TSLA - Solar Stocks Are Underperforming But There Is Light At The End Of The Tunnel For Some

2023-10-19 12:51:35 ET

Summary

• Solar stocks related to residential solar are trading close to their 52-week lows, largely due to changes in the solar landscape in California.
• The new NEM3.0 regime in California has reduced the price for energy export to utilities from customers' solar systems, leading to longer payback periods for newly installed solar systems.
• The deployment of battery systems was expected to offset the slowdown in the solar industry, but the fundamentals of battery deployment are weak, except in underserved remote areas.

Solar stocks are getting hit hard - especially stocks related to residential solar. Enphase Energy (ENPH), Sunnova (NOVA), Sunrun (RUN), SolarEdge (SEDG), SunPower (SPWR), and Sunworks ( SUNW ) are all trading close to their 52-week lows. There is no doubt that rising interest rates have reduced the appetite for new solar system installations, but the more fundamental reason for the malaise is the change in solar landscape in California - the largest residential solar market in the US.

On April 15th of this year, the new NEM3.0 regime under the California Public Utilities Commission, or CPUC, took hold. The change was not a secret and the proposed decision was announced nearly a year back. California Public Utilities lobbied the CPUC to amend NEM2 which was causing a significant cost shift from solar customers to non-solar customers. The solar industry, however, has been extremely successful in not only delaying changes to NEM but also in watering down changes. With NEM3, that dynamic changed, and utilities finally got something close to what they wanted. The good news for the solar industry is that two of the solar-specific charges proposed by utility companies were not adopted by the CPUC. CPUC also provided a 20-year grandfathering period, as opposed to the 10-year grandfathering period sought by utilities, for all systems installed with NEM2 before NEM3 became official.

Just about the only major change from NEM2 is that CPUC reduced the price for the energy export to utilities from the customers' solar systems. The exact implementation details are beyond the scope of this article, but the image below gives an example of what utilities will pay for solar power exported by customers as opposed to what the customer will pay for the power imported from the utilities.

Given the variability of pricing on an hourly basis, the impact of the scheme will vary depending on the size of customer systems and their pattern of electricity usage. For example, a customer who consumes a significant amount of locally generated solar energy during the daytime will get the highest value out of the solar system. On the other hand, someone who does not use much solar power during the daytime will receive a much lower value for their exported energy.

Similarly, depending on the cost of the battery system in place, it could be economical to store energy in the battery from sunrise to about 4 PM and use all that energy from 4 PM to 9 PM when energy prices are the highest.

CPUC does assess that NEM3 will lead to longer payback periods for newly installed solar systems. According to CPUC, at an estimated $3.30 per watt in installed cost, the payback from the new regime will be about 9 years. It is difficult to ascertain what this type of pricing means to a customer without a rigorous case-by-case analysis. In a typical case, according to California Solar + Storage Association analysis , the CPUC decision "would cut the average export rate in California from $0.30 per kilowatt to $0.08 per kilowatt and make those cuts effective in April 2023, resulting in a 75 percent reduction in the value of exports."

Implications On Key Industry Players

California's rooftop solar market, at an estimated 1.3M rooftops, constitutes about 50% of the total US residential solar market. Cutting the export value of solar energy by 75% and increasing the payback period to about 9 years has dampened solar panel deployment under the NEM3 regime. This is a major deployment setback to all residential installers including Tesla (TSLA).

A related problem is that installers, aware of the NEM3 benefit reductions, have aggressively attempted to get customers to have systems installed under NEM2. Consequently, the solar industry in California saw a very strong H2 2022 and H1 2023.

One big industry hope is that the difference in import and export pricing will encourage the deployment of battery systems - with and without associated solar deployments. As a result, the industry was expecting to see a meaningful uptick in battery deployment. Investors were hoping that inverter and battery vendors like Enphase and SolarEdge would benefit as the slowdown on the solar side gets offset, at least partially, by the growth in the battery business. However, this has not happened to any meaningful extent because the fundamentals of battery deployment are rather weak except in remote areas that are underserved by utilities.

Solar installers like Sunnova, Sunrun, SunPower, and Sunworks are in for a tough time as NEM3 structurally reduces demand for residential solar systems. The incremental battery uptake is unlikely to come close to offsetting the solar downside.

Enphase and SolarEdge are in a different boat compared to the installers. Enphase could get hit hard on the revenue side as the company is highly dependent on the US market. However, Enphase has strong tailwinds as it moves some of its manufacturing into the US to benefit from IRA subsidies. These subsidies, once they kick-in, are likely to overcome any drag that Enphase sees from the deployment front. SolarEdge, due to lower dependency on the US residential market, is likely to see a more muted revenue impact. On the other hand, SolarEdge also benefits far less from IRA than Enphase - unless the Company starts getting into the microinverter business.

Prognosis

All things considered, NEM3 is likely to continue damaging the residential solar industry in the near term. But the impact is going to be uneven across different players. Solar system installers, with already broken business models, are likely to continue to suffer. On the other hand, inverter manufacturers like SolarEdge and Enphase have light at the end of the tunnel in the form of IRA benefits. While Enphase's revenue momentum could slow some more, IRA benefits will buffer the hit to Enphase's earnings. SolarEdge is likely to have less of a revenue impact but does not benefit as much from IRA leaving it in a less advantaged position than Enphase.

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