of Uighurs, the Turkic ethnic group in Northwest China. Nonetheless, these companies are still integral to the solar universe in need of panels, raw materials, and components. The ETF’s China-related weighting of around 20% seems a reasonable risk for solar diversification.
Solar tariffs have befuddled investors for years, alternatively advantaging domestic panel producers like First Solar (FSLR) and Chinese importers. Rooftop installers that benefit from cheaper imports and unconstrained supply are often caught in the middle of tariff actions. For years, First Solar was among the lowest-rated stocks, but its fortunes have turned quickly with the Inflation Reduction Act. When underlying demand has massive secular strength, positive catalysts have higher probabilities.
One of the top domestic producers of various solar components, Solaredge Technologies (SEDG) , recently was the target of a patent infringement complaint. While the stock has weakened in light of the litigation, the case and appeals could drag on well in 2023.
The solar industry is too critical for future electricity production in a world in need of more carbon-free energy. Using renewable energy is one of the top priorities of almost every large corporation and nation, which could only become more important in time. However, idiosyncratic issues make investing in individual stocks in the sector a challenge. In aggregate, owning TAN is the best way to get exposure to an industry with forces at work creating insatiable demand for years to come.