16 Oct

Solar Stocks: Paying Too Much for a Rosy Outlook?

WRITTEN BY Vineet Kulkarni

Solar stocks highlighted the top-rallied sectors in the broader markets this year. Strong quarterly earnings growth and improved prospects kept the momentum going in these stocks this year. However, after hitting their respective multiyear highs, many solar stocks have fallen as much as 40% since August.

Solar industry offers huge growth potential

Market experts see massive growth potential in the solar sector for years to come. However, we believe that investors shouldn’t get carried away with just a rosy outlook and pay exorbitantly high prices for this growth. We’ll see whether the current valuation of the prominent solar names is warranted for their underlying growth.

Top solar players First Solar (FSLR) and SunPower (SPWR) disappointed with their Q2 earnings but raised their guidance for the second half of the year. First Solar stock is up about 33%, while SunPower stock has nearly doubled so far this year. SunPower stock has fallen more than 40% from its 52-week high of $16.00 last month.

Considering its price-to-earnings (or PE) multiple, First Solar is trading 17x its earnings for the next 12 months. It seems to be trading at a discount compared to its peers as well as its historical average. In comparison, SunPower is trading beyond 40x its estimated earnings, which looks relatively expensive.

Is the valuation justified for the underlying growth?

Considering only PE multiples for these growth stocks won’t be sufficient for this review. We’ll also look at their PE-to-expected-earnings-growth (or PEG) ratios. Analyzing PEG ratios gives us a better idea, as almost all solar companies are expecting significant earnings growth for the next few quarters.

The PEG ratio represents the stock’s valuation after considering the expected future growth rate. Generally, a PEG ratio of less than 1.0 signifies an undervalued stock.

Based on analyst estimates, First Solar expects its earnings per share to grow almost 80% in 2019 and 50% in 2020 year-over-year. So, its PEG ratio is around 0.3x, which indicates the stock is trading at a notable discount. Although analysts expect SunPower to continue reporting losses in 2019, it could become profitable in fiscal 2020.

Solar panel installer Sunrun (RUN) is trading at a forward PE valuation of 33x, and its PEG ratio is around 0.3x. Sunrun stock has rallied almost 60% year-to-date.

Importantly, we expect strong demand and production ramp-ups to support solar companies to realize their upbeat guidance for the second half of the year. This trend could support investors’ positivity in the sector.

The Invesco Solar ETF (TAN) is up about 9% so far this year. First Solar forms more than 60% of TAN while SunPower forms approximately 3% of the ETF.

Solar inverter stocks took the focus this year

Although solar panel maker stocks had a solid run, solar inverter companies significantly outperformed them this year. Both Enphase Energy (ENPH) and Israel-based SolarEdge Technologies (SEDG) reported record earnings growth this year and look upbeat for the second half of the year. ENPH and SEDG are up more than 420% and 153%, respectively, so far this year.

From the PE valuation standpoint, Enphase Energy stock is trading 26x its forward earnings. It has fallen approximately 30% since touching its all-time high of $35.40 in late August.

SolarEdge stock is currently trading close to its all-time high, and it’s trading 20x its forward earnings. Looking at their PE valuations, SolarEdge stock looks relatively inexpensive against Enphase stock.

Wall Street analysts expect Enphase Energy’s EPS to increase 8x in 2019 compared to 2018. Based on forecasts, Enphase’s 2020 EPS could increase by 20% YoY, which brings its PEG ratio to 1.3x. So, Enphase Energy stock looks to be trading at a premium.

According to estimates, we expect SolarEdge Technologies’ EPS to increase 20% each in 2019 and 2020 year-over-year. Its PEG ratio is around 1.0x, which indicates the stock is fairly valued.

Third-quarter earnings will pave the way ahead

Solar PV installations have notably increased this year, and we expect this trend to continue in the foreseeable future. This bodes well for solar companies’ earnings growth for the next few years.

Solar stocks like First Solar and SolarEdge Technologies look well placed from a valuation perspective. These are expected to release their third-quarter earnings by the end of this month or early next month. Apart from their bottom-line numbers in the upcoming quarterly results, their respective management’s commentary for the next year could drive their stocks in the short to medium term.

Top solar stocks: Analysts’ price targets

Analysts currently seem positive on First Solar (FSLR) stock, giving the stock a mean price target of $77.20 against its current market price of $55.90. This indicates an estimated upside of 38% for the next 12 months.

Among the 15 analysts tracking First Solar stock, seven recommended a “buy,” three recommended a “strong buy,” and five recommended a “hold.” On October 16, none of the analysts recommended FSLR as a “sell.”

Wall Street analysts gave SolarEdge Technologies (SEDG) stock a mean price target of $89.00. This indicates a potential upside of just 5% for the next year against its current market price of $84.80.

Of the 11 analysts covering SEDG, six recommended it as a “buy,” three recommended it as a “hold,” and two recommended it as a “strong buy.” Analysts didn’t give any “sell” recommendations for SolarEdge stock.

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