Solar Stocks Look Ripe

The solar industry has taken it on the chin, for good reason if you ask me, in the last 8 months or so. Lately however, I feel that there is something to look at here, with possible best of breed companies working through the malaise to offer tempting prices for those with long term investing horizons.

Specifically, I’ll be looking at several companies that seem strong, even in the face of a decline in demand, eroding margins, and financing difficulties that are making large scale solar projects harder to implement.

What Went Wrong?

Here’s a very brief rundown of the problems that have befallen the entire solar industry for about the last year or so that have caused the stocks of companies in this market to plunge:

• Increased Supply: It’s no secret that everyone and their mom started a solar company within the last 3-5 years, with the last 2 years showing incredible venture capital being pumped into the sector.

As a result, solar panel manufacturers of all types, from thin film to standard rooftop panel producers, have flooded the market with more and more product. I don’t have to tell you what this does to prices.

• Increased Supply 2: In addition, more and more polysilicon, the building block of most of these panels, went from being in short supply, to being overabundant within the last year or so as more companies are opening shop in the polysilicon business, as well as existing manufacturers putting out more and more of the raw material.

Spot prices for polysilicon have dropped to around $100 a kilogram after soaring to $500 a kg last year.

One of the companies in this space is MEMC Electronic Materials (NYSE: WFR), which has seen incredible demand erosion, as well as margin contraction because of lower spot silicon prices.

• No Financing: The increased supply mentioned above was not a problem so long as all of that supply was being eaten up by ravenous customers around the world.

Lately, even though that demand is inherently there, the ability to finance that demand has eroded considerably, to the point where getting the necessary capital for a large scale solar project has become almost impossible.

The financial crisis has hit the solar industry in one of the most unsuspecting ways: nobody can get capital to finance solar projects, even though those projects are profitable from day 1, will last up to 30 years and will pay for themselves many times over.

• No Financing 2: Along those same lines, even with the generous government incentives that were just passed with the economic stimulus package, retail customers are reining in their spending ways as well, and not putting solar on their roofs as rampantly as they were before not just because of the aforementioned lack of financing, but also because of fear of the down economy, uncertainty about property values and other related factors that would stop someone from a massive cash outlay of that magnitude, even though solar panels on homes increase resale value, and again, pay for themselves many times over.

• Decreased Demand: Two of the largest solar installers were Spain and Germany (of all places!). That spigot has been shut off, or at least turned way down.

The governments of these two nations have curtailed their spending spree towards solar after large build outs and incentive programs aimed at ramping up installations in their countries and getting into the whole Green Movement.

These incentives have been scaled way back, and in some instances cut entirely, leading to further reduced demand.

• Decreasing Margins: What happens when you can’t sell inventory and you have more on its way? Yea, you have to cut prices to get rid of what you got. This has been widely reported already, with SunPower (NASDAQ: SPWRA), (NASDAQ: SPWRB), reporting last week that they wrote down the value of their inventory because of this exact reason.

Further, analysts expect, and SunPower reported, that prices will likely come down another 20-50% depending on the company, the type of panels they make, and what they paid for polysilicon when prices were much higher.

What’s Going Right?

It’s not all gloom and doom though. There are some signs that things are at least stabilizing, and a recovery is in place.

In addition, who believes that the solar industry is irreparable and that these companies are doomed?

We all know that it is only a matter of time before solar comes back because of the worldwide movement towards cleaner alternative energy sources.

Here’s some reasons why things aren’t as bad as they seem:

• Demand Stabilizing: As reported by several companies already, there has been a stabilization in demand, although they still foresee pricing pressure throughout 2009.

Both MEMC and SunPower reported that demand seems to have stabilized and MEMC reported a slight uptick in demand for polysilicon in the first half of Q2.

• The Weak Will Fall: We’ve already seen several companies exit the business over the last few months, and get bought out by other larger competitors, such as the recently announced deal of First Solar (NASDAQ: FSLR) when it purchased OptiSolar and its assets.

There have been other companies closing shop lately, and this is standard procedure for boom and bust times.

This will only leave the strongest standing, and in better position to corner the market when things turn around.

• Getting Leaner: The companies that remain are getting leaner. Both SunPower, MEMC and others in their industry have announced some combination of reduced staff, reduced output, lower capital expenditures, lower overhead, and tighter cost controls. These are probably items that needed to be addressed long ago, but the current environment is providing the impetus for these changes.
• China On The Rampage: China has decided to enter the grand subsidy game by announcing huge potential incentives for large scale solar projects which could greatly benefit Chinese solar companies like Yingli Green Energy (NYSE: YGE) and Suntech Power (NYSE: STP). What remains to be seen is whether or not these incentives have a cap, how they will be structured, etc.
• Results Not Spooking Investors: As we’ve seen in the last few weeks, these poor results and the solar stocks missing estimates badly and lowering guidance and expectations, hasn’t caused their stocks to decline anymore.

It appears that these stocks have been priced for these declines and skepticism, and just Friday, SunPower’s stock was down only modestly, after absolutely blowing their earnings announcement, and lowering full year guidance and projections, as well as writing down inventory.

• Long Term Boom: As I mentioned above, long term, solar is here to stay, and is only going to proliferate more and more places that are seeking ways to take advantage of this alternative energy source.

Unlike other industries that have fallen on hard times, the solar industry is just in a temporary lull, and will come roaring back in very short order.

• Charts Looking Good: I am not one for technical analysis on its own, but along with the news that demand may be stabilizing, and solar stocks might be working through their problems in good fashion, a look at the charts shows that most of these companies have stable chart patterns, and have stopped hemorrhaging losses with every little bad news announcement.

If I do decide to purchase shares of any company mentioned (more below), it would be with strict rules such as taking no more than a 15% loss, etc.

If the whole sector gets even more margin contraction, and prices plummet to a new “stable” level, you don’t want to be around for that, which could entail a 50% decline.

But as of right now, the entry point looks solid all things considered, and represents a fantastic contrarian play, as analysts are tripping over themselves to lower expectations, earnings projections, price targets and lowering their ratings to “Holds” and “Sells” as fast as they can.

This excites me tremendously, especially with a sector like this that has long term promise regardless of what is happening right now.

Some Names To Consider

Here are some names that you might consider in this space, ranked from my top choice to my least favorites, but you should do your own due diligence:

Top Names:

• SunPower: SunPower represents the best in breed in the solar panel space. They are vertically integrated from start to finish, their panels are the most efficient on the market, and they are poised to ramp up production as soon as demand returns. Management is efficient, forward thinking, and the company is one of the stalwarts of the industry trading at historic lows. Be aware that the “B” shares trade at a discount, but are exactly the same as the “A” shares except they provide 10x the voting power.
• First Solar (NASDAQ: FSLR): I personally do not like First Solar. I believe that the company has run too far too fast, and trades for a ridiculous premium over other solar names despite the fact that its margins are deteriorating, and more competition is coming on line even for thin film. It is however a great run company that has thus far executed beautifully, often smashing analysts' projections. Still, I am wary of the name, especially as regular solar panels become much cheaper.

A Cut Below:

• Suntech Power (NYSE: STP): Suntech is a low cost manufacturer based in China that stands to benefit from the Chinese subsidies that were recently announced. I never much cared for Suntech’s “cheap” business model sort of like the Wal-Mart of solar companies. In fact Suntech got hit extremely hard lately as they fell victim to their own success when they overbought polysilicon at much higher prices, and were stuck with inventory they had to write down. Still, the company has been somewhat solid up to this point and is likely to be one of the low cost winners, but not one of my favorites.
• Trina Solar (NYSE: TSL): Trina is in this group of Chinese manufacturers but has something going for it in that it is a vertical provider that offers end-to-end solar products from ingots and wafers, all the way through to solar cells. This offers the company economies of scale and some protection from spot polysilicon prices and a more diversified revenue stream. Trina is probably one of the better players in this next tier.
• Yingli Green Energy (NYSE: YGE): Another Chinese name that could gain favorable traction as China enters the alternative energy subsidy game. Yingli is a cut below Suntech in my book, but still worth looking into if you are interested in playing the Chinese alternative energy group.
• Evergreen Solar (NASDAQ: ESLR): Evergreen has some interesting technology to its name as well as rapidly increasing sales. It’s a cut below because of uncertainty concerning profitability and the current market overbuild, but it is a US company that is one notch below the top picks in this sector that provides more stability than its Chinese cousins do.

Don’t Bother:

• Energy Conversion Devices (NASDAQ: ENER): Don’t bother with this company, their recent traction notwithstanding. ENER has been around for a long time, and has done nothing of substance to date. They managed to catch the final wave of solar stock’s run up, and demand spikes to make it look like there was a real business going on here. Save your money, and move on. I don’t trust the management team or the direction of the company past, present or future.
• Akeena Solar (NASDAQ: AKNS): Akeena is a solar installer in California that has one foot in the grave already. Add it to the potential list of companies that aren’t long for this world. In boom times, Akeena actually looked like it might make it, but the bust times are proving what we all thought for a long time, this company just doesn’t have a sustainable business model right now, and shrinking revenues and profits and intense cash burn to boot. Stay away.
• Canadian Solar (NASDAQ: CSIQ): I hate to be a broken record here, but this Chinese company, which tried to fake out investors with a name like Canadian Solar (I think that says it all), is not worth your time or money. It’s one of the stragglers that was riding the coattails of the big boys in the industry and its brethren from China during the glory days. Those days are over.

So Now What?

While not an exhaustive list of companies in this space, this was just an overview designed to bring this sector to your attention, and go through a few names that might be worth your time to investigate as time goes on.

As I mentioned before, I feel that this sector is a good contrarian play as financing gaps will be closing shortly, and more solar projects are going to start ramping up again in the next 6-12 months.

Since the stock market is a forward looking barometer of performance, it is in your best interest to scope out laggards before they turn around, and specifically, ones that have been shunned by Wall Street, but that have a bright future ahead of them, no pun intended.

No one in their right mind can argue that solar is dead as an industry, and in fact isn’t going to explode in the next decade.

Unlike the newspaper industry which is on its deathbed, the solar industry is up and coming, and just going through a temporary lag right now.

Use that lag, that is being caused because of the aforementioned problems, to your advantage and invest in the best companies in this sector to profit handsomely when things turn around.

That is the beauty of being a long term investor.

I may be early to the party, but because my focus is on the long term, I can wait things out till my investment thesis plays out, without worrying about trying to time the market.

I will warn one more time however, that if these charts and stocks show more fundamental weakness, I would be extremely careful and bail out with a 10-15% loss and no more.

If the sector gets revalued to a lower level, there’s no need to hold into that, just get out, take your loss, and get back in when things have settled at a lower level.

I personally feel we are close to that, if not already there, so a prudent 1/4 or 1/2 position in a couple of these names is warranted.

Comments

[EGF:]

Hi-
What is Chris' opinion on WFR? Book value is listed at $87 a share.
Is this possible?

Apr 27 02:20 PM

[Amouna:]

A company that I like as well with a great balance sheet (which shows good management skills), ongoing contracts and a ramping up of production and vertical integration is JASO. Watch for this one as it may be one of the shining names to come from China in the years to come...

Apr 27 02:22 PM

[TraderMark:]

I just had a flashback to 2007. All is well again - China is here to save the day from a highly commoditized business . Solar fun is here again.

Apr 27 07:56 PM

[VP of Commo...:]

I like DXO... Solar just follows oil anyway...

Apr 27 10:29 PM

[Chris Ferna...:]

I always know that I wrote a good article when people get pissed off and decide to pipe in some noise. Thanks guys!

I'll address the comments that deserve attention, and leave the rest for those that want to continue to hate because I struck a nerve and they are long the positions that I said suck, and short the ones I said buy. Good luck guys.

Freya: I am not a day trader either, but there are certain instances when taking a small loss is a smart play on a contrarian opinion. This is one such case.

EGF: Tangible book value for WFR is $9.31 per share. Stock is trading well above that.

TraderMark: Did you read the entire post? I never said China is saving the industry, in fact I listed 6 other reasons, China being one of them, for a possible few select companies, not the entire industry...

Steve: I guess I better get back to school, so much to learn for little old me...

Thanks for reading, the good, bad and ugly.

Chris

Apr 28 02:07 AM

[Gregory Pepin:]

Your article is very interesting.
I think the long term for the solar industry is great. In the next month it is going to be dead money as there is no long term investor on the market and also the credit crisis spread doom and gloom in the sector so much that Shorters are having fun with those stock so far (also day trader).
On names you recommend,
i would include :
SOLF : The main reason is due to the quality of their management (mostly compose by occidental people) they have been cautious before everyone in the Q3 of 2008. They didn't want to provide too "positive" forecast and has always offer a very very prudent tone. Like that a lot.
Q-cells : It is the worldwide leader in term of production and it's the reference in Germany. They have agreement with many customers and have a strong backlog and reputation. It's a pioneer in the business. They also have some stake on Thin Film company to maximise from every technology around solar.
LDK : This is a different story. LDK Produce Wafer (the best low cost Wafer in the business). They decided to invest in Poly plant to have very low price of Poly for their Wafer. So far, it has been a tough investment as the poly plant is always delay (and cost a lot) but if the plant finally works the long term growth of LDK is great. They also have an amazing backlog.

Apr 28 08:46 AM

[skv009:]

Chris, nice & informative Article.

But, does the situation get reflected in solar panel prices they are selling in terms of Average Selling Price?
I am waiting for quarterly results from FSLR tomorrow, let's see, whether this crunch affect their ASP or not...

Apr 28 09:51 AM

[smlcap:]

Not a bad article. I wouldn't crucify the author for minor and mostly insignificant errors and omissions. His opinions are his own, and similar or the same as the masses.

Here is an excerpt of an article written this past Sunday from Motley Fool. Here, you will see where Motley Fool got its name. The author is promoting the buy and hold strategy, and trashing trading, or day trading. The headline of the article is "Stop Buying These Stocks"
======================...
What this means for you
In other words, if you're interested in preserving your capital and accumulating long-term wealth, stay away from short-term speculation in subpar companies.

Don't buy First Solar (Nasdaq: FSLR) because you're counting on a jolt from President Obama's alternative energy program. This company specializes in an unproven technology that is rapidly evolving, and it has a host of competent competitors. The potential rewards in this space could be vast -- or nonexistent.

I don't know if this is funny, or sad. Here is a total jack ass giving investment advise.
He declares First Solar "speculative." And a "subpar" company. Why? I guess because he believes that solar is an "unproven technology." Instead, he advises the readers to buy The Marvel Comic Book company. As Marvel is a better long term investment. I guess that's because, unlike First Solar, Marvel is a proven technology. In his mind.
======================...
"Instead of the companies I mentioned earlier, why not buy shares of Marvel Entertainment (NYSE: MVL), your friendly neighborhood comic book company?"

He also writes that Ford and Bank of America are bad choices for the long term. I mean......c'mon!
My post here may be somewhat off subject. I just thought everyone would like to have a good laugh. I'm making money trading FSLR and BAC. I feel the Motley Fool article was irresponsible and insulting. I don't get the same feeling from reading the above Seeking Alpha article.

Apr 28 11:11 AM

[Fred W:]

Chris,
SPWR does have the most efficient commercialized product on the market--production costs are simply too high--overhead issues: too many people at SPWR don't add any value, just names w/good looking CVs.
I am surprised that you failed to mention the demise of MMA's solar business--one of the more important solar financing "events" in the last few months...a year ago it was being shopped for well over $100M...sold a couple of weeks ago for less than $20M--JUST the worst case residual value of the equipment at Nellis AFB is worth over $40M.
Lastly, Evergreen was a company with a valuable differentiation point due to its more efficient use of silicon during manufacturing--the value of that advantage has been greatly reduced in proportion to the Si spot price...roughly 1/4 what is was this time last year. EVER management are bumblers that will continue to lose money on each sale with the hopes of "making it up in volume". MA's state level supports for local production are the only things that will keep EVER alive.

Apr 28 11:30 AM

[vodop09798:]

Good article. It didn't shake many shorts out of the trees. That's a rarity.

Apr 28 11:35 AM

[Wisdom vs. ...:]

Chris, good article, thanks, so i am going to fill in a couple holes:

S Pulvia and smlcap, i am glad you guys can read balance & income reports, but its time for a trip to the woodshed: FSLR is extremely risky b/c the panels offer VERY poor efficiency and cheap finishing (no metal frame). FSLR thin film has very little room for improvement, and CSi $/kW is coming down quickly and will continue to do so; MOST LIKELY, thin film will become more expensive, and MOST LIKELY FSLR will go bankrupt. (BTW, i will not install thin film)

Chris, i do not know where this idea that Suntechs are 'cheap' comes from. they are premium here at ground zero, high efficiency, good temperature variance and well built-- and not inexpensive. Another thing i disagree with is vertical integration; MOST LIKELY long term, vertical integration will be more expensive, just like every other industry

Sunpowers modules are overpriced. they are so much more expensive than their competitors that they offer a lower ROI despite superior compatibility and conversion effiencies; they are the best, along with qcells and other europeans, but their prices & profitability are going to come down a lot.

not going in too deep here, but if you are interested research further: china's solar market is quite different b/c the eletricity grid is so weak in most of the country that grid interconnectivity is out of the question; therefore, cities/ industrial parks are building their own mini grids, and batteries are equally important as panels

Apr 28 12:06 PM

[frflyer:]

Chris
"ENER has been around for a long time, and has done nothing of substance to date."

While I agree that it hasn't been the best stock to own, and that they seem to constantly struggle to hit on the right business model to achieve profitablility, it's a bit of an exaggeration to say they haven't done much. They invented the NiHM battery, the phase change technology for memory devices that is being adopted in the industry, developed thin film solar and a manufacturing process for it, been a pioneer in amorphous metal technology, as well as programs to develop fuel cells, hydrogen tanks that are low pressure amorphous metal, created what I believe is the first x-ray mirror some years ago. It's thin film nano structure is smooth to the atom. I've been watching them since at least the early 90s, before they went public anyway. They were delisted once, and went public again.

Apr 28 11:16 PM

[Chris Ferna...:]

Hey guys,

A quick note to ease everyone's comments: My post/article was NOT meant to be exhaustive, fully fleshed out, or concerned with getting every single detail right and the metrics spot on.

It was a piece meant to touch on a broad subject: namely, solar stocks have been beaten down, and those looking for potential contrarian plays in the market, might have something to work with here, with the caveat that a tight stop is in order just in case the industry collapses to a new "resting place" and my contrarian viewpoint is either too soon, or incorrect.

I appreciate the added information that you guys have provided to help people reading this flesh out the numbers, and the information, lots of well informed readers on this post that added some incredible value!

Specifically:
- dzr_greg (thanks for the additional companies!)
- skv009 (ASP WILL be coming down!),
- smlcap (Motley Fool usually has decent things to say, I won't bag on them for the information they teach newbie investors),
- Fred W (MMA was on my watchlist once upon a time! I thought the company was in a sweet spot, unfortunately, they were in the wrong place at the wrong time...but you are 100% right, their portfolio is very lucrative, and someone will step in to take their place!)
- wisdom.vs.information (agree 100% about FSLR being at or near as good as it's gonna get, and that's why I don't like it, agree also with SPWR having to lower prices dramatically, and cut costs to reach grid parity, and I didn't know about China's infrastructure being so weak, definitely something to look into, thanks for that!)
- frflyer (you are right about ENER...I meant that they didn't have a competent bus. model, or management team to ever get this thing right, and it was time to bail on them long ago, but you make some damn fine points about their overall contributions.)

Again, thanks all, and remember, I am just one man, can't possibly cover every single nagging detail that might bug you guys, so that's what these comments are for, keep em coming, cause it adds value to the information we all have.

Take care,
Chris

Apr 29 02:27 AM

[Chris Ferna...:]

Steve,

FSLR had a great quarter, indeed, but I guess I'm not the only "expert" that doesn't know what he's talking about, and sees FSLR as a company on the precipice ready to fall:

"I am struggling to find a comparable company that was a leader in its industry and managed to dodge the bullet that is killing every other company in the space -- maybe GE during the Jack Welch years," said Kaufman Bros analyst Theodore O'Neill, who has a "sell" rating on First Solar shares.

"Gross profit margins were up sequentially in a large way, which also just makes this hard to fathom in the environment that we are in," O'Neill said.

Have fun holding the next "Microsoft".

Apr 30 02:51 AM

[H.J. Huneycutt:]

Good article.

Personally, I like Evergreen Solar (ESLR) and LDK. Both have their risks, but risk-reward is favorable.

I agree that First Solar (FSLR) is priced for perfection and ready to fall. Margins are extremely impressive for them, but there aren't too many companies that can maintain 50%+ margins for the rest of their lives; or even for 3+ years --- everyone buying in is assuming that First Solar will do just that.

They are not the "Microsoft of Solar" because solar companies function more similiarly to commodity producers than software companies. First Solar does not have the moat that Microsoft does. If anything, First Solar is probably a better short target than a long target.

Apr 30 07:02 AM

[Chris Ferna...:]

Hey Stevie,

Thanks for the information!

Let me ask you 2 more questions while we are still in session:

1 - You seem like a good analyst, why aren't your articles published on SA? You should submit sometime...

2 - Which do you think will happen based on market demand, economics, valuation, etc.: SPWRB doubling in price in the next 6 months, or FSLR doubling in price ever again?

Ring, ring...oops, looks like schools out for today...

Peace.

May 01 02:43 AM

[Scrumpy:]

Wow, that was intense. I actually was in school there and thanks for the lesson everyone. More undecided about FSLR than ever now. Good to know the extent of Ever's mismanagement and I believe overhead problems as well. In two years maybe.

Chris, Gregory Pepin's recent article heaping praise on FSLR using "great" twice in the same sentence smells of a $35 dollar share bump worship and nothing more. It'll bump up some more in this phony Tarp and stimulus funded rallying before it finally collapses and you graduate with honors Chris:) It ain't Microsoft and it sure ain't Apple. I know no one's listening but I thought I'd add my two cents anyway.

May 02 11:01 PM

[bartpr:]

i find it amusing that you do not think much of csiq but it has been one of the best performers of the group. could your analysis be lacking?

May 13 10:23 PM

[abhunter:]

What about LDK?
No mention here....strong player.

Aug 28 10:57 AM

[Freya:]

STP/CSIQ lay their charts on top of each other. Daily last 6 months.

Virtually identical formations, the only difference really is that STP has gone up more in April than CSIQ.

If Solar is not dead as an Industry, why not just buy an ETF and hold. This "buy and get out" if it drops 10-15% isn't a confidence builder. All it does is squander money because a 10% down day can be had on any given day.

I'm not a Day Trader.

Apr 27 01:53 PM