California Mandates Solar On New Homes, Who Wins?

On Wednesday, the State of California Energy Commission unanimously approved a measure that will require the installation of solar power generation on all new homes starting in the year 2020.  

If it were a separate country, California would be the world's fifth biggest economy and builds around 80,000 homes a year, so the impact could be significant. Currently about 15,000 of those homes include a system for generating electricity. If the measure is adopted by the State Building Standards Commission  - as is expected - approximately 65,000 new solar systems per year will be sold in California.  

The proposal is not without controversy because it is expected to add about $10,000 to the cost of each new home in a state where housing is already some of the most expensive in the nation and remains in short supply.  Proponents of the measure counter that the additional cost of $10,000 on a 30-year mortgage is about $40/month and the expected monthly energy saving is about $80/month.

Solar stocks rallied on the news and home builders with exposure to California fell. Solar panel manufacturer First Solar FSLR was up 5% and the state's largest Solar system installer SunRun RUN was up 15%. KB Homes KBH was off 6%.

Are investors correct about who the winners and losers will be in an environment of state-mandated solar installations? Sort of, but it's more complicated than it seems.

The Reaction in Homebuilders is Likely Overdone

According to Real Estate website Zillow, the median price of a single-family home in California is $537K and has been rising steadily since 2012.  The addition of solar power will add $10K, or less than 2%.  Fluctuations in the cost of labor and building materials would have a much bigger impact on home prices than adding solar power.  

KB Homes beat the Zacks Consensus Earnings Estimate in each of the past four quarters and analyst projections have been rising, earning the homebuilder a Zacks Rank #1 (Strong Buy).  Although they are one of California's leading homebuilders, they operate in seven states across multiple price points and are unlikely to be adversely affected by the new California rules.  

Selling the stock almost two years before the California Solar mandate is set to take effect seems like more of an interesting day trading idea than a serious long-term investment thesis. Investors would be wise to consider such news-selling a buying opportunity.

Additionally, large homebuilders are already experts at navigating municipal regulations and minimizing expenses.  It's likely that they will follow the lead of Lennar Homes LEN which has been offering solar as a standard feature on all of its California homes for over four years.  Lennar started its own subsidiary, SunStreet Energy Group, to manage the acquisition and installation of solar equipment, taking advantage of huge economies of scale to purchase large quantities of panels and associated hardware at big discounts to retail prices.

Solar Equipment Producers and Installers

U.S. Producers First Solar, Sunpower SPWR and Tesla TSLA all manufacture high quality Solar panels with innovative features and long warranties.  They currently sell primarily to the retro-fit market in which a homeowner contracts with a local company to install solar power on an existing home.  All three got a bump in stock price on the news, though the effect on them should be similar to the homebuilders – minimal and far in the future.  The new California plan is not going to change revenues or earnings this quarter, this year, or even next year.  

In fact, since the big homebuilders are likely to source the least expensive equipment that complies with the new rules – especially for mid-market priced homes where the margins are thinner - less expensive imported panels will probably dominate the installations on new homes.

Sunpower in particular may even be slightly hurt by the new plan in the long term. Widely considered the gold standard in panel quality, it's reasonable to believe that the market for high-end retrofit solar installations in California will actually decrease in 5-10 years as more homes are built with solar included.

Installers like SunRun also could also be negatively affected if the mandate encourages homebuilders to manage installations in-house. SunRun is currently a Zacks Rank #5 (Strong Sell).

The stock of Chinese JinkoSolar Holdings JKS, has had a rough go of it this year, due primarily to the imposition of tariffs on imported solar panels by the Trump Administration.  Down 20% in an industry that has been up an average of 12%, JinkoSolar has been disappointing investors, missing earnings estimates in the first quarter by almost 50%.  

Analyst expectations for 2018 have been rising recently, however, and JKS is currently a Zacks Rank #1 (Strong Buy). (It should be noted that JKS is a small-cap ADR, so analyst coverage is thinner than it is for Large U.S. companies and estimates are more likely to change quickly.)

U.S tariffs on imported solar panels is automatically reduced by 5% each year before being phased out entirely in 2022, so as the California plan takes effect, the tariffs will be on their way out, leveling the playing field once again for foreign competition.

Wait and See

Despite the fact that traders love to buy and sell stocks based on provocative news items, the effects of the new California rules are extremely difficult to predict, but it's not likely to hurt the homebuilders or help U.S. solar manufacturers nearly as much as recent moves would suggest.

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