By Alex Kimani
Higher interest rates are one of the reasons behind the steep selloff in renewable energy stocks
- There have also been huge sell-offs in special-purpose acquisition companies, electric vehicle stocks, and software stocks
- Higher interest rates are likely to put pressure on solar and other renewable energy projects due to the fact that developing new energy systems is capital intensive and is often funded with debt
Back in 2013, an announcement by the Federal Reserve about pulling back on the central bank’s easy-money policies sent markets into a tizzy. Treasury bond yields skyrocketed, junk bond prices fell, emerging-markets stocks tumbled, and stock volatility was off the charts leading to the coining of a new phrase on Wall Street, “taper tantrum.” Investors were expecting a similar scenario after the Fed met at its annual gathering at Jackson Hole in August to discuss tapering of asset purchases.
But alas, the market appears to be taking everything in its stride this time around, with no signs of a violent taper-tantrum in sight. The concept of an end to purchases now appears less frightening to investors after living through the Fed not only slowing down asset purchases but actually reducing the size of its holdings sheet in 2018 and 2019.
But the fact that short-term interest rates have not gone up by much does not mean that all is well. An expensive stock market trading near record highs compounded with a looming threat of higher interest rates is leading to investors increasingly shunning growth stocks in favor of more defensive value companies.
Among the first casualties is the renewable energy sector.
After enduring a torrid season in 2021, renewable energy stocks are off to another bad start in the current year.
The solar sector’s favorite benchmark, Invesco Solar Portfolio ETF (NYSEARCA:TAN), is down 8.1% after the first week of trading while its wind power counterpart, First Trust Global Wind Energy ETF (NYSEARCA:FAN), has lost 4.4%.
One of the leading names in the solar sector, Enphase Energy, Inc. (NASDAQ:ENPH), has tanked 21% since the beginning of the year and is now down 44% from its all-time high reached just a couple of months ago, with higher interest rates blamed for the crash.
There have also been huge sell-offs in special-purpose acquisition companies, electric vehicle stocks, and software stocks, as investors adopt more defensive positions.
U.S. 10 Year Treasury yields have taken off to 1.78%, up 28 basis points this year. Minutes released from the Federal Reserve’s last meeting in December 2021 suggest that an interest rate hike is now imminent as it tries to tamp down inflation.
The energy sector–one of the best performers last year–is so far holding up well, with the sector benchmark, Energy Select Sector SPDR ETF (NYSEARCA:XLE), up 10.5% in the new year.
UBS Wealth Management has tapped the energy sector as its second-rated sector pick this year, saying, “relative to oil prices, the sector looks cheap. Free cash flow yields are very attractive, capital discipline has improved, and the sector should benefit as demand recovers.”
Unfortunately, the renewable energy sector has come under pressure as tailwinds subside and headwinds multiply.
Bank of America has flagged the major catalysts driving the alternative energy sector in 2022, citing Build Back Better tailwinds subsiding, while a confluence of headwinds sustain into 2022.
BofA sees inflation biting as polysilicon, copper, steel, and epoxy resin, freight costs rise and drive solar and wind build costs higher. Meanwhile, delays in sourcing utility-scale solar panels are likely to continue, as Customs Orders targeting parts of China have not been fully resolved
On its part, Enphase has lately fallen out of favor due to its rich valuation and expectations of a difficult business model transition.
Last week, Bank of America downgraded ENPH shares to Neutral from Buy with a $187 price target, down from its earlier PT of $297, following the company’s latest analyst day. ENPH has highlighted efforts to diversify beyond its core microinverter business, but has raised concerns of a slower transition than perceived. Meanwhile, ENPH is by no means cheap: even after the latest crash, ENPH shares trade for 17x trailing 12-month sales and 72x trailing 12-month free cash flow, a huge premium even for a highly-rated growth stock. BofA’s Julien Dumoulin-Smith sees 2022 as a transition year for Enphase, “as Resi storage efforts principally and [management] entrenches itself with long-tail installers to ensure a pathway to sustained and potentially ever higher margins.”
The analyst stresses Enphase’s “clear long-term ability to pivot to 40% gross margins as it becomes entrenched with installers through software integration and additional product portfolio,” but also fears that near-term EBITDA growth will be slower than recent trends suggest.
Higher interest rates are likely to put pressure on solar and other renewable energy projects due to the fact that developing new energy systems is capital intensive and is often funded with debt. Higher rates make it more expensive to break ground on new projects. Higher interest rates lower the value of future cash flows, which in turn lowers the value of a stock.
BofA, however, says First Solar (NASDAQ:FSLR) and Maxeon (NASDAQ:MAXN) remain more insulated than most of their peers.
Buy speculative growth stocks
At a time when many analysts are downgrading on valuation given the risk to high-multiple stocks in a rising interest rate environment, analysts at Raymond James are encouraging investors to buy speculative story stocks.
RayJay analyst Pavel Molchanov attributes clean energy’s nearly 60% underperformance last year versus the S&P 500 in 2021 to “healthy consolidation”, as the sector was up 58% in 2019 and 203% in 2020.
The analysts have upgraded First Solar to hold from sell; Clean Energy Fuels (NASDAQ:CLNE) to hold from sell; ReneSola (NYSE:SOL) from buy to strong buy; SunPower (NASDAQ:SPWR) from hold to buy and TPI Composites (NASDAQ:TPIC) from buy to strong buy.
To Molchanov’s credit, he was sell-rated on a number of the worst-performing clean energy stocks during 2021, lending credibility to his very non-consensus call for buying long speculative clean-energy stocks into a rising rate environment.