Wind turbines on hillsides and solar farms in the desert have become familiar sights across the country, and the stock market has taken notice. Retail investors frequently ask why the Suzlon Energy share price can jump several per cent in a single session while a veteran engineering name such as the BHEL share price tends to move more gradually. The answer lies in business models, investor sentiment and risk profiles. Before putting money into any renewable energy business, it helps to understand what you are really buying, what could go wrong and how to protect your savings if enthusiasm fades.
The Promise and the Pressure
India’s clean energy goals lend tailwinds through policy support, tax breaks, as well as corporate demand for green power. This creates a long runway for manufacturers of turbines, panels, inverters and ancillaries. Investors are tempted at the thought of a country that would add hundreds of gigawatts of renewable energy over a period of time, keeping their suppliers busy.
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But a dominant narrative also fuels enthusiasm that could balloon well beyond performance. Popular favourites tend to see prices get extended on the back of fervour and hype. History tells us that whenever the performance disappoints (and it always does), the correction is brutal too. A wise investor recognises the difference between a long-term case and short-term valuation.
Understanding Business Cycles
Renewable equipment manufacturers tend to have a lumpy demand pattern where orders come in fits and starts depending on government tenders, state auctions and the cash position of developers. There are times when a flush of orders that arrive can jack up revenues for a couple of quarters; only for business to slow down as developers wait to place fresh orders.
Changes in policy can also impact business dramatically. A minor tweak in duty structures or tariffs, availability of bank financing, connectivity norms or even solar park allocations could make a project viable or otherwise. Developers can postpone commissioning and payments to suppliers if margins do not look attractive at current prices. While researching a company, look out for its reliance on specific policies, customers or even states as a revenue source.
Technology and Competition
Technology evolves fast in this sector and larger, efficient turbines as well as innovations in design and IT can help companies gain market share while cutting costs of production and electricity generation. An off-kilter player not adapting to the new normal could lose out on lucrative tenders despite an overall growth in demand.
The competition in the space is brutal with domestic and global majors, conglomerates as well as some new-age players fighting for a slice of the pie. Assess if the company has the patents, the service network and maintenance contracts to have recurring revenues and a steady-state operating margin. A strong service offering tends to support stock prices during troughs when new orders may be thin on the ground.
Financial Red Flags and Green Flags
Players that are coming out of a financial crisis could make for a compelling purchase but there could be hidden landmines as an old management tries to execute a turnaround plan. Watch out for improvement in a company’s finances and its ability to fund further growth. Some tell-tale signs of a weak balance sheet could persistent promoter issues, borrowings that far outweigh cash on hand and consistent need for fresh funds through dilution.
Some green flags could include improved margins and consistent cashflows that signal a mature business model alongside reduction in leverage and increased transparency around disclosures. On the flip side, watch out for unnecessary changes to accounting standards, related party transactions, defaults in payment cycles and management commentary that fails to address critical concerns. Reading the fine print (notes on the financials) could give away useful information about the health of a business.
Position sizing and patience
Since renewable energy stocks tend to be volatile, deciding how much to bet becomes key to unlocking upside potential. A prudent move would be to consider this space as part of the portfolio rather than the entire universe of stocks with a significant overweight in renewables. Size position to limit downside risks and protect capital.
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Invest in tranches and not at one go – use some funds upfront and the remainder based on quarterly performance. Having a method to exit a position is as important as having a rationale to enter one. Pre-define a course of action in events such as a change in the business premise or a bloated valuation. Avoid leveraging to invest in a volatile space and time the entry so as not to get caught out during a correction.
A Balanced Conclusion
Though clean energy will continue to be a polar star for India’s economy, a positive narrative does not always translate into value. There is a need to adopt a studious as well as judicious approach towards the sector and related stocks. Understanding business cycles, being cognisant of financial health and a diversified exposure will help build a resilient portfolio.