Sunday, March 30, 2014

Solar Power Captures Investors' Attention

Despite all the excitement surrounding solar energy over the last couple of decades, the technology has yet to go mainstream. However, that is slowly starting to change.

Perhaps the biggest reason for the slow spread of solar energy has been the high cost associated with converting a household to take advantage of solar energy. While the long-term savings can be substantial for homeowners who convert their homes to solar power, it can be hard to see the advantage of those savings when considering spending upwards of $20,000 to make the change.

The good news is that for new homebuyers, the choice is now a bit easier. Homebuilders have been increasingly offering solar panels in new home construction, which makes it considerably easier for homebuyers to outfit their homes with panels since the initial cost is spread over the lifetime of a mortgage as opposed to a one-time fee.

The benefits of solar panels to both homeowners and municipalities are also catching the eye of various local governments, and we have already seen two different towns in California require solar panels installed on all newly constructed homes.

While I remain optimistic that solar panel is going to assume a more meaningful role in mainstream life, not everything is going so smoothly at the current time. A big player in the industry, First Solar Inc. ( FSLR ) recently ran into trouble after posting weaker than expected fourth quarter results. Earnings were 89 cents per share, well below the $1.03 consensus estimate. Quarterly revenues were $768, sharply lower than the $969.4 million Wall Street had forecast.

The company blamed lower revenues from commercial installs as being the primary driver for the weak quarterly results.

In addition to the weaker than expected fourth quarter results, First Solar also issued first quarter guidance in a range of $0.50 to $0.60, well below the $0.81 expectation.

However, another top player in the industry, Chinese based Trina Solar ( TSL ) was able to post strong quarterly results. The company boasted a 73% year over year increase in revenues, and operating income of around $14 million (up from a loss of $70 million in the previous year.) The quarter was aided by strong sales growth in China, where selling prices actually moved a bit higher.

Two other big companies in the industry, JinkoSolar ( JKS ) and SunPower Corp. ( SPWR ) each posted better than expected results for their recent quarters.

A big reason why I remain bullish on the sector is that it does appear as though solar energy is starting to gain traction, particularly in the U.S. A recent report from the Solar Energy Association indicates that solar energy is taking on a more pivotal role in the U.S.

According to the report, solar represented 29% of all new electricity capacity last year. That figure was up from just 10% in the previous year. A big reason why solar panels are going up so fast can be tied back to a drop in cost. During the fourth quarter of last year, the average cost of a solar system was running at $2.59 a watt, that is down 14% year over year, and a significant drop from the $8 a watt average as recently as 2009.

Last September, we took our last look at the solar industry and at the time I suggested that perhaps the best way to play the industry was with a hedged option trade on the Guggenheim Solar ( TAN ) exchange-traded fund. The reason being that this ETF holds the biggest names in the solar industry, so you could take advantage of the overall strength of the industry, but shield yourself against any volatility that may hit one or two stocks.

At that time, TAN was trading at $29.42, and I suggested setting up a January 20/24 bull put credit spread with a target return of 12.7%, or 36.4% o an annualized basis (for comparison purposes only). As it turns out, the stock closed on January expiration at $41.77, so investors who followed my advice easily locked in their total return on the trade.

Now, I am once again going to look to set up a new hedged trade on TAN. At the current time, I remain just as bullish on the sector as I was back in September, but still believe that the volatility within the sector warrants another hedged trade. Is it possible that we could enjoy a better return by simply buying shares of TAN at the current time? Sure, but in a volatile sector like solar, it is better to be safe than sorry.

A nice hedged trade on TAN would be the July 31/35 bull put credit spread. IN this trade, you would sell the July 35 put, while at the same buying the same number of July 31 puts for a credit of 40 cents. The trade has a target return of 11.1%, which is 31.9% on an annualized basis (for comparison purposes only). TAN is currently trading at $46.04, so the trade has 23.1% downside protection.


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