TAN - TAN: Take It From A Florida Man This One Could Shine Then Burn

2023-12-20 09:07:33 ET

Summary

• Invesco Solar ETF is a tactical trading vehicle rather than a long-term investment due to the volatile nature of the solar industry.
• The solar industry faces challenges and skepticism, with some believing that it can only survive with significant government subsidies.
• TAN has the potential for a 25% upside in the short term, but also a 40% downside if market conditions worsen. It is currently recommended as a Hold.

Invesco Solar ETF (TAN) is one I've followed for many years, and I've come to regard it as one of my go-to ETFs in the alternative energy sector. It gets a Hold rating from me, but that's akin to saying that when the sun is out, it is warm. Ask someone in Ottawa this time of year about that, versus where I live in South Florida.

My point is that with ETF security ratings, particularly on one that jumps around in price like this one does, and carries controversial issues on its back constantly, a "Hold" rating only partly tells the story. So, here's the story (mine, anyway).

Opinions on TAN and the solar industry are forever all over the map, but I think I can tie them together. Maybe it won't make everyone happy, but I can try! The bottom line for me is that TAN needs to be viewed for what it is: a political and Wall Street "football" of an industry, which is life-enhancing and pleasing to the soul, or a waste of money and effort, depending on who you talk to. To me, that's what makes a market. And in the case of TAN, it makes it a terrific trading vehicle at times, but not a long-term hold for the foreseeable future.

Thus, I rate TAN... well, that's a tough one, because it depends on how one interprets what ratings mean. Because as long as markets reward "risk on" industries like solar, TAN has a chance to rally perhaps another 25% to the $65 area, before running into a 3-year wall of resistance in the form of a fierce downtrend in its price pattern.

Would I own it in a portfolio for tactical purposes now? Yes. Is it high enough on my watchlist in terms of reward potential versus the risk of major loss (my personal criteria) that I'd own it over a bunch of other "risk on" industries and sectors? No. That's how I get to a Hold.

What's the downside risk? That's what I always ask before making any move. In the case of TAN, it should make a lower low than the last time it fell, because that is what it typically does, and that's what risk on segments of the stock market due when a recession is looming and government debt is so high, there may come a day when the incentives to "go green" run low or run out. In price terms, looking out 3-6 months, that gets me to $41 best case, and $27-$32 if it picks up momentum, which is more likely.

Harnessing the potential of volatile ETFs

But as with many niche/industry ETFs like this one, the investment process is two-fold:

1. Determine if it is something worth following for potential investment (for me the answer was yes going all the way back to its 2008 inception).

2. If it makes the "watchlist," determine what would prompt me to put it in my portfolio. In the case of TAN, I view it as purely a position to "rent, not own." That is, it's a tactical position nearly all of the time, unless/until conditions arise that lend themselves to owning it for at least 12 months.

Here's why I drew that conclusion a while ago. This is a chart of 1-year returns (monthly intervals) going back 10 years. This is the poster child for volatility. It has made as much as 250% or more in a 12-month time frame and has also been cut in half.

And frankly, sometimes the two opposite scenarios occur very close together chronologically. So in viewing TAN in the current investing climate (pardon the pun), the first item off the investor checklist is "it's a rental, not an own." Its annualized 10-year return is around 5.5%. But does that mediocre figure mean I'm going to shun it? No way, not with the explosive upside potential it has.

Solar industry issues

Raymond James Managing Director Pavel Molchanov recently commented

"I know it might seem surprising, but actually the amount of solar installations in 2023 is a record globally, including a record in the United States...so it's not a volume problem. It's in some cases more of a margin problem and, of course, for the stocks as distinct from the fundamentals, it's also a question of valuation. So stocks can be down even if the fundamental business trends are actually up."

This is the hurdle with engaging in a long-term relationship with industries like this one. Back in October , TAN fell by 7% in a single day (and to make it worse, it was a Friday!) when one of its top holdings disclosed that it would miss sales and income estimates, as a combination of cancelled work and delayed projects prompted the setback.

"Setback" might as well be TAN's middle name, because, like a sports team that is forever rebuilding, this industry has had a yoke on its shoulders for as long as I can remember. That stems in part from the belief in some corners of the investment markets that solar companies can only last as long as significant government subsidies continue. And increasingly, the narrative is that while solar, wind and other long-term solutions to address climate change have value, they are not going to reach the point where they can be more than complements to a fossil fuel-centered energy policy in the US and elsewhere.

Notable ETF features and characteristics

I like TAN's concentrated nature. Four of its 53 total stock holdings make up 37% of assets, and the top 10 comprise just over 60%. It is a tenured, $1.5 billion ETF, but the risk factor inherent in this business includes the fact that these companies are quite small. TAN's weighted average market cap is under $3.5 billion.

Yet the current portfolio sells at under 11x trailing earnings and about 1x trailing revenue. Those are eye-popping stats for investors starved for valuation-driven ideas. The portfolio has a 5-year forecasted earnings growth rate over 20%, so on paper, TAN is a steal. But that assumes a lot goes right, and some of that will be determined by regulatory and government entities. The recent Cop28 deal is clearly a positive, but investors in this industry tend to "shoot first and ask questions later" both on the upside and downside. So again, the near-term upside target is reachable, but then what? The "resistance" chart-wise here is onerous. That said, if it flies through it, that will be a sign that long-term sentiment is finally changing. We'll see.

TAN's global nature also may help if the US Dollar's recent dip turns into a slide. 42% of the portfolio is non-US, split across Europe and Asia, and including all solar technologies (crystalline and thin-film photovoltaic solar and solar thermal), the entire value chain (raw materials, installers, to financing), and related solar equipment (power inverters and encapsulates).

The stocks eligible for TAN are then grouped into pure-play and medium-play buckets. Companies where solar is their primary business are pure plays (i.e. at least 2/3 of revenue from that business), and medium-play companies have multiple business lines but solar accounts for at least 1/3 of revenue. The portfolio allocation tilts toward pure-play companies, and the ETF is rebalanced quarterly.

Setting the sun on TAN (final thoughts)

Chart-wise, the price points I cited above imply 25% upside potential and 40% downside potential over a 3-6 month time frame. And the wild part of all of this? I could see BOTH occurring by Q2 or Q3 2024.

So, is it a Buy, Hold, or Sell? Given that it is sitting smack in the middle of a trading range from about $40 to $65, I land on a Hold rating. But I would strongly urge anyone reading this to pay more attention to everything other than the bottom line rating. Context is everything, and investors ultimately have to answer to themselves.

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