The Future Looks Bright for this Solar Power Company

Posted On September 25, 2015 10:36 am

Low oil prices have been weighing on the alternative sector for a while. Recent concerns about a competitor have set up a long term buying opportunity in the solar power name.

Making money by investing in the creative yet disruptive technology is never easy. For investors it means not only getting the big picture theme but also choosing the right company. It also often means being able to hold on through the volatility times and scary downturns.

The solar industry is no exception. Some of the earlier highflyers such as companies such as Trina Solar (TSL) and Yingli Green Energy have totally flamed out.   Some newcomers such as Solar City (SCTY) and Sun Edison (SUNE) after enjoying initial investor enthusiasm have come under pressure on concerns over their valuation and paths to profitability. They have become favorite targets of short sellers who question their balance sheet.

But a couple of names, most notably First Solar (FSLR) SunPower (SPWR), have become stable and profitable and trade at a very reasonable valuations. The recent downswing in their shares represents a great buying opportunity. Before I get to the specifics of my trade recommendation let’s take a quick look at the industry.

Becoming Cost Efficient

Historically, the price of oil has been inversely correlated with the renewable energy sector—the lower the price of oil, the less competitive renewables become- and helps explain the recent weakness in solar stocks. But while this continues to be true in the transportation sector, where sales of electric vehicles have faltered this year as gas prices have declined—the correlation to the broader energy sector is increasingly false. This is due to three primary reasons:

  • oil is barely used any more to generate electricity in developed economies;
  • the cost of producing power from renewable sources has declined in conjunction with oil prices.
  • the fundamentals of the renewable energy business have never been stronger.

Although capital costs for wind and solar are higher than fossil fuel facilities, if all the costs of generation are included (i.e. the levelized cost of energy—LCOE), renewables are cheaper than fossil fuels. This is because fuel costs can account for 80% of the cost of gas-fired generation, and over 50% of the cost of coal. Indeed, the global LCOE of wind is already lower than coal and gas, and solar in the sunniest regions is on-track to beat the fossil fuels by 2020 or before—with recent technology advances improving efficiency by 40%. The cost of solar panels is dropping exponentially, while energy-storage mechanisms are improving rapidly.

Solar Cost 9.24.15

The rapid decline in costs and the increased efficiency solar panels of is also driving accelerating adoption. Cost have declined from $76 per watt in 1977 to less than $0.36 per watt today. 

Growing Demand and Mainstream Use

Going solar used to be associated with making your home environmentally friendly or even “going off the grid” completely. But now the biggest demand is coming from the business sector and is being done for economic reasons. Solar generated power is increasingly becoming fungible as it can be stored and resold.

Conventional wisdom holds that as natural gas prices remain near historic lows and the global coal industry declines, utilities will switch to producing electricity from natural gas instead of solar or wind. However, utility-scale solar PV accounted for 52% of total new generation capacity during the second quarter. During the second quarter of 2015, the U.S. added 1,393 MW of solar capacity—the seventh consecutive quarter that America has added over 1 GW.

While residential solar capacity is surging, with total megawatts installed jumping 70% year-over-year in the second quarter. But we are also seeing accelerated uptake by business with high profile companies such as Google (GOOGL) and Apple (AAPL) using solar to power not only their corporate campuses but also their server farms.

The fact that the switch in both residential and commercial use is being done with fewer incentives –during the first half of 2015 over one-fourth of all residential installations occurred without subsidy incentives and business’ received next to no subsidy- demonstrates solar is truly becoming more cost effective. The time it takes for a home switching to solar to “pay for itself” has shortened to about 3 years from the 10 year transition cost just five years ago.

Technologist Peter Diamandis argues solar is in the midst of its “deceptive phase” of growth on the road to disruption. The fact that 5,000 times more solar energy hits the Earth’s surface in a year than humanity uses today means that solar has significant head room for growth. Diamandis believes solar will be the central driver for the world’s future economy.

First Solar Tops My List

Whereas many companies such as SunEdison are involved in many forms of renewable energy such as wind and hydro, First Solar (FSLR) is focused strictly on solar. And within solar is it strictly focused on design and manufacture. It will do some consulting and installation for large scale projects but it has steered clear of moving too far down the distribution and sales chain where margins get slimmer.

The company is expected to earn $3.43 a share this year, and increase by 15% to $3.91 next year. At its current price of $43 a share it’s trading at just 11x forward earnings. That is very cheap for a company that could see a acceleration in demand from both users and investors. A rebound in oil prices would quickly change sentiment and cause multiple expansion back towards the 17x EPS it averaged over the prior three years.

The stock has declined to important support level on the chart and put in a bullish reversal on Thursday.

FSLR Chart 9.25.15

The $43-45 level offers an attractive entry point for establishing a bullish position.

The Trade:

I want to give this trade plenty of time so I’m going to use 2017 LEAPs call options. Specifically;

-Buy January2017 $40 Calls for $10.50 a contract

My expectations are for the shares to reclaim their 2014 high above $75 share. This would make the calls worth a minimum of $35 or a 250% gain within the 18 months until expiration.

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.