Solar stocks had a tough year, but Wall Street is sticking by the trade. Here are analysts' top picks

Published Wed, Dec 29 202112:42 PM ESTUpdated Wed, Dec 29 20216:59 PM EST

What a difference a year makes in the energy sector: 2021's been the best year on record for traditional oil and gas stocks , while 2020 was the worst. For renewable energy stocks, however, the opposite is true. The Invesco Solar ETF , which tracks the space, is down nearly 27% for 2021. The solar fund knocked it out of the park during 2020 with a gain of 233%, so a pullback is not entirely surprising. But in a year when the S & P 500 is up about 27%, the underperformance is notable. The group has faced a number of headwinds this year, including policy uncertainty on the federal and state levels, supply chain problems and rising raw material costs. But Wall Street analysts remain generally bullish on the space, saying this is a long-term opportunity with huge growth potential ahead. "The sentiment around the Sustainability sector continues to be positive in the mid to long term despite near-term pressure on the stocks, with investors leaning into the secular shift that is occurring not just in sustainable energy and mobility technologies, but in the intersection of these two markets," Cowen said in a note dated Dec. 21. "[W]e believe the macro growth opportunities are compelling over the medium and long term as the global transition to cleaner energy and technologies accelerates," added B. Riley Securities in a Dec. 23 note. JPMorgan, meanwhile, said it has the highest level of conviction regarding the "secular growth and profitability for the sector in our ~10 years of covering this space." Solar industry plagued by headwinds If analysts are bullish over the long term, the immediate future could prove to be a different story. The group often moves in outsized swings compared to the benchmark indexes. The TAN fund fell 6.6% on Dec. 20, which was the day after Democratic Sen. Joe Manchin said he could not vote in favor of the Build Back Better plan. The bill included more than $500 billion for green projects, making it the single largest climate investment initiative in U.S. history. Provisions included tax credit extensions for renewable energy sources, a stand-alone energy storage credit and funding for nuclear and green hydrogen. Morgan Stanley said the industry's knee-jerk reaction to news of the bill's potential demise was unwarranted . These stocks had already been drifting lower, with uncertainty around the funding already priced in. Additionally, some of the initiatives in the bill have traditionally received bipartisan support, meaning they could be passed even if the full bill is not. For instance, the investment tax credit , which has been instrumental to renewables' growth, was extended under the Trump administration. The post-BBB weakness built on sharp declines from the prior week when California regulators issued a proposed decision that would slash incentives that have been instrumental to the industry's growth. Solar industry groups have slammed the proposed changes, and a final decision is expected from the California Public Utilities Commission at the end of January. Policy uncertainty in the form of a potential extension of the Section 201 tariffs on imported solar cells and modules is also weighing on the group. These tariffs are set to expire in February, but on Nov. 24 the U.S. International Trade Commission recommended extending them. President Joe Biden will make a final decision. Solar stocks also faced the same supply chain issues plaguing every corner of the market. Rising raw material prices increased costs for companies, leading some firms to slash industry-growth expectations . Despite these headwinds, Wall Street analysts still see upside. Morgan Stanley said investors should focus on key long-term drivers for the industry. The firm pointed to growing customer and investor interest in clean energy, barriers to entry for new companies looking to break into the space, as well as grid instability and rising power costs pushing consumers to distributed generation. Pressure is also coming from other stakeholders. Morgan Stanley noted that switching to renewable energy is a low-hanging fruit for companies that want to cut their emissions – a topic on which investors are increasingly focused. Names to own for 2022 and beyond Several Wall Street firms, including JPMorgan, pointed to residential installers Sunnova and Sunrun as attractive bets for investors. Analyst Mark Strouse said he believes each company's profitability will accelerate in 2022, due in part to installation volume growth and declining customer acquisition costs. He added that each company also has elevated inventory levels relative to historical levels, which position them well to ride out ongoing supply chain challenges. Sunrun is the largest residential solar installer in the U.S. in terms of market cap and customer count. The company has large exposure to the California market, and fears over fallout from the proposed changes to the state's net metering policy sent shares tumbling earlier in December. But Guggenheim said Sunrun and Sunnova continue to look attractive due to their growth opportunities outside of California. Additionally, the firm noted that the companies had plans in place to tackle the scheduled phaseout of the investment tax credit. Sunnova also makes RBC's list of best long-term ideas. The firm said Sunnova is poised to take advantage of the home electrification megatrend, including the expected surge in electric vehicles on the road. Amid the buildout in rooftop solar, the companies that make inverters – often known as the brains of a solar system – also stand to benefit, and Wall Street firms like SolarEdge and Enphase . The two companies are the only pure-play solar names in the S & P 500. SolarEdge joined the benchmark index earlier in December, while Enphase was added in January. Cowen and B. Riley are among the firms that favor SolarEdge. Cowen said the company is well positioned to take advantage of the strength in the global residential and commercial solar market, while also pointing to growth opportunities including around the company's new energy storage product. Citi likes both SolarEdge and Enphase, while Roth Capital favors Enphase. The company is one of just a few solar stocks in the green for the year, but shares have come under significant pressure this month, sliding more than 20%. "We would recommend accumulating shares opportunistically as we expect ENPH to outperform in 2022," Roth's Philip Shen said in a Dec. 20 note. Shen also favors Array Technologies , as does JPMorgan, which highlighted the stock as a top pick for 2022. The company makes the racking infrastructure that supports solar systems. Its software tilts the panels throughout the day to make sure each one is maximizing energy production. The stock is down more than 60% this year, partially due to the company's high exposure to rising steel prices. Additionally, on Nov. 30 Array announced plans to raise capital in order to finance an acquisition, which sent the stock tumbling more than 20% in a single session. But JPMorgan's Strouse said that the company's recent acquisition of Spain-based Soluciones Técnicas Integrales Norland, S.L. provides Array with international growth opportunities, while rising commodity prices should be less of a headwind during 2022. For income-seeking investors looking for exposure to the renewable-energy theme, Hannon Armstrong is one way to enter the space. Roth Capital, Cowen and B. Riley all pointed to the company, which finances clean energy projects, as a top pick for 2022. Roth's Shen noted that the company serves as a "defensive buffer against policy and supply chain risk," while Cowen pointed to expansion opportunities as businesses develop energy-efficient infrastructure - CNBC's Michael Bloom contributed reporting.

Sutad Watthanakul | EyeEm | Getty Images

The Invesco Solar ETF, which tracks the space, is down nearly 27% for 2021. The solar fund knocked it out of the park during 2020 with a gain of 233%, so a pullback is not entirely surprising. But in a year when the S&P 500 is up about 27%, the underperformance is notable.

The group has faced a number of headwinds this year, including policy uncertainty on the federal and state levels, supply chain problems and rising raw material costs.

But Wall Street analysts remain generally bullish on the space, saying this is a long-term opportunity with huge growth potential ahead.