The brighter side of divesting from fossil fuels

The brighter side of divesting from fossil fuels

For the past several decades, fossil fuel companies in the oil and gas industry were highly regarded by investors at both the individual and institutional levels. The reason was simple—these were the companies that exhibited the strongest earnings growth, thanks to the commodities super-cycle that took the price of oil to over $100 per barrel. Investors were rewarded with rising stock prices and dividend payments from Big Oil stocks like Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX).

But in an environment of $30 oil, investors are increasingly looking for alternatives, since energy stocks are no longer as rewarding as they once were. Combined with a newfound desire to construct socially-responsible investment portfolios, asset managers of all sizes are taking clean energy companies more seriously as candidates for investment. Companies that focus on renewables, particularly solar, are proving an ability to turn a profit and reward investors with compelling returns, while oil and gas stocks continue to burn investors.

Investment opportunities in clean energy

What held the fossil fuel divestment movement back is that the biggest institutional investors around the world—including mutual funds, pension funds, and endowments—needed to earn satisfactory returns. Big Oil companies are distasteful to many, but their attractive returns and dividend payouts were too good to ignore. But in recent years, the push to divest from fossil fuels has accelerated. Among the institutions divesting from fossil fuel producers include the world’s largest sovereign wealth fund, held by Norway, as well as two of the world’s biggest pension funds, in California. Furthermore, endowments of esteemed universities including California, Oxford, and Syracuse, have committed to divest from fossil fuels.

Fortunately, there are investment opportunities in clean energy that investors can take advantage of, and not have to sacrifice growth potential. Solar power company First Solar (Nasdaq: FSLR) is a great example. First Solar designs, produces, and sells solar modules, which convert sunlight into electricity. It also develops, designs, and sells solar power solutions. It offers its products and services for residential, commercial and industrial applications. First Solar’s financial performance over the past year reflects the incredible progress it has made. Last quarter, the company generated record quarterly sales of $1.3 billion. Over the first nine months of 2015, revenue and diluted earnings per share increased 10 percent and 84 percent, respectively. As First Solar grows, its margins are increasing as well, thanks to the benefits of scale. Gross profit margin is expected to reach 24-25 percent for the full year 2015, compared to prior forecasts of 21-22 percent.

The following chart shows that in just a few years, First Solar has gone from steep operating losses, to generating increasing levels of profit.

Going forward, First Solar should continue to grow. Its improving profitability has strengthened its balance sheet. The company now holds $1.8 billion in cash and short-term marketable securities, compared with just $251 million of long-term debt. Its strong net cash position should provide enough financial flexibility to continue investing in its future growth.

Analysts and investors are finally taking notice

Analysts are finally starting to realize the merits of companies like First Solar that are expanding distribution, realizing economics of scale, and improving profitability. The median price target from the 17 brokerage houses that follow the stock is $74 per share. This represents approximately 14 percent upside potential from its current $65 stock price. In the past one year, First Solar has received five upgrades from analysts with top-tier research firms like Goldman, Deutsche Bank, and others. Analyst Brian Lee of Goldman specifically praised First Solar’s balance sheet in the firm’s upgrade. In a note, he said “We believe this positions the company better than peers to navigate short-term tightening in financial conditions and maintain a relatively low cost of capital. No developer has more offensive firepower than First Solar heading into the next several years.”

As analysts raise their earnings and stock price targets, investors are taking notice. Major investment organizations have taken significant positions in First Solar. For example, Essex Investment Management increased its position in First Solar by 14 percent in the fourth quarter last year, and it now owns more than 249,000 shares.

While oil and gas stocks are in free-fall due to the collapse in commodity prices, solar stocks are powering up. Shares of First Solar increased 45 percent in the past one year, and strongly outperformed fossil fuel producers Exxon and Chevron.

First Solar stock still looks cheap. It trades for just 11 times its trailing 12 month earnings. For investors considering divesting from fossil fuels in favor of clean energy alternatives, there may not be a better time than right now.


Companies to Watch

Exxon Mobil & Chevron: These stocks are already under significant pressure, down 13 percent and 16 percent, respectively, in the past year. Selling pressure could continue, or possibly get even worse, if institutional investors continue to divest the stock from their investment portfolios.

SolarEdge Technologies (Nasdaq: SEDG): SolarEdge, a manufacturer of inverters used in rooftop solar systems, has also received positive commentary by analysts. The company has beat earnings estimates in each quarter since its initial public offering last year, and the stock is up more than 50 percent in just the past three months.

Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.  

Originally published on February 4, 2016