Yahoo Finance Renewable Energy ETFs: Value Play or Value Trap?
Renewable energy stocks have experienced a significant decline in recent months, lagging behind fossil fuel companies. This decline is primarily attributed to the impact of higher interest rates on the sector. The S&P Global Clean Energy Index has plummeted by 20.2% over the past two months. This performance marks its worst annual showing since 2013, in stark contrast to the 6% gain observed in the oil and gas-heavy S&P 500 Energy Index, per a Financial Times article.
ALPS Clean Energy ETF ACES, Global X Hydrogen ETF HYDR, Invesco WilderHill Clean Energy ETF PBW, First Trust NASDAQ Clean Edge Green Energy Index Fund QCLN and SoFi Smart Energy ETF ENRG have lost in the range of 15.3% to 19.8% in the past one month (as of Oct 27, 2023).
Challenges Faced by Renewable Energy Sector
Despite substantial financial incentives such as tax credits, subsidies, and loans offered by governments in the United States and Europe to green energy companies, the renewable sector remains vulnerable to rising interest rates. This vulnerability stems from long-term energy price contracts and increased costs due to global inflation and growing demand.
Renewable companies are basically facing challenges in terms of profitability. Solar power and wind turbine companies have been particularly hard-hit by the decline. NextEra Energy, a U.S.-based wind and solar generator, has revised its three-year growth expectations downward due to tighter monetary policies and higher interest rates, affecting their ability to distribute profits to shareholders.
Challenges for Offshore Wind Companies
Offshore wind companies like Danish developer Ørsted have been affected by the threat of less generous tax credits and delays in turbine foundation manufacturing in the US. Ørsted's shares have declined by approximately 30% since late August. Analysts at UBS estimate that sensitivity to higher interest rates could cost Ørsted between DKr5bn ($709mn) and DKr10bn ($1.42bn), as quoted on the above-mentioned FT article.
Clean Business Models Not Suitable for a High Inflation, High Interest Rate Environment
Some traders argue that the business models of renewable energy companies are ill-suited for a high inflation, high-interest-rate world. Rapid growth requires leveraging the balance sheet or issuing equity, which is less feasible in a higher-rate environment.
Stiff Competition from China?
European solar module manufacturers have raised concerns about cheap Chinese alternatives pricing local companies out of the market, contributing to supply-demand imbalances. Even Chinese manufacturers dominating the solar supply chain have seen significant share price losses, with some constituents of the S&P Global Clean Energy Index, such as Sungrow Power Supply, JA Solar Technology, and Risen Energy, falling by 32%, 33%, and 44% respectively since January.
Valuations Falling in the Solar Sector
The valuation of companies in the global solar panel manufacturing sector has decreased significantly, with enterprise value to EBITDA multiples dropping from about 16 times a year ago to about nine times.
Due to cheap valuation, some investors, like Anaconda's Saleur, have shifted their stance on solar companies, no longer shorting them and even investing in some stocks, believing that much of the value destruction in the sector has already occurred, the Financial Times article indicated.
Broader Alternative Energy Space Boasts Higher Valuation Than S&P 500
Broader alternative energy space has a forward P/E of 19.58X versus 16.31X P/E offered by the S&P 500. Projected EPS Growth of the space is 6.98%, slightly higher than 5.60%. Dividend growth is poor in the space compared with the S&P 500. Return-on -equity, Return-on-assets and Return-on-investments have been trading at a negative figure.
Bottom Line
Against this backdrop, we believe the space may see further decline in prices as it is not extremely undervalued. Rates are likely to remain higher for longer. Inflation too remains sticky. Investors, who have strong stomach for risks, may consider clean ETFs like TCW Transform Climate ETF NETZ (down 2.8% past month),V-Shares MSCI World ESG Materiality and Carbon Transition ETF VMAT (down 4.4% past month) and SPDR MSCI ACWI Climate Paris Aligned ETF NZAC (down 5.6% past month). These ETFs have lost the least in the past one month (as of Oct 27, 2023).
(Disclaimer: This article has been written with the assistance of Generative AI. However, the author has reviewed, revised, supplemented, and rewritten parts of this content to ensure its originality and the precision of the incorporated information.)
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Invesco WilderHill Clean Energy ETF (PBW): ETF Research Reports
First Trust NASDAQ Clean Edge Green Energy ETF (QCLN): ETF Research Reports
ALPS Clean Energy ETF (ACES): ETF Research Reports
Global X Hydrogen ETF (HYDR): ETF Research Reports
TCW Transform Climate ETF (NETZ): ETF Research Reports
SPDR MSCI ACWI Climate Paris Aligned ETF (NZAC): ETF Research Reports
V-Shares MSCI World ESG Materiality and Carbon Transition ETF (VMAT): ETF Research Reports
SoFi Smart Energy ETF (ENRG): ETF Research Reports
