SunWorks Inc (SUNWQ)

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The Solar Industry Is Well-Positioned Irrespective Of The Investment Tax Credit Outcome

Disclosure: Author is long SCTY.

Summary

The current solar ITC has been one of the main drivers of growth in the US solar industry.

While a step down in the ITC will have a large short-term impact on the industry, particularly in utility-scale solar, US solar companies should still be fine in the long term.

The cost reduction potential of solar and the increasing possibility of an ITC renewal puts the industry in a relatively good place.

The solar industry has grown tremendously over the past decade, which is largely due to the presence of an invaluable 30% solar ITC (investment tax credit). This ITC, which allows for "credits equal to 30 percent of the basis that is invested in eligible property," has been a crucial element for leading US solar companies of all types. In fact, the distributed solar industry as it currently stands would be nonexistent without the 30% solar ITC.

As the 30% solar ITC is expected to decline to 10% and 0% for commercial and residential systems, respectively, by 2017, the entire solar industry is rightfully worried about the consequences of such an outcome. The solar industry's historical 30 to 40% growth rates will almost certainly be unsustainable in the years following a solar ITC step-down. This will have negative implications on leading solar companies across the board, from those involved in utility-scale solar to those involved in distributed solar.

Growth Slowdown

The solar ITC step-down is expected to have a major impact on the general solar industry. Growth in the US utility-scale solar sector is expected to be particularly vulnerable to a step-down, which will undoubtedly have a large impact on companies like First Solar (NASDAQ:FSLR). While distributed solar is also expected to experience a slowdown in growth, the industry will likely fare far better in an ITC expiration scenario. Given the relatively recent emergence of the currently popular distributed solar lease/PPA products, the industry is still massively underpenetrated. This should help soften the blow of a tax credit decline.

In fact, companies like SolarCity (NASDAQ:SCTY) and Vivint Solar (NYSE:VSLR) have a market opportunity in the tens of billions of dollars at the current rooftop solar prices. To put things into perspective, the National Renewable Energy Laboratory estimates that the potential for rooftop solar stands at more than 600 GW in the US. Given that the overwhelming distributed solar market leader SolarCity is expected to install just under 1 GW of rooftop solar this year, there will be huge opportunities in this arena irrespective of a solar ITC step-down.

While the expiration of the current solar ITC will undoubtedly have negative consequences for US solar companies, the market does seem to be exaggerating the risks for US solar companies. As utility-scale solar companies like First Solar are becoming more geographically diversified across the globe, a slowdown in US demand should have a somewhat blunted affect on these companies. With demand in areas like India exploding, the US will likely diminish in importance for these companies. Even distributed solar companies are starting to expand internationally, which should also shield them from the full effects of a tax credit expiration.

Given the underpenetration of residential solar, the expiration of the current solar ITC is expected to have a disproportionately negative impact on utility-scale solar.




Source: GTM research, SEIA

Rapid Cost Declines

An expiration of the current ITC would be a huge problem for the solar industry if costs were to stagnate moving forward. However, this is extremely unlikely to happen as the solar industry is known for its precipitous cost declines. In fact, total costs across all solar segments have approximately halved since 2010. To be more specific, average utility-scale costs dropped from around $3.50 per watt to around $1.50 per watt and average residential solar costs dropped from around $7.00 per watt to around $3.50 per watt.

The current solar industry is still nowhere near mature in terms of technology, which means that solar modules should continue to become more cost-effective moving forward. On top of this, US solar soft costs are still hugely inflated, especially on the distributed solar side. This means that continued rapid cost reductions across all segments of the solar industry are not only possible but also likely. While an ITC step down will have a huge negative effect on the economics of the solar industry, the continuous cost reductions occurring within the industry should more than offset this.

A Renewal of the Current 30% Solar ITC Seems Increasingly Likely

The US government is starting to put an increasing emphasis on climate issues, evident in the ambitious climate goals and agreements being made. The reduction of GHG emissions is rapidly becoming a priority at the Federal level, which is increasing hopes that the solar ITC will be renewed in its current form. In fact, SolarCity CEO Lyndon Rive believes that there is more than a 50% chance that the solar ITC does in fact get extended.

Most leading solar companies like First Solar, SolarCity, and so forth, are being valued as if the solar ITC will almost certainly decline in 2017. In fact, First Solar has a mere P/E ratio of 10 despite the fact that it is a leader in an exploding industry. Even worse, SolarCity and other rooftop solar companies like Vivint Solar or Sunrun (NASDAQ:RUN) have market capitalizations lower than their retained values. The market seems to be discounting the very real possibility that the 30% solar ITC gets extended beyond 2016.

Conclusion

While an expiration of the current 30% solar ITC will undoubtedly have an adverse effect on US solar companies, many seem to be underestimating solar's immense potential for continued cost reductions and the chances of an ITC renewal. Leading utility-scale solar companies like First Solar and leading distributed solar companies like SolarCity are well prepared regardless of how the solar ITC situation plays out. The solar industry is now at a point where subsidies are becoming far less important determinants of long-term success.