Renewable energy may be the future, but its stocks are full of hot air
Dozens of listed companies already operate in the space, driven by a persistent government push, and the scope for growth. IPOs have also started flooding in.
The surge in market activity in the sector is promising, but steep valuations raise a crucial question: are investors overpaying?
Government-led tailwinds
The government has launched initiatives such as PM-Surya Ghar to provide free electricity to one crore households through rooftop solar systems, PM-KUSUM to remove diesel from the agricultural sector, as well as PLI schemes to incentivise the manufacture of solar photovoltaic (PV) modules.
The result? India already ranked fourth worldwide on renewable energy capacity. Five years ahead of its COP26 target, more than 50% of India’s installed power capacity is already from clean energy. Renewable energy capacity has clocked a 10% compound annual growth rate (CAGR) to 227 GW in 2025. The 500 GW target by 2030 implies a 17% CAGR over the next five years.
Sky-high valuations
Primary markets are inundated with clean energy producers. Vikram Solar listed on the bourses recently, while Inox Clean Energy and Clean Max Enviro Energy have filed their draft IPO papers. Hero also plans to list its renewable energy arm Hero Future Energies.
Buoyed by the scope for growth, investors have been rewarding clean energy players even if they are yet to demonstrate healthy returns on equity (ROE). Borosil Renewables is in losses but the stock has delivered a scarcely believable 8,000% return since 2018. Other such examples include NTPC Green and SJVN, which have ROEs of 3.9% and 5.8% but trade at 156 and 56 times their respective earnings.
Even companies with healthy ROEs face significant risk in this dynamic sector, so caution is certainly warranted.
Not all sources are created equal
Not all clean energy sources are equally viable. Nuclear power is yet to find its way through changing regulations, while biofuels are much too small in scale. Wind energy is significantly constrained by the availability of large and open windy land. Environmental concerns including noise pollution and harm to wildlife have also played spoilsport, and wind turbines’ mechanical complexity make them costlier than solar panels.
Meanwhile, thanks to technological advancements, solar panel costs have declined and floating solar panels have addressed concerns about land scarcity. Their flexible sizes make them amenable to everything from small rooftops to full-fledged power plants. They are also relatively easy to install and are more compatible with energy storage and off-grid solutions.
Given their appeal as an immediate solution to address energy security in agriculture and households, the government has announced several solar-focused incentives such as the PM KUSUM and Solar Rooftop Yojana. This explains the almost 40% CAGR in solar capacity since 2014 – miles ahead of the sub-10% CAGR growth in other energies. That said, wind and nuclear are expected to catch up.
Concentration risk
Renewable energy production is seasonal, vulnerable to the vagaries of nature, and generally geographically concentrated. Solar energy is only produced during the day, and is affected by the angle of sunlight as well as the season. In India, it achieves the highest efficiency in Gujarat and Rajasthan. Similarly, wind power is most feasible in large and open areas with high wind speed – typically along the coastline and in hilly areas.
But as we shall soon see, geographical concentration leaves producers vulnerable to regulatory risks. This explains why the big names including Adani Green and NTPC Green are diversified across energy sources. Of course, solar-focused players have also done well thanks to the reasons explained above. Solar-focused and diversified players have typically had higher ROEs.
Moreover, companies that launched with a focus on specific energy sources have also started diversifying. Hydropower major SJVN has diversified into thermal, wind, solar, and even trading and transmission. KPI Green Energy and Azure Power, which were initially focused on solar energy, and Orient Green Power, which was primarily into wind energy, have diversified as well.
Risk of losing incentives
One of the biggest risks facing the clean energy industry is a rollback of government incentives. The industry is not viable on its own yet, but government incentives have closed the gap. That said, governments have a long history of rolling back incentives – either to pivot to more effective ones (FAME-II vs PM E-Drive) or on finding that the industry has matured.
Solar and wind energy have enjoyed the benefit of accelerated depreciation since the 1980s. Back then, 30% of the project cost could be claimed as depreciation in the first year, reducing taxable profits and tax outgo and supporting cash flows during the investment-heavy years. This was increased to 100% by the early 2000s only to be rolled back to 80% in a few years.
Around FY13, the accelerated depreciation for wind projects was rolled all the way down to 15% – the general rate for plant and machinery. But this turned out to be premature. Wind energy production fell sharply in the aftermath, resulting in an return to 80% in a couple of years. In FY18 the accelerated-depreciation rate for both wind and solar was reduced to 40%.
State governments have also made the regulatory environment volatile for renewable energy. Gujarat Solar Power Policy of 2021 introduced banking charges at Rs.1.5 per unit of solar power production and increased the cross-subsidy surcharge.
Risk of obsolescence
Complications in storage and transmission plague all forms of clean energy. Given their intermittent nature, energy storage systems have become crucial to maintain grid stability during transmission. This adds to costs. Geographically concentrated production tends to raise transmission costs, too.
The technology behind energy storage systems is evolving, resulting in a risk of obsolescence for first movers. Something like this happened to Websol Energy System. Established in 1990, it invested heavily in reclaimed technology and a mix of manual and automated production. But the technology turned out to be challenging and costly, and led to sub-par products. Websol had to write off large investments.
In fact, the company was retiring obsolete technology to keep up with the latest advancements as recently as FY23. In the latest such upgrade, it had to discard its multi-crystalline technology and invest in Mono PERC and TOPCon instead. These technologies have their own sets of risks, including patent theft allegations by a large US solar producer.
Bottom line
Companies that can’t find their feet is this rapidly evolving industry will either succumb to the pressure or be acquired by larger peers. Unless a small player has demonstrated a competitive edge and resilience, investors may be better off betting on the big names.
Larger players with deeper pockets are also more likely to weather the persistent regulatory and technological storms in the sector. Diversified players may perform better than concentrated ones, but valuations will determine the upside from here.
For more such analysis, read Profit Pulse.
Ananya Roy is the founder ofCredibull Capital, a Sebi-registered investment adviser. X: @ananyaroycfa
Disclosure: The author holds shares of some of the companies discussed. The views expressed are for informational purposes only and should not be considered investment advice. Readers are encouraged to conduct their own research and consult a financial professional before making any investment decisions.