Too Much Solar May Benefit Inverter Companies

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 |  Includes: AEIS, EQS, SATCQ, SBGSF, SPWR
by: Tom Konrad, CFA

2009 is likely to be a watershed year for the solar photovoltaic [PV] industry, and one which many PV manufacturers will not survive.  Even before the credit crunch and plummeting housing market made capital intensive PV much harder to finance, the easing of supply constraints in the market for solar grade silicon meant that PV supply was liable to increase rapidly, putting pressure on marginal producers. 

I expect that the loss of PV demand due to tighter credit markets will more than compensate for the added demand due to the extension of the solar Investment Tax Credit [ITC] and the exemption of the ITC from the Alternative Minimum Tax in the United States.  One other change was that utilities can now benefit from the ITC, and this may be an added boost to the market.

With PV demand increasing at a slower rate, and PV supply continuing to grow rapidly, and possibly even accelerating, PV cell prices will have to fall significantly to clear the market.  Low cost producers such as First Solar (NASDAQ:FSLR) will continue to make money on every panel, although its profit margins will shrink, but the real pain is likely to be felt by higher-cost, commodity producers, and those with thinner profit margins. 

With volumes increasing rapidly, but much thinner profit margins for even those producers able to remain profitable in a much more competitive climate, I have sold all my holdings in PV manufacturers Sharp(SCHAY.PK), Evergreen Solar (ESLR), and Solar exchange traded fund TAN (NYSEARCA:TAN).  

Balance of System

The news is not all bad for the solar industry, however.  If volumes rise and prices fall as dramatically as I expect, suppliers of other parts of solar systems and services, such as installation, will also see volumes rise.  Those suppliers with pricing power will still be able to maintain or even expand margins even as their volume expands, with a dramatic effect on potential profits.

Which suppliers will have the most pricing power?  Competition theory suggests that pricing power will go to those market participants: 

  1. In industries which have barriers to new entrants
  2. Suppliers and customers have little bargaining power
  3. Have little internal competition
  4. Sell products for which there are few substitutes.

Possible candidates in other parts of the solar supply chain are solar installers, assemblers of solar modules, and suppliers of solar inverters.

Solar installers suffer from fairly easy entry into the industry, and are likely to have fairly weak bargaining power with cash-strapped customers, who can easily choose to not buy solar at all.   Solar module assembly is also fairly low tech, and does not seem to present real barriers to entry.  

One wildcard here may be vertically integrated solar companies.  Sam Weaver, VP of Cool Solar, a solar installer in Boulder, CO, likes SunPower Corporation's (SPWRA) vertically integrated approach, which the company hopes will allow them to squeeze all components of a solar system equally. 

However, vertically integrated solar companies may be able to gain competitive advantage over companies operating in one or two of these sectors.

Inverters

The inverter industry is in a much better competitive position.  First, there are few active participants, making the inverter market relatively uncompetitive, in comparison to cells, modules, and installation.  In the residential grid-tied market, the major players are privately held Fronius and SMA.  Sam Weaver says there are also a couple companies looking to enter the market, meaning that it might become more competitive, although probably not so competitive as the PV market. Until it was recently acquired by Schneider Electric (OTCPK:SBGSF),  Xantrex Technologies allowed public investors (including myself) an entry into this market, although it also competes in commercial and utility scale markets.

The utility scale inverter market is more promising for investors, partly because there are more publicly traded companies.  When I last wrote about inverter stocks a year and a half ago, my thought was to avoid the bubbly nature of the solar sector, but still benefit from its growth.  At the time, I listed Xantrex, SatCon Technologies (SATC), and  Sustainable Energy Technologies [STGYF.PK] as possible ways to play the industry.  

Xantrex was bought out at approximately double the price it had been trading in March 2007, wile SatCon is up about 50%.  Sustainable Energy Technologies is down around 40%.  Considering that most alternative energy indices have lost about 50% over the same period, even Sustainable Energy Technologies has been doing fairly well.

Since that time, Advanced Energy Industries (NASDAQ:AEIS) introduced its Solaron high efficiency utility scale inverter line.  AEI has a solid balance sheet and cash flow, while both SatCon and Sustainable Energy may need to raise money in the next year, which leaves them vulnerable if financial markets continue to be very tight.  I have sold part of my holdings in both companies.   The downside of AEI is that it is exposed to many other industries, which I have not yet researched properly, and probably do not have the same growth prospects as the inverter industry.

One final inverter play was highlighted by AltEnergyStocks.com guest author Saj Karsen, who found value in Equus's (NYSE:EQS) stake in a private inverter company, Infinia.

For investors interested in playing the Solar market, inverters still seem a relatively good bet, in comparison with direct investment in PV companies.

DISCLOSURE: Tom Konrad has owns shares in  SATC and STGYF.