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  • Roger S. Conrad

The Renewable-Energy Investment Bible

By Roger S. Conrad on Apr. 2, 2015

In the US, renewable-energy developers continue to reap the rewards of favorable policies at the state and federal level. However, concerns about rising electricity costs and general opposition to government subsidies raise questions about whether this support will continue.

Although SolarCity Corp (NSDQ: SCTY) and other outfits with unsustainable business models pose the most risk to investors’ wealth, long-term contracts and the participation of utilities in the space should ensure that renewable energy won’t reprise its disappearing act from the 1980s.

SolarCity’s backers trot out the tired argument that distributed solar power represents a paradigm shift that will erode utilities’ earnings power and loosen their stranglehold on the market.

Never mind that utilities’ investments continue to spur development of wind- and solar-power generation, as well as other forms of renewable energy.

Unlike standalone developers, utilities recoup these capital expenditures in their regulated rate bases and long-term contracts, which help to guarantee a reasonable rate of return and provide a high level of visibility to cash flow. These companies can also enjoy an extraordinarily low cost of capital, enabling them to finance any capacity that they build or acquire under favorable terms.

Moreover, utilities continue to lead the way in the development of storage solutions and improvements to grid infrastructure that will be critical to supporting wide adoption of renewable energy.

The greatest hope for effective energy storage technologies, for example, resides with Hawaiian Electric Industries (NYSE: HE) and its would-be acquirer, NextEra Energy (NYSE: NEE). AES Corp (NYSE: AES), another utility, owns the world’s largest energy storage facility—excluding notoriously inefficient pumped-storage solutions.

Even utilities that traditionally have relied on thermal- and nuclear-power plants have also made a push into green energy, including Southern Company (NYSE: SO), which emits the most carbon dioxide of any US utility.

The stocks may lack the sex appeal of SolarCity and other popular names that continue to champion the death of the utility sector at the hands of distributed generation. But with government support for renewable energy looking increasingly tenuous, utilities’ investments and balance sheets will become even more important to green energy’s future.

Solar-power developers will survive, but only if they help to serve utilities’ primary goals:

  • Meeting standards for grid reliability;
  • Reducing the environmental impact from primary resource extraction and the generation, transmission and distribution of electricity; and
  • Keeping costs and customer rates as low as possible to encourage consumption and economic growth.

Upstarts that don’t toe this line will find themselves in trouble, especially if their valuations reflect hype instead of fundamentals. SolarCity, the poster child for these problems, trades at an astronomical 18 times sales even though the company lost $1.47 for every dollar of revenue it generated in 2014.

Don’t be surprised if SolarCity tumbles to less than $10 per share when the going gets tough.

At the same time, because many investors view renewable energy as an opportunity for developers to usurp utilities, a good chunk of this industry trades at reasonable valuations relative to their long-run growth prospects.

This issue highlights the best opportunities in the following areas:

  • Yieldcos: These spin-offs from power companies and renewable-energy developers promise above-average dividend growth, fueled by drop-down transactions from their sponsor. These generation assets usually operate under long-term contracts, providing a high level of visibility on future cash flow.
  • Generation: Generation companies grow their cash flow and dividends by developing power plants that operate under long-term contracts. International companies in this category look especially cheap because of weakness in their home currencies relative to the US dollar.
  • Energy Storage: Reliable storage capacity that can hold a charge and provide power when the sun doesn’t shine or the wind doesn’t blow remains the holy grail for renewable energy. Such a solution is still years away, but progress continues.
  • High-Voltage Transmission: To avoid opposition, wind- and solar-power farms are often located in sparsely populated areas; delivering their output to the market requires the construction of new transmission infrastructure.
  • Retail: Companies that sell electricity and natural gas in the 15 states with competitive power markets have huge customer bases to which they can market rooftop solar panels. And these outfits actually turn a profit.
  • Utilities: Regulated electric companies recoup investments in large-scale renewable-energy projects through increases in their rate bases. These names also have huge advantages over would-be disruptors in rolling out distributed generation, thanks to their low cost of capital and huge customer rolls.
  • Component Manufacturers: Bargains are hard to come by in this overhyped market segment, but a handful of names have proved their ability to profit through boom and bust.

Each area we highlight in this report includes overpriced stocks and marginal players that will struggle as utility investment replaces government policy as the primary driver of development.

And in this bull market’s seventh year, prospective investors should proceed with caution and gradually ease into even the surest of bets. Building your position incrementally and setting buy-limit orders at dream prices are two strategies that can improve your overall returns.

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    • Elliott H. Gue

      Founder and Chief Analyst: Capitalist Times and Energy & Income Advisor

    • Roger S. Conrad

      Founder and Chief Analyst: Capitalist Times and Energy & Income Advisor