China Solar Safari: Hunting for Five Value Companies

by: Shawn Kravetz

Big Five Game are viewed as the five trophy animals of an African safari. We have just returned from another trip to China visiting solar companies and would like to offer our Big Five as well as our top five reasons why analysts are still off the mark on Chinese solar stocks.

Suntech Power (NYSE:STP): the African Elephant. The biggest of them all, they are deceptively fast despite their size. However, in this case, their enormous capacity and high cost of goods sold will make for a challenging balance of 2009. As the only company that is a true leader in every big global market, they are well positioned in 2010 and beyond, but the near term will be tough.

Trina Solar (NYSE:TSL): the Leopard. The fastest of them all. Trina is, in our view, the low cost crystalline silicon manufacturer today, having overtaken the previous leader, Yingli (NYSE:YGE). Moreover, they are strong marketers. This is a devastating combination. With a capital raise now behind them and analyst estimates still too low, this is our favorite solar position.

LDK Solar (NYSE:LDK): the African Buffalo. This animal has caused the most hunter deaths in Africa, and perhaps the same holds true for the stock. The scale of their wafering operations is stunning. Their polysilicon plant, still doubted by many, is a sight to see. A year from now, we expect to see a cost leader of epic proportions serving a booming market.

Yingli (YGE): the Lion. This king of the jungle deserves our respect even if it now shares cost leadership with other nimble creatures. It remains a cost leader with great scale. Moreover, it has been the most successful in attacking that other great lion of the thin film world, First Solar. Though Yingli has, at times, chosen to wage a price war, as a cost leader they can win that battle, and we remain quite bullish on this ferocious feline.

Canadian Solar (NASDAQ:CSIQ): the Rhinoceros. Not as well known as the other animals in the kingdom, this large and fierce competitor is different than the rest. Its herbivore diet is CSIQ’s proven ability to use UMGSI (upgraded metallurgical silicon) instead of traditional polysilicon. This is a powerful weapon in the wild. A superb cost structure and savvy marketing make this a dark horse among Chinese solar leaders. Estimates remain too low and CSIQ is one of our favorite holdings.

With the Big Five now clearly in view, what are the five reasons analysts are still off the mark on Chinese solar stocks?

  1. Volumes will be bigger than expected. Most analysts forecast 2009 installation volumes to remain flat with 2008 levels if not decline moderately. A few of the more bearish analysts expect volumes to be halved from 2008 levels while few expect volume growth. We recognize that tracking volumes represents an almost impossible task. Until a few weeks ago, many analysts were unaware that the Czech Republic and Benelux were viable solar markets never mind absorbing significant volumes. Our industry contacts, company visits, and published second quarter results are telling us a different story. On our recent trip to China, it was difficult to find a company that wasn’t shipping multiple megawatts per day and operating their facilities at full utilization. As second quarter results begin to hit the wire, we are learning that companies from SunPower to Canadian Solar to LDK shipped meaningfully more product than the most bullish expectations. As companies provide Q3 guidance, phrases such as “a doubling of Q2” have become the norm. We admit that 2009 likely will not achieve volume growth rates of years past, but we fully expect 2009 volume growth rates in the 10-20% range despite a crippling macroeconomic environment. As importantly, we believe that solar volumes in 2010, a mere 5 months away, could more than double from 2009 levels. In 2008, one country, Spain (the world’s 9th largest economy), drove solar. In 2010, the world’s four largest economies are getting in gear: the U.S., Japan, China, and Germany (as are #5 France and # 7 Italy).
  2. Prices will be firmer than expected. The Street’s herd of solar analysts confidently proclaim that average selling prices (“ASP”) for silicon modules will tumble below $2.00 per watt by the end of 2009 and below $1.50 per watt by the end of 2010. While linear extrapolation of current pricing trends facilitates easy modeling and story crafting, it does not accurately capture the complexity and geographic diversity of module prices. A few phone calls to the same, stale industry contacts does not make a global market. Like volumes, tracking global pricing from Germany to the US to Mongolia (Trina ships modules there) challenges the limits of what is possible. Thousands of transactions, each unique in structure, size, and currency, represent the average selling price. While we agree that prices continue to decline, albeit far less violently than earlier in 2009, we believe that current and second half demand is much stronger than most analysts appreciate (see above) which will drive firmer pricing. At today’s pricing levels, end-customer economics represent safer and more compelling returns than almost any other potential investment. We also believe that analysts are ignoring the potential for aggressive shipments to Germany in Q4 to beat the next subsidy degression and for substantial higher-priced volumes to reach emerging solar markets (e.g., Italy).
  3. Costs will be lower than expected. Analysts are guilty of underestimating second quarter volumes, but they should stand trial for overlooking these companies’ cost structures. For example, Canadian Solar exceeded second quarter revenue estimates by about 20%, but they trampled consensus EPS by $0.58 (consensus = ($0.09) vs. actual = $0.49). We don’t think that Canadian Solar will be the last Chinese solar company to flabbergast analysts in the second quarter.
  4. Chinese leaders are winning more share than expected. Would you buy a Ford (NYSE:F) Taurus for $26,000 or a Toyota (NYSE:TM) Camry for $20,000? When credit flowed and economies were strong, solar customers could justify the $26,000 Taurus (i.e., American/European branded modules) because the economics supported it. However, in today’s environment, more customers are opting for the value-priced Camry and in large and growing numbers. Almost daily, we learn of another Chinese supplier supplanting an established western peer at a distributor or an integrator.
  5. These businesses are more durable than expected. Common sense dictates that falling selling prices cannot drive margin expansion. Well, common sense is wrong in the case of solar. In 2008, the low non-silicon processing costs of the Chinese were buried beneath the weight of $400/kg silicon. Silicon comprised ~80% of module costs. Today, falling module prices have thrust silicon prices to multi-year lows. Chinese solar companies have very successfully driven their costs down faster than ASPs by leveraging lower silicon prices and driving down processing costs. Silicon represents about 40% of module costs today, which allows the Chinese cost structures to shine. Some Chinese producers are shining while some American/European competitors are witnessing a partial eclipse.

And what becomes of the original Kings of the jungle (Sharp (OTCPK:SHCAY), SunPower (SPWRA), First Solar (NASDAQ:FSLR), and Q-Cells (OTCPK:QCLSF))? Well, that’s another safari for another time.

Disclosure: Funds the author manages are long Canadian Solar, LDK Solar, Suntech Power, Trina Solar, Yingli, and are short SunPower