India’s push toward clean electricity has become one of the most closely watched themes in the equity market. Many investors exploring Green Energy Stocks are motivated by the long runway of policy support and rising power demand. Others focus on a single large name, and they often check the Adani green share price to gauge how the market values a company building solar, wind and hybrid capacity at scale. Enthusiasm is understandable, but a sector this capital-hungry rewards those who understand the economics before committing funds.
How Renewable Companies Earn Money
A renewable power producer makes money by selling electricity to a distribution company, government agency, industry or even another producer, where the contracts are long-dated, twenty-five-year deals with tariffs set at the point of signing. This is advantageous to the company, as it provides visibility on revenues for the life of the plant if it achieves its design parameters.
The two variables that determine this are the capacity utilisation, or the ratio of electricity actually produced versus the potential, and the availability of the grid to take the power. A solar park in a sunny region but with weak transmission infrastructure may need to cut production, while late payments by the state utility may affect the working capital. While assessing the companies, look out for the load factors, collection periods and the ratio of operating capacity to under-construction.
The Funding Equation
Solar and wind farms require huge capital expenditures to build, and these are mostly financed by debt. The economics of such a business model is skewed if the interest rates rise or the construction is delayed beyond the projected timelines or if the debt financing becomes unavailable. Thus, it is important for the investor to assess the net debt to operating income multiple, the repayment schedule and the mix of domestic and external borrowing. Companies that raise long-dated finance that matches the life of the asset are more attractive than those that use short-term borrowings. It is also useful to assess the quantum of funding at a project level where the lenders have a lien on the plant versus corporate level.
Equity dilution is a pertinent concern when a company is constantly issuing fresh shares to raise capital. It is important to assess if the new projects being undertaken have a higher return than the cost of new equity.
Policy Support and Its Limits
The government has a target for non-fossil capacity and provides production-linked incentives for manufacturers of solar panels and offers exemptions for certain transmission charges and a mandate for distribution companies to buy renewable energy. These policies have attracted huge private investment into the space.
However, while policy support is a tailwind, it is also a threat. The tariffs offered in renewable auctions have come down sharply, impacting the quantum of revenue for the developer. Import duties on modules can also impact project costs, while land banks and environmental clearances add to the timelines. Thus, while assessing the stocks, investors should consider policy as a background score and look for companies that have a track record of completing projects on time and within budget.
Building a Sensible Approach
Decide on the size of the theme in your portfolio, as the sector is highly vulnerable to rate hikes and capital market risks. It is best to limit the exposure to a size that one can stomach during a down-cycle and also balance the risk by having different segments in one’s portfolio – generation companies, equipment manufacturers, transmission utilities and energy storage.
Assess the valuations in tandem with the growth projections. While a company projecting a multiple expansion of capacity may seem attractive on paper, it is important to assess if the funding, land and grid connectivity is in place. Monitor the capacity addition, debt and collections in each quarter and compare it to the projections. Think in decades. Renewable is a long-term proposition and the best returns are reaped by those who have the patience to wait. Such investors will also be wary of chasing headlines.
