States’ RPS Mandates Justify Lofty Solar Valuations

Introduction

Have you opened your electric utility bill lately? Chances are you have noticed the insert sent to you by the utility company that declares their power mix or multiple generating sources that the company utilitizes to bring power to your home or business.

Commonly termed as a portfolio of electrical generating assets (not necessarily all owned by the same utility company), for most investor and publicly owned utilities [IOU/POU] the power mix includes energy generating resources such as natural gas, coal, hydroelectric, nuclear, and of late interest, renewable energy resources such as solar, wind, biomass, and geothermal. For example, in 2007, the power mix disclosed for SMUD, a utility company serving the Sacramento metropolitan area, was found to be 60% natural gas resources, 20% large hydroelectric, and 16% eligible renewable resources.

Did you also know that more than half of the States in the US mandate or require that a certain portion of the power mix or a certain percentage of the portfolio of electrical generating assets be comprised of renewable energy resources such as wind, solar, or biomass? This requirement stems from a regulatory policy adopted by the individual States called the Renewable Portfolio Standard or RPS.

Renewable Portfolio Standard [RPS]

While the RPS is a general policy that places an obligation on electric supply companies to produce a specified fraction of their electricity from renewable energy resources (Wikipedia.org, 2008), most States have adopted individual RPS requirements that a certain percentage of renewable generation or wattage be met by a certain date.

In California for example, RPS mandates require that 20% of the power generation be met from renewable resources by 2010, and further requires 33% RPS generation by the end of the next decade. In Texas, the Public Utility Commission [PUC] boosted the RPS requirement to 5,880 MW from 2,000 MW by the year 2015, and further requires utility companies to create 10,000 MW of renewable energy capacity by 2025 (wikipedia.org, 2008). In New York, the Public Service Commission requires that 24% of the State power portfolio come from renewable resources by 2013 (US DOE, 2008).

Sounds noble, but does it mean anything? Goals, after all, can be rhetorical and soon forgotten like one's New Year's resolutions, right?. Not quite. In California, the California Public Utilities Commission [CPUC] and the California Energy Commission [CEC] are two joint agencies in charge of implementing and enforcing the RPS program, and can fine individual utility companies for failing to meet RPS goals.

Status Of RPS Generation In California

According to the CEC (Commission), in the past three decades, California has built one of the largest and most diverse renewable energy portfolios in the world. Presently about 11% of the State's electricity comes from renewable energy resources such as solar, wind, geothermal, and biomass. However, a key finding by the Commission concluded that utilities are falling short of the RPS goal and are not expected to meet the 20 percent renewables goal by 2010, although they have sufficient quantities under contract (CEC,2007).

As seen in the graph below, the differential between current level renewable production and the 2010 stated goal is an estimated 30,000 Gigawatt hours per year (GWh/yr). This differential further increases to 75,000 GWh/yr in 2020. Assuming that this differential is met primarily by solar, wind, and biomass generating resources in a 40-40-20 proportion, the RPS 2010 goal will create a demand for a combined additional 24,000 GWh/yr from solar and wind alone (or 12,000 GWh/yr for solar and wind each).

click to enlarge

Graph Courtesy of the California Energy Commission (CEC, 2007)

As a worst case scenario, a one megawatt (1 MW) solar/photovoltaic [PV] power plant is capable of producing 2,920 megawatt hours per year [MWh] (1 MW x 365 days / year x 8 hours generation / day). Therefore, to meet the differential demand, additional solar [PV] capacity of 4,100 MW (12,000 GWh/yr x 1,000 MW/GW / 2,920 MWh/1MW) will be required by 2010. And to meet the 2020 goal of 33% RPS renewables, the additional solar [PV] power plant capacity required will be 10,300 MW (75,000 GWh/yr x 40% Solar x 1,000 MW/GW / 2,920 MWh/1MW).

Whether a 40% solar [PV] goal in the RPS power mix is achievable is not a long term concern. Market experts predict that the cost of solar [PV] generation (Bloomberg TV, 2008) will eventually decrease to a level lower than or comparable with coal / natural gas power generation ( < $0.10 kWh). This can also be a foregone conclusion as PV solar panel producers such as Evergreen Solar (ESLR), Sunpower (SPWR), and First Solar (FSLR) ramp up production capacities to capture economies of scale and leverage their fixed costs. I believe that may be the reason why many IOUs are not stepping up to the RPS goal; they may be holding on to invest when solar [PV] generation costs come down further.

RPS Beneficiaries and Valuations

ESLR, SPWR, and FSLR are three domestic, integrated solar panel [PV] producers amongst a host of other international companies that I believe could all be beneficiaries of RPS mandates. These are also companies that I follow. While SPWR and ESLR have retracted from their early year highs, they still trade at lofty sales multiples of 7 and 16, and forward earnings (FY09) multiples of 24.3 and 22.6, respectively.

Consensus revenue and earnings estimates for SPWR are doubling YOY, with FY08 revenue expected to be $1.36 billion (up from $775 million in FY07), and mean EPS estimate at $2.17/share (up from $1.26 in FY07) (Yahoo! Finance, 2008). With momentum in earnings and revenue growth, I expect SPWR to meet mean analyst price target estimates of $114.

ESLR, on the other hand, recently announced (Smart Money, 2008) the signing of sales contracts to supply solar panels worth $1 billion between 2008 and 2013, and holds another backlog of $850 million from previously signed contracts in 2006/07. While cash flows from operations and earnings are negative, the company is expected to turn profitable in 2009. ESLR share price moves in tandem with sector peers (see chart below). The mean analyst price target for ESLR is $14 (Yahoo! Finance, 2008).

Graph Courtesy of Yahoo! Finance

At 32 times sales, FSLR trades at what I believe is a "cautionary" valuation. Since the inception of its IPO in November 2006 at $24, the return on FSLR has been more than ten-fold and reminiscent of internet-era boom stocks.

However, of the three companies mentioned in this article, FSLR is the one that is highly profitable with the largest profit margin (31.5%) and return on assets/equity ratios of 11.4% and 26.1%,respectively. I also believe that FSLR forward P/E (FY09) of 46.7 may be moderately expensive, and a short-term correction on valuation concerns is possible. FY08 analyst consensus revenue and earnings estimates for FSLR (Yahoo! Finance, 2008) are expected to be $1.03 billion (up from $504 million in FY07), and mean EPS estimate at $2.93/share (up from $2 in FY07).

With similar momentum in revenue and earnings growth as SPWR, I expect FSLR to also meet mean analyst price target estimates of $330.

Graph Courtesy of Yahoo! Finance

Conclusions

To meet their RPS obligations, investor and public owned utilities in States like California will need to build an additional 4,000 - 10,000 MW solar [PV] capacity in the coming decade. The nationwide RPS requirement could additionally create a tremendous demand shift in electrical generation from traditional fossil fuel resources such as coal and natural gas to solar and wind energy. Solar [PV] generation could also take the place of fossil fueled resources as aged power plant production is taken offline.

The RPS has created a terrific opportunity for all market participants, especially new alternative energy players such as ESLR, SPWR, and FSLR. With industry changing dynamics and these companies in hyper growth mode, the exorbitant valuations are likely to be sustainable and presently justifiable. Furthermore, if America has to meet self-sufficiency in energy production and generation with net reductions to greenhouse gas emissions, it must adhere to RPS mandates and targets.

References

1. Wikipedia.org, May 2008.
2. US Department of Energy [USDOE], May 2008.
3. California Energy Commission, 2007 Integrated Energy Policy Report, December 2007 [PDF file].
4. Bloomberg TV News Report, May 2008.
5. Yahoo! Finance Analyst Estimates, May 2008.
6. Smart Money, "Evergreen Solar Shines After $1 Billion in Orders," May 22, 2008.
7. Yahoo! Finance Analyst Opinion, May 2008.
8. Yahoo! Finance Analyst Estimates, May 2008.

Comments

[gebby:]

excellent article. thank you very much .

2008 Jun 02 10:04 AM

[Jojostreet:]

great read. keep up the good work.

2008 Jun 02 01:48 PM

[The Stockac...:]

Agree with this article. But would strongly suggest SOL (Renesola) as the best solar play by far. Google around and read about this amazing company. You will agree. Check IBD, etc. After SOL's next earnings announcements', SOL will be at least $43.00 per share, likely by late July. Most analysts have a target price of $40.00 or better. The addition of the SOL's new ADR's (today's SOL announcement) will not have any affect of share price of SOL, only its amazing earnings will. The ADR's will help with well needed quick growth. The way the management is placing the new SOL ADR's is in a careful manner that will show little diluted affect, very well planned by the company. This coming quarter's earnings will be outstanding, better than the last. Go to the SOL site (and perhaps google around a bit) for an explanation of all of this... too much to explain here. SOL as with most exponentially growing Chinese companies, by nature and custom (and perhaps by law in China) is very modest in prediction of growth and profit. Hence why last quarter's announcement had such an amazing affect on share price. I have been following SOL for some time. It will be above $110 by this time next year... one has to have patience. The cost of all energy will be very expensive later this year and into 09'. Oil and gas as energy is becoming very expensive. Solar companies are showing multiple quarter after quarter growth in profit that seems amazing, few industries before have shown this kind of growth in history. Similar to when computers were new in the 1990's... IBD's and Bloomberg's computerized and completely unbiased ranking systems (as well as other professional ranking systems) now has many solar companies, and energy exploration companies, in their rank of most profitable and most growing of companies in the world, for now and the near term. SOL is the best of the sector (solar and perhaps energy generally) by far, in profit and growth. Why did I research SOL so much today? Because I decided to buy 25,000 more shares which I will likely do early tommorrow. But anywhere under $25 is an amazing price for SOL, and anywhere under its high of about $29 is also still a very good buy that won't soon last. I would suggest to buy now for the amazing future of this company and sector. It should be noted that asian area investors, Hong Kong, China, Japan, India do not read or care what Morgan Stanley would say or not say. (MS downgraded SOL today, in the face of multiple upgrades and strong buy recommendations of many other brokers, especially brokers located in asia). Asian investors will be buying SOL tonight and each nite while the US is asleep. By next week, SOL will easily creep to $27 per share. If SOL does not reach over $50 share price by July, it certainly will by late August. Most of Asia, Tokyo, Hong Kong, the middle east and much of europe is in plans to put solar panels on every street light for starters, beginning now... by next year, the inexpensive product line of SOL will be required spending in most countries and their governments. SOL is an amazing buy at today's price.

2008 Jun 02 04:33 PM

[Trader Tim:]

Great Article! A job well done!

2008 Jun 03 02:29 PM