What to Do Now With Solar Energy Stocks

I would like to say that nothing has fundamentally or materially changed in the solar energy sector since I wrote my first piece on solar-related stocks in June. In that piece, I laid out the case for being short-term bearish on solar stocks even as I looked positively over the longer-term horizon. I wanted to buy solar stocks at cheaper valuations given my concerns about the potential for commodity prices to correct, the pricing premiums that assumed flawless execution, the potential for the credit crisis to impact project financing, and other concerns.

The main change in the past several months is that many of the risks in the sector have not only been realized but look more daunting than most people could have expected. Now that almost everything seems to have come apart for solar stocks, it can be too easy to lose sight of the remaining longer-term potential.

Some of the currently publicly-traded solar companies will probably not survive the current economic turbulence. I originally maintained my long-term optimism because I figured that even in a recession, countries would look to investments in alternative energy, and solar in particular, as an excellent way to support economic growth, create new jobs, and increase energy security - the U.S. is currently the best example of all of this.

But with the concurrent steep deflation in commodity prices, I now expect that many countries will feel pressure to get more selective in their projects. Lower energy prices will afford them the "luxury" of allocating resources to what will seem like more immediate problems threatening economic and social stability. Under these conditions, I have chosen not to get aggressive taking advantage of today's "cheap" prices.

While caution rules, I have used this opportunity to add to two long-term positions, Solarworld (Germany) and 5N Plus (Canada). I have not yet added to my position in the Claymore Global Solar Energy ETF (TAN) (one of the solar ETFs) and will likely wait things out at least another month or two. I will reassess these positions by next Spring.

I want to make my first longer-term purchase of Sunpower (SPWRA), but I am waiting for more weakness to get flushed out. Energy Conversion Devices (ENER) is well-below the point where I thought passage of the ITC would provide support, and I now have no plans of making a play there.

My short-term positions include net short in First Solar, Inc. (FSLR) (explained below), short MEMC Electronic Materialas (WFR) (did not like news of executive departure and think they will experience on-going operational issues), short LDK Solar (LDK) (anticipating financing problems or need for more capital, but this may not materialize anytime soon), and net long Suntech Power Holdings (STP) (earlier technical strength that I observed has since been violated, now playing a bounce).

October was full of important solar-related news. October should have been a month of celebration with the passage of the U.S. Investment Tax Credit (attached to the mega-bailout bill). Instead, it was a month that continued the steep selling in solar stocks that began in September and coincided with the general panic in global stock markets. Analysts applied even more negative pressure on the sector as they scrambled to adjust expectations downward in the face of worsening economic conditions. Four sets of downgrades stood out the most to me: Goldman Sachs (GS), Thomas Weisel Partners (TWPG), Friedman Billings, and UBS (UBS).

On October 7, 2008, Goldman Sachs downgraded the solar sector. This move seemed to be the most damaging of any of the analyst actions. Goldman made explicit the growing concern that the solar sector could not escape the impact of economic panic:

The risk of oversupply in the solar market will soon become a reality as considerably less generous demand subsidies take hold just as a wave of supply and tight financing hit the market. We believe that liberal subsidies of the past in markets like Germany and Spain are unlikely to be replicated in the future given fears of their ultimate cost in a bad world economy.

We have all read press release after press release announcing plans for new capacity, silicon supply agreements, and other related commitments stretching for years into the future. Given the confidence that most solar CEOs have expressed to-date, we can only assume that a lot of optimism resides beneath these plans and commitments.

We can even recall all the earnings pre-announcements that guided revenues, earnings, and capacity output expectations upward for much of 2008. As reality descends upon these plans, we should expect to see the news switch to earnings warnings and disappointments going forward.

The week after Goldman's downgrade, Thomas Weisel Partners followed with a similar downgrade: "The credit crisis upon us is leading to waning demand due to limited capital flows to project developers." Friedman Billings warned that "the increased risk to poly suppliers' ability to deliver polysilicon is, in our view, significant" presumably because of problems in financing manufacturing operations.

And then this past week, UBS chimed in with its own dour outlook. The UBS analyst expects "solar demand in 2008 and 2009 to be between 4.4 gigawatts and 5 gigawatts, down from a previous estimate of 5 gigawatts to 7.3 gigawatts...much of the drop is [from] a decrease in demand from Germany." Their "industry research suggests the residential segment in most regions is becoming less elastic in a global recession with difficulty obtaining credit."

I think you get the point. Needless to say, downgrades of several individual stocks accompanied this analyst's commentary.

After all this bad news, I am sure many solar enthusiasts looked ahead to FSLR's earnings with a nervous mixture of dread and fleeting hope. For anyone interested in following the solar industry, I highly recommend listening to FSLR's earnings report (you can also review the transcript on Seeking Alpha).

First Solar's management was quite open, direct, and explicit in their assessment of industry conditions, including their views on the impact of the on-going credit crunch. I suppose First Solar can afford such frank talk given their leadership position in the industry and given a financial position that is probably the strongest in the industry.

The biggest downer from this report was FSLR's observation that "...solar projects lending outside of Germany has essentially stopped for the time being" (although it made me a bit more confident in my Solarworld (SRWRF.PK) holding). FSLR proceeded to reassure analysts that FSLR is well-positioned to cope with these weak conditions:

However, we believe most of our IPP customers have adequate funding to bridge lending delays into 2009 and we assume that neither these delays nor higher debt costs will impair project economics for our customers at First Solar's current module prices.

In other words, this financing drought is much more likely to hurt FSLR's competitors. Moreover, FSLR has the financial muscle to support their customers until conditions improve:

...because of the uncertainty over how the capital costs and availability will evolve in 2009, we also believe it's sensible to model the contingency scenario in which First Solar provides financial support to enable higher project returns if needed to support the market.

How many solar companies could make such a bold claim? FSLR further reassured analysts that they can navigate around risks to European demand: "Today, we have identified potential financial risk in our customer base that represent approximately 15% to 20% of our planned sales in to Europe in 2009 and we have identified the demand to reallocate such volumes."

Market players were spooked enough at first to send FSLR's stock price as low as $106 in after-hours trading. The stock bounced almost $30 back up and tacked on another $10 in regular trading the following day. For the time being, the market seems willing to bet that not only will FSLR be a survivor but also that FSLR will manage to remain stable through the global economic downturn.

The market was likely reassured by FSLR's sober assessments, pragmatic plan of attack, and apparently confident understanding of market dynamics. I am willing to believe it too, but I am not willing to pay up for it.

FSLR's valuation is much cheaper these days, but it is still not cheap enough considering the economic risks that likely lay ahead of us. FSLR has a forward P/E of 21, which is "OK" given a PEG ratio 0.7, but not great. FSLR still has a very high price-to-book (P/B) ratio of 8.4 and even higher price-to-sales (P/S) ratio of 11.5 (stats from Yahoo!Finance). First Solar has $582M of cash on the balance sheet with only $167M in debt, but that cash will be in peril if FSLR is forced into the financing game in a significant way. I would consider going long FSLR after a retest of the 52-week lows of $95, but I would be much more comfortable dipping in around $85.

One last little tidbit that was lost after the FSLR earnings news is that FSLR's executive vice president resigned at the end of October. The Arizona Republic says that Mr. Schultz "ranked No. 3 in [Arizona] among top paid executives. ...with a $40.7 million a year job." No explanation has been given for the resignation, but perhaps it has less meaning coming after the earnings report. Time will tell... (You certainly cannot blame a guy for cashing in his chips at this point after amassing such impressive wealth off solar panels).

Finally, I decided to take a look at what the shorts think of the sector these days. In terms of the absolute number of shares short, it looks like shorts have generally used the last two months of selling as an opportunity to reduce positions, and presumably nab profits.

The only solar stocks in my list to experience an INCREASE in shorts from August 29 to October 15 are Trina Solar (TSL) (+14%), China Sunenergy (CSUN) (+7%), and STP (+8%). It is hard to come up with a general conclusion since the overall shares short are still high relative to the first half of the year.

But perhaps we can tentatively conclude that the risk of further downside is beginning to soften. Since shorts in the oil ETF peaked in mid-August even though oil has continued to slide (losing around 40% more since then), I cannot over-interpret what the shorts are doing here.

We are also still in a period in which the government may arbitrarily change the rules of the game (a la banning short sales), so shorts may be less willing to hold onto positions here. 

(click on charts to enlarge)

Be careful out there!

Full disclosure: (Net) short FSLR, WFR, LDK; (Net) long STP, long Solarworld, long 5N Plus. For other disclaimers click here

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Comments

[bluesmoke:]

Good article. A couple things of note - Goldman isn't always right, and solar is here to stay.

2008 Nov 03 08:38 AM

[Sol Invictus:]

Thanks Dr.

Quick question, where do you get the numbers of share short? I would like to track it as well. Thanks

2008 Nov 03 09:57 AM

[dr hoodoo:]

good luck covering ... you are the invariable example of the sheepish short that I love ... fundamentals are picked apart for negative nuggets which ignore the fact that bulls last and shorts languish ... bear mkts last an instant while the bulls run a long marathon

2008 Nov 03 11:00 AM

[Gumby:]

Get stock certifcates now!! This will prevent short sellers from shorting YOUR SHARES! Stock certifcates is the most misunderstood financial vehicle of all times!!! Call your mutual fund managers and ask them whether they hold stock certificates or not! You can threaten to move to another mutual fund that holds stock certifcates!! This will get their attention and get their lazy asses off the chairs !! It is much more difficult for individual investors to hold stock certificates because of too much hassle .. unless an individual investor owns more than $10,000 worth in any stock... Mutual fund managers has no excuse for not getting stock certifcates for their large portfolios of stocks worth billions .. Starve the short sellers.. limit their shorts to less than a few percent of each stock ..iinstead of 10-50% ... which is a disaster !!

2008 Nov 03 12:29 PM

[Gumby:]

We could have electronic stock certificates by now with our computers now everywhere, but Wall Street is not in any hurry to offer that... If you complain about CEOs making millions, then your weapon is stock certificates!!! First, all of you who have mutual fund shares,you go call mutual fund managers and tell them off!! I dont care if it means more workloads for mutual fund managers... Those managers are so lazy!!

2008 Nov 03 12:32 PM

[Gumby:]

For individual investors, we can wait until they come up with electronic stock certifcates sure to follow once our mutual fund managers start carrying stock certificates as they should!!

2008 Nov 03 12:33 PM

[Gumby:]

i am going to repeat this in other articles in efforts to build up readers' interest and concerns .. Readers are wasting time grumbling about CEO pay and stuff and not doing anything about stock certificates because they dont understand what stock certificates do for us... Stock certificates is not obsolete by any imagination... They are proofs that we have shares and nobody can touch our shares for any other purposes.. Am I making myself clear to you or what?? 99.99% of readers dont seem to understand it...

2008 Nov 03 12:37 PM

[31October:]

Dr. Duru, I always seek your POV. But are you really "short LDK Solar (LDK) (anticipating financing problems or need for more capital..."
Read the following:

By Fang Yan and Pily Zhou
SHANGHAI, Oct 24 (Reuters) - ...LDK Solar Co Ltd (LDK) has no plans to raise funds from the capital markets for the next two years as it has enough cashflow to fund an expansion which would more double its capacity by 2010, its chief executive said on Friday...The company... plans to expand capacity to 2.2 gigawatts at the end of next year and to 3.2 gigawatts at the end of 2010...founder Peng Xiaofeng told Reuters ...Peng declined to say how much the project will cost, but said proceeds from a recent share sale and cashflow are more than enough to cover the expense. "We are one of the most profitable firms in the sector and our profit exceeds $100 million each month. The proceeds and our cash flow are far more than enough to fund the expansion," he said...LDK raised $192.4 million from a secondary offering of 4.8 million American Depositary Shares. While boosting its capacity, LDK, which supplies wafers to solar products makers such as Suntech Power Holdings Co (STP), would also consider making acquisitions especially in the upstream polysilicon business, he said.
He did not name any potential targets. Peng, also chairman of LDK, also said that he did not expect any negative impact from the global economic turmoil, as its order book was filled until 2018.

Long LDK.

2008 Nov 03 12:43 PM

[Bob55:]

Dr. Duru, I find it strange you had an article advocating buying into solar right before all the stocks tanked and now that solar stocks are finally moving towards the upside, you are now taking a short position with these stocks.

It is with some hope, especially for solar investors, that the government will take a position against short-selling to provide some protection for this and other industries that appear to have been under siege in recent weeks.

2008 Nov 03 02:06 PM

[Chickenpookie:]

Bob55 - Short selling does not cause stock prices to fall unless they are overpriced to begin with. If anything, it keeps them from falling quickly and causes them to increase rapidly because short selling is done with intent of later purchasing the financial instrument at a lower price. The bone of contention lies with naked short selling when the underlying shares aren't delivered, known as illegal naked shorting.

en.wikipedia.org/wiki/...)
tinyurl.com/4smml

2008 Nov 03 06:56 PM

[Chickenpookie:]

I hope on one was short ESLR today!

2008 Nov 03 07:04 PM

[dr hoodoo:]

blogs.barrons.com/tech...

Guess you shouldn't believe everything from the professional analysts you're reading ... maybe they are not unbiased, however that would require some critical (read free thinking) thought on your part... something you were supposed to learn in college DOCTOR ... Doctor of mechanical eng???? wow this site is so full of rich and varied sources... I think I'll walk downtown and stop some strangers for some opinions on my portfolio... but then I might run into someone with a degree in finance... one last thing TOOTSIE sucks!!!!!!!

2008 Nov 03 08:14 PM

[NOWHEREMAN:]

Buy the solar stocks on dips, do not chase them. For instance, if Friday's unemployment numbers suck, they will probably retreat.

The momentum players shove them up, exit the market and wait for another opportunity to jump back in, Do the same.

2008 Nov 04 08:52 AM

[John Cordes:]

There is such a smorgasboard of misinformation in this article it is hard to know where to start. As pointed out by another poster, LDK announce no need for financing, SOL just recieved large financing facility from the Bank of China, the entire sector took a long overdue swing to the upside yesterday, presumably just offsetting by one day the time between writing the article and seeing it published. Bummer.
You cite concerns with Pollysiclicone supplies then turn right around and talk about over production and cost erosion. Which is it ? Your analysis of FSLR's seems to be running in complete opposition of the opinion of the market, but you couldn't have known about the run up yesterday that preceeded the publication of this article. Most bazaar of all, you talk about the sector weakness and down trending as thought the stock market over all didn't crash in October, as though the sector had an isolated problem. It did, it crashed somewhat harder that the rest, but it will recover somewhat more aggresively too. Witness the near 15% to 20% yesterday in some stocks.

2008 Nov 04 09:08 AM

[gebby:]

everything here is after the fact. " because the stock went down i no longer want to buy it" solars should do extremely well. the economics of global climate change trumps all. ask al gore long ldk at 15, long sol at 4.65, long yge at 3.90, long solf 6.22 long stp 30 would buy spwra. ener, eslr, and even fslr despite the higher valuation. own until jan 20th.

2008 Nov 04 09:13 AM

[leh:]

Short AFTER the Obama rally (which started yesterday IMO), not before.
As long as oil stays weak, I think this trade will work.

2008 Nov 04 09:21 AM

[NOWHEREMAN:]

In that case look for oil to jump, big time toward the end of November.

2008 Nov 04 01:52 PM

[Dr. Duru:]

As usual, the commentary on any article related to solar stocks combines insightful rebuttal, entertaining rants, and opinion presented without bothering to read the original piece carefully.
Here are my responses for various things I can respond to - in case it still matters to anyone:
1. Sol Invictus: Shares short from nasdaq.com
2. 31October and jcordes: clarification on LDK - My article says that my original thesis on financing turned out to be wrong.
3. Bob55: I recommend you review my articles again to get clarification on where I have stood short-term vs long-term in solar. Summary, short-term lots of risks remains for solar and I have been one to under-estimate just how bad things could get. In the long-term, I am positive on solar using just a few select positions that I am willing to hold through the short-term problems.
4. dr hoodoo: It's "Tootie" not "Tootsie"
5. jcordes: I had no comment on SOL, I offered no personal opinion on poly supplies. I provided quotes from analysts on THEIR opinions.

2008 Nov 09 12:43 PM