Solar stocks are sinking — What can turn the group around?

Published Sun, Jan 30 20229:20 AM EST

Solar stocks are coming off a punishing 2021, and so far the 2022 story has been much the same: investors are fleeing the space. The Invesco Solar ETF fell to a 52-week low on Friday, bringing its year-to-date loss to more than 20%. And that's after the fund declined 25% in 2021. The group's been hit from both broad-based and industry-specific headwinds. Such punishing performance — some stocks are more than 70% below their recent highs — begs the question if or when the bottom might be in, as well as if this is a buy-the-dip opportunity. Those who are bullish on the space note that despite the volatility this year and last, countries are announcing decarbonization goals, creating a large addressable market for companies in the space. Additionally, the recent underperformance does follow a record 2020 when the Invesco Solar ETF surged 233%. Even those who remain optimistic acknowledge that valuations had, in come cases, looked detached from fundamentals. What's driving the underperformance? Part of solar stocks' underperformance stems from a broad rotation out of growth-oriented areas of the market. For a while investors chased growth at all costs, but with the Federal Reserve set to hike rates, the future profits promised by these companies begin to look less attractive. "There has been a massive indiscriminate selling of growth/tech/innovation positions as anything thought to be a long-duration equity (such as clean energy) had to be sold amidst the Fed's hawkish pivot," said Anastasia Amoroso, managing director and chief investment strategist at iCapital. "Clean energy was caught in this rotation." On the policy front, the stalled Build Back Better plan earmarked more than $500 billion in climate-related initiatives. The plan also called for an extension of the Investment Tax Credit, which has been instrumental to solar's growth. The ITC, as it's called, will decrease beginning next year. And policy headwinds aren't just on the federal front. In December solar stocks sold off after a California regulator proposed slashing a key rooftop solar incentive that's made the state a leader in renewable energy. A study by energy research firm Wood Mackenzie said that if the proposal is implemented as is it will cut the state's solar market in half by 2024. But the decision is not yet final, and experts say clarity around what the policy will look like going forward could lend support to solar stocks. Supply chain issues and rising raw material costs have also weighed on renewable energy stocks, although management teams have said some of the bottlenecks are expected to ease in 2022. Despite the recent headwinds, Amoroso pointed to three key factors that should boost the group longer term: government climate goals, favorable economics and stepped-up corporate commitments. "Valuations have reset materially lower and if the Fed uncertainty abates, the longer-term structural positive momentum in solar should re-assert itself as demand growth remains robust even without extra policy support," she added. JPMorgan recently noted that following the sell-off the group is now trading at a roughly 35% discount relative to its one-year average multiple, and a roughly 15% discount to the three-year average. "[L]ong-term investors interested in the long-term decarbonization theme (which is generally not impacted by these near-term headwinds) are being offered an attractive entry point, in our view," the firm wrote in a Jan. 24 note to clients. Where's the opportunity? JPMorgan's analysts led by Mark Strouse said investors should focus on companies that have differentiated business models as well as above average margins to ride out the near-term volatility. The firm has been bullish on the space for months even as these stocks suffered heavy losses. Still, Strouse sees opportunity ahead and favors residential installers Sunrun and Sunnova , as well as Array Technologies . The company makes the racking infrastructure that supports solar systems, while its software tilts the panels throughout the day to make sure they are maximizing energy production. All three stocks are more than 65% below their 52-week high levels. Ecofin Senior Portfolio Manager Matt Breidert expressed a similar opinion, saying sentiment is "quite washed out" and that in the nearly decade that he's been covering the space these times have been "better entry points given the volatility in the sector. He likes solar panel manufacturer First Solar , in part because of its domestic manufacturing capabilities. Shares of the company have held up relatively better than peers, and are down 40% from the recent high on Nov. 1. Meanwhile VanEck portfolio manager manager Shawn Reynolds owns Sunrun , SolarEdge and Hannon Armstrong . He said all three have "strong track records" that aren't shared by their competitors. "These three companies are definitively clear market leaders on the renewable energy front and the necessary growth that is embedded in net zero targets implies an enormous addressable market that they all should capitalize on," he said. Degas Wright, chief investment officer at Decatur Capital Management, favors Enphase Energy . The company was one of the few solar names to end 2021 in the green, but shares are down 32% year to date, and 56% below their 52-week high from November. Wright likes the company because of its pricing power, noting that it isn't easy to substitute for the company's specialized inverters known as microinverters. Additionally, he said that the company's headwinds are temporary. - CNBC's Michael Bloom contributed reporting.