Solar Industry's Long Term Outlook

by: Gregory Pepin

Investing in Solar has been a roller coaster experience. Since the beginning of the crisis, Solar stocks went down between 50% to 80% from their highs. They did that huge pullback in less than a year (Most of Solar Highs has been reach in the summer 2008).

During the great bull period of Solar (the First Half of 2008), analysts were very bullish and most of them had very high price target for almost all the companies. The weather was clear according to brokers.

Now, most analysts are bearish on the industry, they feel that it will be a very tough road for the industry and they cut (or should I say killed) their price target.

But all those analysts don't focus on the long term potential of the industry, so I'm asking the question, what is the long term outlook for the Solar Industry?

Concerning the Short term, I would like to point out to the following elements :

- Right now, Solar stocks are mostly under the pressure of Shorters (Naked or Non-Naked) and Day traders. In order to prove my point, i just need to point out the average volume on those stocks between last year and this year. To understand it, check Google for the average volume in terms of dollars exchanged for SolarFun (SOLF), Renesola (NYSE:SOL), Evergreen Solar (ESLR), LDK (NYSE:LDK) etc. for last year and this year. You will see a huge difference. (a fall of 50 to 80% of the avg volume)

- Right now, some solar projects are reported (there is no cancellation, based on comments of all Solar management). Companies that expected to invest in Solar in the end of 2008 and in the first half of 2009 are sometimes delaying their plan until the credit market works again. The shutdown of the demand created the oversupply.

- The freezing of the Credit Market created oversupply (mainly due to the over capacity out of small Chinese manufacturers). Q4 of 08 and Q1 of 09 have been a period of cleaning out inventory and bankruptcy for most of the small non listed Chinese solar companies. This has created big pressure on the spot market price (Cleaning Inventory means big sales...) for solar panels. It also hurts margins.

- The over-supply of Solar Panels has been reflected in the polysilicon price that fell from 500$/kg at the peak to 100$/kg now.

So I guess the short term for the Solar industry will still be cloudy. In fact, any investment in solar stock now is dead money for the next 6 months (with a roller coaster on the downside and the upside).

Now I think for this sector we should look to the long term picture :

- Most governments are betting on Renewable energy to get out of the crisis and create the economy of the 21st century : China, USA, France, Germany, Japan, Italy, Spain, Grece (List to be continued.... probably)

- In the renewable energy sector, Solar is the best placed because it can be installed everywhere (which isn't the case of Wind Energy for example). To prove that, Solar panels can be installed even in places where there isn't huge solar exposure: Germany is right now the biggest worldwide market.

- Solar Projects are profitable over the long term right on day 1. Banks knows that, companies knows that too. So as soon as the credit markets unfreeze, banks will be more then open to finance solar projects.

- All the projects that are delayed now will sooner or later be done. But at the same time, Solar projects that were planned in the next months (and years) will also be done. So we could have a huge rebound in demand as soon as the credit market works again.

- Most solar companies reduced their capacity in order to meet a slower demand. But as soon as the credit markets works again, the pick up in demand will be huge (All the delayed projects and projects that were planned will be done at the same time), but ramping up production isn't as fast as the potential growth in demand. So we could move from an oversupply situation to an undersupply situation.

- A potential undersupply situation in the next years (as soon as the demand picks up), will create a big bump in the spot price and therefore helps margins.

- Greed-parity in most markets is supposed to be at 2$/w without government subsidy. Most solar companies are targeting a cost of production in the 1.30$-1.60$ over the next 2 years. Therefore, margins could be healthy even without government subsidies when the markets stabilize. Now include subsidies and you can imagine the margin potential over the long term.

- Oil price will go up as soon as the economy rebounds. The pick up in oil price will also create new demand and fuel the potential under supply over a few months when the recovery occurs.

I do believe that if you are a long term investor (with a time target of 5 years) investing in solar companies could be a very good choice. The low price of the entire sector right now is a great opportunity for a long term holder. I think that all the listed companies will survive the downturn and will find financing to develop when needed.

Now what are my sector picks?

- First Solar Inc (NASDAQ:FSLR): Best in Class. They produce Thin Film panel which is different then most other competitors. They have a great cost structure which allows them to keep great margins even with the price pressure. Their earnings confirm their great situation. They also have the best balance sheet in the sector. In addition to that, the CEO is planning to work on a better implementation of Solar in low carbon bills which will help his company and the entire sector.

- Evergreen Solar: The stock has been crushed lately because they haven't been able to generate profit (except one quarter a little more then a year ago). They also got hit by the Lehman Bankruptcy (created dilution on the stock) and the bankruptcy of a french polysilicon producer (Forced a non-cash provision). But in the polycrystalline panel they have the best Wafer technology that lowers the cost of production. They also are in discussion to produce their product in Asia which will also reduce the labor cost. Their String Ribbon technology already proved the impact on the margin of a solar business : Just look at the Margin of Sovello (the joint venture ESLR has with other Solar companies). In addition to their technology advantage that will allow them to be very competitive on the price side, they have more then a billion dollars of backlog contracts that they can already fulfill with their Devens facilities.

- SunPower (SPWRA), (SPWRB): This company offers the best solar panel, in terms of efficiency, in the business. They have a vertical integrate structure that puts them in a great position for big projects (that are now impacted by the credit crisis, but will have a boom as soon as credit flows again). The management has a great cost control and also is a reference in the business. SunPower is clearly a leader over the long term in the industry, especially for big projects.

- Q-cells (QCE): It's the biggest producer in the world right now. This German based company is a leader in the industry already. They also invested in thin film and nanosolar business (which is the same kind of panel that SunPower and Evergreen Solar produce) to gain from other technologies, aside from what they produce. They also have a joint venture with ESLR that has a strong upside potential (Sovello). They are at the center of the biggest market right now and are leaders in Germany. Also, their Joint Venture with LDK Solar has a great potential for a Utiliies project.

- SolarFun: They have a great cost structure (especially for Module). Their biggest advantage (if you compare to other Chinese producers) is their management. It's an occidental management that always has been cautious and prudent. They have been the first to warn about the slowdown in the business in Q3 2008. They also were the first to write down inventory in the business. The quality and prudence of the management is a major proof of the quality of the company. Also, their strong relationship with Q-cells is a very positive sign about the company's value in the sector. We can also take into account that they are one of the two biggest suppliers of Schueco (which is the leading solar installer in Germany). We also can take into account that they have been able to diversify their market (All over Europe) even when the Spanish market dropped.

- Suntech Power (NYSE:STP): It is the Chinese leader, and they have a strong business in both Thin Film and polycristalline Panels. Their size and their exposure in all markets positioned themselves for great shape in the future. They have solid partnership in USA and Japa, for example, that allow them to be able to maximize on the growth of both markets. We just need to be careful of their management team, which is Chinese and therefore might be negatively received by Wall Street.

- MEMC Electronic (WFR): Leader in Wafer production. Their semi-conductor business might pressure their margins, but their solid balance sheet and great cost structure in Wafer production helps them to be a major player in Wafer business. The Semi-conductor business is also a way to keep a strong and diversified business that other solar companies might not have right now.

- LDK Solar: LDK is a special company. They are the best Wafer producer (aside from ESLR, which doesn't sell their wafers) in the market. They have the best cost structure in terms of Wafers in the business (still with ESLR as an exception). Now they have a huge backlog (More then 3 gigawatts of wafers). But they have issue with management credibility and therefore wall street is hitting hard on this stock (mainly because the CEO owns 2/3 of the company). But over the long term, LDK invested a poly plant in order to reduce their cost over the long term. This strategy is a very risky move, but if the poly plant works (it is facing some issues right now) their strategy will strongly reward the bottom line because they will have a very low poly cost which is a main component of the Wafer production cost. But also, the polysilicon spot price will have to stay above 100$ to make the big investment valuable. But we can assume that as soon as business picks up, Polysilicon will trade between 100 and 200$/kg. So LDK could be a big industry leader if they show some more credibility with their management, and more importantly, if their poly plant starts to work.

Disclosure: I hold Q-cells, ESLR and FSLR stocks and some of my customers own FSLR, ESLR, LDK, SOLF stocks.