Suntech Power Looking Increasingly Bright

Over the last few years I have been fascinated by solar energy and the impact it can have on our world. If plants can use sunlight to create food, why have humans with all our technological and scientific advances, found it difficult to harness solar energy in a meaningful way? One of the problems that solar energy faced along with other forms of alternative energy was that it was not competitive on a cost basis with fossil fuels like coal and oil and hence did not get enough investment capital or government funding. As the price of oil jumped up more than 600% from a low of about $10 a barrel in late 1998 to over $75 a barrel in 2006, interest and investment in alternative forms of energy spiked. The holy grail of solar energy has been generating more electricity from solar cells, which are also known as photovoltaic cells. Photovoltaic cells are built using silicon wafers and commercially have an efficiency of about 14 to 16 percent.

Many new companies are developing various ways to generate more electricity from less silicon, through techniques ranging from thin film technology to a patented system called the SunFlower 250 developed by an IdeaLab company called Energy Innovations. The SunFlower 250 uses 25 moving mirrors to focus sunlight onto a solar cell array mounted above. Suntech Power is a Chinese solar energy company that uses thin film technology to build photovoltaic cells. Suntech (STP) is one of the few profitable companies in this sector and has been profitable since 2003.

I have been watching the solar energy sector and Wall Street's short love affair with companies like Suntech, which fueled Suntech's shares up more than 200% since it went public at $15 a share in December 2005. With the entire sector falling out of favor thanks to concerns about polysilicon supply and eroding margins, Suntech's stock has lost almost half of its value in recent months. Suntech currently appears to be very richly valued with a Price/Earnings ratio of 86.43 and a Price/Sales ratio of 13.57. I would never consider paying 13.57 time annual sales for a company unless it had an absolutely amazing growth rate. Suntech seems to fit the bill with revenue growth of 188% in 2005 and an expected growth rate of 126% this year. Based on their first quarter 2006 revenue growth rate of over 130% and their projected revenue growth of 163% to 179% in the second quarter of 2006, it looks like they will handily beat analyst expectations for full year 2006 revenue growth.

Apart from Suntech's profitability and high growth rate, there were two other events that got me interested in Suntech Power. The first event was the $1.25 million contract Suntech won to supply 130 KW of solar energy for the 2008 Beijing Olympics. The Chinese government is very keen to wean itself off electricity generated from fossil fuels like coal. This comes as no surprise when you consider the following facts from this New York Times article (subscription required),

"China uses more coal than the United States, the European Union and Japan combined. And it has increased coal consumption 14 percent in each of the past two years in the broadest industrialization ever."

"The increase in global-warming gases from China's coal use will probably exceed that for all industrialized countries combined over the next 25 years, surpassing by five times the reduction in such emissions that the Kyoto Protocol seeks."

China's gross domestic product [GDP] grew by an extraordinary 11.3% in the second quarter of 2006 when compared to a 2.5% growth rate in the United States. Given this amazing GDP growth, China is very interested in building energy efficient cities (incidentally New York City is now one of the most energy efficient cities in the United States thanks to increased adoption of green architecture) and is investing in sources of clean energy. Suntech is likely to benefit from this trend and could potentially win additional contracts like the 2007 Beijing Olympics contract.

If you would prefer to invest in solar energy but not in a company that produces solar panels, you could also go one step deeper into the solar food chain and consider investing in a company like MEMC Electronic Materials (WFR). MEMC is one of the leading companies that produce polysilicon, which is used by companies like Suntech power to create their solar panels. Polysilicon has been in great demand in recent months leading to price increases and hence better margins for MEMC. In fact, MEMC released quarterly results on Thursday, July 27 and reported profits that more than doubled to $81.9 million in the second quarter when compared to the same quarter last year.

MEMC recently signed an agreement with Suntech to provide polysilicon to Suntech over a 10 year period. This 10 year agreement was the second event that made me decide to feature Suntech in this month's SINLetter. MEMC will supply between $5 to $6 billion of polysilicon to Suntech over a 10 year period. According to full year 2005 results from Suntech, cost of goods came in at $157 million. If we consider that $100 million of this amount was for polysilicon, then the only way Suntech would need $5 to $6 billion of polysilicon in a 10 year period would be if it were to grow at an annual pace of 50% for 10 years. This is a very strong signal from Suntech and the drop in price from an intraday high of $45.95 on January 23, 2006 to the current $25.93 could make Suntech a bright long-term investment. For a glimpse of the future, consider the following statement by Suntech's CFO Amy Zhang during the first quarter 2006 conference call:

Total net revenues in the second quarter are expected to be in the range of $110 million to $117 million, representing year-over-year growth in the range of 163% to 179%.

Competitors:
SunPower (SPWR), Evergreen Solar (ESLR), DayStar Technologies (DSTI), Kyocera (KYO) and Emcore (EMKR) are direct competitors of Suntech Power. Suntech also faces competition from companies that create other forms of alternative energy such as wind and fuel cells. Some examples include the aptly named Energy Conversion Devices (ENER), General Electric (GE) on account of its wind turbines division and fuel cell stocks like Hoku Scientific (HOKU), FuelCell Energy (FCEL) and Ballard Power Systems (BLDP).

The Good:

Suntech Power has an astounding triple digit revenue growth rate and is expected to grow more than 126% in 2006.

Suntech is one of the few profitable solar energy companies and has been profitable since 2003, a year after inception.

The Chinese economy grew at a red-hot rate of 11.3% in the second quarter and the government is keen on investing in alternative sources of energy.

Suntech has allayed investor fears about polysilicon shortage by recently signing a 10 year supply contract with MEMC Electronic Materials.

Suntech beat analyst expectations when it reported first quarter 2006 results and improved both gross and operating margins.

The Bad:

Suntech, along with other alternative energy stocks has been very volatile in recent months, experiencing wild price swings. Just ask anyone who invested in Suntech Power or Evergreen Solar six months ago in the midst of the alternative energy craze.

A very rich valuation with a current P/E of 86.43 and P/S of 13.57.

Supply and price of polysilicon, the raw material used to produce photovoltaic cells, are a big concern. The recent 10 year agreement between MEMC and Suntech should hopefully help alleviate this problem.

Some investors continue to remain skeptical about investing in Chinese companies and are worried about the derailment of the Chinese economy due to governmental interference or the growing gap between the rich and the poor, which has lead to many riots in rural China. Oddly enough there was a story about this in Barron's magazine just last weekend.

The Numbers:

P/S 13.57

P/E 86.43

Cash $359.3 Million

Long Term Debt $3.7 Million

Update: On August 2nd, a day after this newsletter was sent out to subscribers, Suntech Power (STP) decided to acquire a leading Japanese solar company MSK Corp in a two-step transaction worth up to $300 million. Suntech's stock shot up almost 10% that very same day. On August 4th, Goldman Sachs initiated coverage of Suntech Power with a buy rating.

STP Performance Since IPO

Comments

[borisb]

good story. had 10% bounce this week.