Three Solar Picks That Should Thrive, Even with Reduced Subsidies

The last time around that I picked on SunPower (SPWRA) - there was a lot of opposition to my conclusions - most of which have proven to be true. Plus, its [alternative energy] situation has been worsened by a decrease in the price of crude oil, and the strength of the dollar [which will cut U.S. based companies' earnings - SunPower in particular - as it did not properly hedge its projected foreign sales]. In any case, SunPower’s growth over the next couple of years is projected to be heady - in the twenty to forty percent annualized rate [depending on who you ask].

Most of this growth will be in the EU, and California - where everything alternative-energy is heavily subsidized.  With the European & the CA economy also in the tank [much like the U.S.], we see the ability to get subsidies as becoming substantially harder as the months/years progress, and companies that rely on these hand-outs, [despite being inherently inefficient, they get to rely on subsidies as "free money"] will find it impossible to do business without the aid of the government - making them vulnerable to competition from more efficient players in the same marketplace - domestic and foreign.

But, we will focus on the efficient integrated manufacturers of PV modules, who have demonstrated multiple years of heady growth and profitability, and will survive and thrive, even in an economic environment of reduced subsidies.

SunPower has been in the solar-cell game since 1985, and in the business, for a few years.  Their solar cells’ efficiency is the highest [in the commercial market], and hence they command a premium in the marketplace.  It is best suited for installations where space is hard to come by. For now, SunPower’s gross margins are pathetic at 20%, much like a memory company on its last legs of profitability. But, the management wants to grow this to at least 30% in the next three years, and to 40% in the next five.

Its biggest competitors are SunTech (STP), and First Solar (FSLR). SunTech is based out of China, and makes its panels for an impressive $2/Watt [SunPower is at a little over $4/watt], and First Solar - which eschews the use of Silicon, and instead uses a Cadmium Telluride [CdTe] based thin film. While FSLR claims that its raw materials are the “by-products” of mining, it is a known fact that Te is a rather rare element, while Silicon is much more readily available and getting cheaper, as the biggest barrier to producing pure Silicon is the availability of huge amounts of cheap power.

Pick #1

SunPower.  The company is cheap - at the current valuation.  I opined - that it was worth no more than $40/share [while thinking that it was worth more like $25], a few months ago. This current valuation is due to circumstances that include:

• The economy
• Over-supply of silicon
• Too many solar panels on track to flood the market in 2009 [prices are already down 20% y-o-y when we did a channel check]
• Improper hedging of non-U.S. sales by SunPower

The stock was begging me to take another look - which I did, and noticed that none of the “problems” afflicting SPWRA/B are operation, management, or technology related. Sure, there is a huge problem with the economy, but most of SPWRA/B’s customers are buying the product as they can see an ROI in the double digits - especially in states like CA and HI where the baseline rate is over 11c/KWH [non-time of use pricing, but baseline - which is the lowest rate that people pay and yes, I know, there are exceptions].

So, the reasons why I like SPWRA/B are:

1. Most of its next two years’ sales will be to non-residential customers - making them inherently less sensitive to the economy.
2. Almost all of SPWRA/B’s customers will receive subsidies or tax credits for buying their PV systems - and generate an ROI in the double digits on their investment.
3. SPWRA/B is attractively valued at 1.2x sales.
4. Heady growth rate that the management is confident about delivering on.
5. Excellent management [with the exception of the hedging issue - which I suppose they were not concerned about - since for the last three years, both its sales and earnings were buoyed by a sagging dollar (and a buoyant Euro)].
6. Technical excellence.
7. The market hates SPWRA/B - while I like it now.
8. The B shares (SPWRB) - with eight votes/share are a better deal than the A shares - which have one vote per share, but both Series A and Series B, have the same rights - when it applies to equity in the company, dividends, etc.

Pick #2

SunTech Power. STP makes PV modules. In fact, Akeena Solar’s (AKNS) Andalay Panels are based on SunTech’s panels.  Unfortunately, as an installer, AKNS is beyond the scope of discussion in this article.  I picked STP ahead of FSLR - as STP’s manufacturing costs are similar to that of FSLR’s - despite the fact that SunTech uses Silicon.  Added to the fact that silicon prices have nowhere to go except down, SunTech can easily increase its gross margins from the current mid-20’s in % to about 34%. SunTech’s current relative valuation (in light of its projected growth rate) is even cheaper than SunPower’s. 

STP at $10.10 is valued at 1.1x TTM sales, and a TTM PE of a little under nine. That is cheap for a company projected to grow at over 20% for the next five years, and one that currently is the low cost leader in the world of integrated PV module manufacturers.

Pick #3.

First Solar. I picked FSLR at #3 - despite its superior gross margins because:

• Sand is cheaper than CdTe [but, as mentioned above, it takes a lot of cheap energy to make pure Solar-cell grade silicon].
• Thin film based solar panels [the kind FSLR makes] are less efficient than silicon-based PV modules.
• Apart from being less efficient, thin-film based solar cells have much worse performance at low-light conditions - compared to silicon based solar cells.
• FSLR sells at a premium valuation. At $110/share, FSLR’s market value of $9 Billion is a multiple of 9x TTM sales.  On a TTM PE basis, the stock sells at 32x.

Notes:

1. Double digit ROI calculations based on a PV system that generates 4KW. We priced the system through multiple installers, and assumed a PG&E credit of $1.90/Watt and the Federal Tax Credit (30%) for grid connections after Jan 1, 2009.
2. We focussed on gross margins and growth rates and cash flow in this article. While we did look at earnings, P/E, etc., what matters for semiconductor companies - is valuation, gross margins and growth rate.
3. The “President-elect Effect” impacted these stocks positively only for a week - as the market realized that all that the part of the $850 Billion that affects alternative energy does - is to continue the subsidies for businesses and increase subsidies from a $2000 tax credit/installed system to a credit of 30% of the cost of an installed system - for individuals. The non-business PV market represents only about one percent of the total U.S. PV market.
4. FSLR’s modules are the hardest to recycle [though the company will gladly do it for you if you ship it to them to the appropriate location].
5. STP uses both poly and single crystalline silicon based cells in their PV modules.

Disclosure: No positions in any of the mentioned stocks.

Comments

[Buffett Jr:]

You forgot LDK.

2008 Nov 19 05:34 AM

[gebby:]

if the companies are lowering their rev and earnings estimates for 09 due to the credit crisis why do the stocks continue to correct? it seems many worse case scenarios are priced in. LDK, TSL, SOL also have experienced drastic corrections despite continued strong growth.

2008 Nov 19 08:34 AM

[gebby:]

see barack obama short video on climate change youtube.com/watch?v=hv...

2008 Nov 19 08:42 AM

[it-trade:]

Interesting article. States many facts you tend to forget when solar stocks are so far down in the short term.

2008 Nov 19 01:11 PM

[sirfisup:]

This credit crisis will be short lived in the US. I expect a major stimulus package to be enacted in the first Q which will be in the neighborhood of $500 billion I also expect a mortgage rescue plan to be enacted and that funds to accomplish this will be from the remaining $350 billion of the unused TARP. In addition Obama will invest heavily in green technologies and will further spurn solar with new feed in tarriffs which are common place in Europe. Obama will make alternative energy more of a collaborative effort with Europe and the emerging economies and we could see a major resurgence in the solar sector which will make this downturn look like a small blip. Let us not also forget that China will be providing more concrete details as to how it will invest their own stimulus package of $560 billion. The details concerning China's stimulus are expected in late November and could include some significant benefits to the Chinese solar industries in the form of added subsidies that may be targeted to the rural areas of China where electricity is still non existent today. This doom and gloom is greatly excaberated by the price of oil and this too will come to pass. OPEC continues to cut production and the production costs in the US are still too high for it too be considered as a future viable option. The US with only 3% of the worlds reserves needs to adopt a policy of which will be less reliant to Middle East Oil and I do believe that this transitional period that we are in has hurt the solar industry and that the constant negative news is keeping investors from enetering the market until the new President and his administration take office.

2008 Nov 19 01:12 PM

[Abe Mishima:]

It hurts to be right even when you are wrong. STP took a tremendous hit this morning (11-20-2008), down over 30% at one point. Margins are forecast to shrink in 2009, but the more serious issue is debt. SPWRB increased it separation relative to SPWRA, in a negative way. As long as the options market is non-extant for SPWRB, traders do not want to get into the class B shares. Last but not least, FSLR is now below $100/sh. This has been a cloudy week for solar. When is the sun going to shine again?

2008 Nov 20 11:40 AM

[BigVinnie:]

Sunpowers growth is right on point at 30%.
Even with a sluggish market 2008 3q growth achieved was roughly at 28%.
This is defenitely a company to invest into during a sluggish market especially when there are ITC's, and rebates offered to the consumer, offer more buying power.
I've purchased hundreds of the SPWRB stock for voter rights and more control. Honestly 'B stock" the best bargain which I believe is overlooked by many skeptics.
I've served as a sub contractor for sunpower corp and business is booming even with the economic slow down. The outlook is very good.

2008 Nov 24 02:09 PM