Description

Europe's green energy stocks have recently entered a bear market, so this seemed like a timely idea. 

Solar and wind farms are long-duration assets by nature, as the upfront capex outlay needs to be monetized over the next three decades. The present value of a given project therefore depends on the prevailing cost of capital and power prices which are often locked in upfront via Power Purchase Agreements (PPAs) with utilities. Valuation of a publicly traded asset owner would typically account for both projects already in operation and the future pipeline.

Sunny Spain is Europe’s hub for solar farms. The period of 2020-22 was extremely lucrative for local solar farm developers as near-zero capital costs coincided with sky-high energy prices in Europe (Spanish PPA prices peaked at €70-80/MWh). The resulting lucrative IRRs incentivized a wave of new solar farm buildouts that are still ongoing.  However, after peaking in mid-2022, European energy prices have given up most of the gains, with Spain leading the declines.  We estimate that in order to deliver an acceptable IRR of >10% for a new project today, PPAs need to be at least €45/MWh.  The CEO of the leading Spanish solar farm owner Greenergy recently commented: “Prices of PPAs are going down in Spain <…> I would say that our price in Spain is more in the mid-30s now”. 

In the mid-30s, IRR of new projects is barely positive.  Turning to the higher-rate but unpredictable spot market may improve new farms’ IRRs but is hardly a sound strategy as certainty is required for long-duration capital commitments.  The challenge is further exacerbated by the recent step-change in interest rates that mechanically raises the IRR hurdle for new projects and devalues those in operations, even though their prices are locked in.  In a recent profit warning, the CEO of NextEra Energy Partners acknowledged as much: “Tighter monetary policy and higher interest rates obviously affect the financing needed to [sustain previous shareholder dollar returns]”. Essentially, the current business environment is the opposite of the industry’s utopia of 2020-22. 

Among several companies that experienced a parabolic appreciation in equity value since 2019, Solaria Energia (Bloomberg: SLR SM) in particular owes this to lofty expectations of future projects (over 50% under our estimates). Obviously, a lot depends on underlying assumptions, of which WACC and PPA/power prices are key. There is a wide range of valuation outcomes and we encourage everyone to run and underwrite their own scenarios. On a high level, at a WACC of 8% (what we think adequately approximates today's cost of equity and new debt) and PPA at €35/MWh, equity is worthless. The current share price seems justified at a WACC of 5.5% and PPA at €45-50/MWh applied to the projected pipeline. We think a fair price for the share is in the single digits (assuming a mid-cycle WACC of 6.5% and PPA of €35 through 2040)

While math is an important input and there are a lot of nuances to how the industry works, ultimately our excitement about the idea is based on common sense / powerful high-level trends:

Spanish PPAs - prices are back to normal

Interest rates - cost of capital has skyrocketed

SLR share price - still (seems like) a bubble. Could it be the Road Runner moment?

The obvious risks to the short case would be another energy price shock and a fast decline of interest rates to sustained low levels. 

P.S. a few housekeeping items:

1) SLR recently announced a small deal at the PPA price of 45. We have no insights other than that seemed unrepresentative of the broader market trends and timely (ahead of the recent CMD)

2) During the CMD, SLR talked about selling newly built capacity in the merchant (spot) market. In our understanding, prices there carry a 10-20% premium to PPA, improving IRR. There could be several angles to view this, a sign of desperation arguably one of them. 

3) SLR claims to be the lowest capex per MW player due to its expertise and in-house capabilities. We equally have no view but question why, since they claim to be able to build at ~1/3 of the price for which new farm capacity can be sold today, they aren't immediately selling assets for high return.

Catalyst

Lower PPAs for new contracts, earnings misses as a result