The divide between 'new' and 'old' energy stocks is growing — Here's why

Published Tue, Jan 11 20221:54 PM EST

The diverging performance between "new" and "old" energy stocks has accelerated during the first trading days of 2022, building on last year's trend that saw oil and gas stocks soar while solar stocks sank. Wall Street analysts say there's upside for both sets of names, although investors need to be selective. The S & P 500 energy sector , which is made up of oil and gas stocks, is far and away the best-performing group year to date, jumping more than 10% during the first six trading days of 2022. This builds on the sector's nearly 50% gain for 2021, which was its best year on record and made it last year's best-performing S & P 500 sector. The Invesco Solar ETF , on the other hand, is down 8.1% through Monday's close. The Invesco WilderHill Clean Energy ETF , which tracks a broader range of renewable energy stocks, has declined 9.1%. Part of the divergence is thanks to a trend playing out in the broader market — the rotation out of growth stocks into value names. With interest rates set to rise, stocks with high valuations that promise future profits begin to look less attractive — and many renewable energy stocks fall squarely into this category. Oil and gas companies, meanwhile, are fully operational and have more predictable cash flows. "The increase in rates led to a rotation out of growth securities and those with cash flows that are more speculative and into value plays and those with excellent cash flow prospects, i.e. energy," said James Mick, managing director and senior portfolio manager with TortoiseEcofin. The recovery in oil and natural gas prices has also boosted energy stocks. While gains faded toward the end of 2021 following an omicron-induced decline, they still ended the year sharply higher. While the macro and micro environment is supportive for traditional energy names, the same cannot be said for solar stocks. The industry has faced a number of policy headwinds, supply chain issues and rising raw materials costs. On the policy front, the stalled Build Back Better plan earmarked more than $500 billion in climate-related initiatives. Additionally, a California regulator has called to ratify a key rooftop solar incentive in the state known as net-energy metering, which solar advocates say would be detrimental for the industry. Solar stocks tumbled after the proposed decision was released in December. A final decision is expected at the end of January at the earliest. Trade uncertainty has also hit the group. A decision around the potential extension of the 18% U.S. import tariff on silicon solar modules is expected by February. When looking at the opposite direction the two groups of energy stocks have gone, it's also important to note each one's starting point. The Invesco Solar Fund surged 233% in 2020, while the S & P energy sector declined 37% for its worst year going back to 1989. The sector is now trading at its highest level since July 2019, but remains more than 30% below its all-time high from June 2014. Part of last year's performance could therefore be reaction to 2020's return, although the sharp divergence within the group is still notable. Looking ahead, Wall Street analysts say it isn't a zero-sum game. Stocks within both groups can outperform, although investors need to be choosy. "Old" energy stocks Goldman Sachs has an overall "bullish energy equities view" and holds buy ratings on a number of stocks, including Exxon , Phillips 66 , Diamondback Energy and Halliburton . All four stocks are up double-digit to start 2022. Refiner Phillips 66 is on the firm's conviction buy list, and Goldman said the company stands to benefit from improving jet fuel demand. Goldman added that Halliburton should benefit from improving oilfield services pricing. In some ways, 2021 marked a turning point for oil and gas companies. As the pandemic took hold — drying up demand for petroleum products — companies cut expenses, halted production, paid down debt and focused on returning money to shareholders in the form of dividends and buybacks. Investors are likely to reward this type of discipline going forward. Bank of America said 2022 will see growing interest in traditional energy stocks. "With improved performance we expect investor apathy conflated with ESG concerns to be replaced by a what we would regard as a more rational view on the value proposition of 'old energy',...anchored on transparent valuations defined by free cashflow and defended by outsize cash returns prioritized over growth," analysts led by Doug Leggate said Monday in a note to clients. The firm anticipates energy stocks growing to 5% of the S & P — up from 3% — making the group "relevant again in the eyes of investors." Bank of America's top ideas include Occidental , Hess and Exxon. "[W]ith 2022 a transition year for its balance sheet, free cash flow, disposals and dividend growth – and at its size we believe [it] can lead the sector weight higher through renewed confidence in its dividend outlook," the firm said of Exxon. When it comes to natural gas companies Morgan Stanley said Cheniere is a top pick. The firm noted that the company is the largest U.S. liquefied natural gas exporter. "Over the next several years, strong FCF supports declining leverage, growing dividends, and share repurchases," Morgan Stanley said in a Monday note to clients. "New" energy stocks Analysts are no less bullish on solar stocks, especially after the recent downturn. Goldman Sachs said Sunday that demand and overall fundamentals "remain robust." "[W]e see healthy upside potential for the group into 2022 in the midst of a cleaner macro trade policy backdrop as well as improving supply chain issues." Goldman said first-time investors in the space should focus on residential solar stocks and those that have leverage to battery storage. The firm added inverter maker SolarEdge to its conviction list while removing Sunnova , although the firm maintains a buy rating on both names. "Best positioned for upside to consensus estimates on battery storage ramp and improving margin mix," analysts led by Brian Lee said of SolarEdge. The firm also has a buy rating on shares of Enphase . The microinverter maker ended 2021 with a gain, but shares have since fallen off a cliff and are down nearly 20% for 2022. JPMorgan also rates the company at overweight, and said fundamentals are not behind the recent price decline. "The decline is more a reflection of a broader market rotation out of growth stocks and into value stocks, as evidenced by the relative underperformance of the highest growth/multiple stocks, generally," the firm said Monday. Shares of Sunnova and Sunrun are also down sharply over the past year, to the point that investors are paying for just three years and 5½ years of growth, respectively, according to BMO Capital Markets. "We think the market has meaningfully overshot the mark," the firm said, adding that residential solar companies are "riders of the storm." BMO is also bullish on shares of Enphase and SolarEdge, saying that fundamentals remain strong and policy headwinds are not insurmountable. UBS, on the other hand, prefers utility-scale power and storage companies for 2022. The firm said that despite logistical challenges and rising raw material costs, states' renewable energy targets will fuel upside. The firm holds buy ratings on shares of Array Technologies , Shoals Technologies and NextEra Energy Partners , among other names. —CNBC's Michael Bloom contributed reporting.

Solar Farm at Death Valley

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