Is SunTech's Optimism Justified?

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Includes: SPWR, STP
by: Troy Jensen

I have been knee-deep in research on SunTech's (NYSE:STP) latest earnings release, and I wanted to share some of my findings, both macro and focused, in order to provide some guidance on SunTech, the solar vertical, and the near and long-term outlook for SunTech. I see a lot of positives, and if SunTech can navigate some of the upcoming challenges successfully, they are positioned to be a strong leader in over the next 3-5 years in the solar space.

1. I just had a long conversation with the head of a leading Greentech distribution company, massive in size. 2010 orders are looking much stronger than 2009, and I think we will see an uptick (from ALL that data I am seeing) in Q1 that will result in a surprising YOY increase. BUT, let's take that optimistic view with caution. This is a vertical very similar to other technology verticals I have been deeply involved with my whole career - the technology is changing constantly, the main players are going through growing pains (an example would be SunPower's (SPWRA) accounting difficulties and potential restatements - been through several larger startups, and earnings restatements are very common on the fast-moving tech sector), and I am not going out on a limb by saying the strongest players today could easily be eclipsed by emerging advances from other firms tomorrow. Tread carefully - the laws of Disruptive Innovation and Disruptive Technology rule the day in the GreenTech vertical.

2. We can all count on subsidies to remain, especially in the U.S. with the current Administration in power, but we can also count on those subsidies shrinking in all likelihood. Government fiscal policy will dictate cutbacks, as industrialized nations struggle with high percentage of government debt versus GDP. That said, we also cannot predict what types of legislation will be enacted to continue to force the private sector towards Renewable Energy implementation (e.g. California). It's a low-visibility environment when we look at government policy, but there is a momentum and political environment currently that trends positive for Renewable Energy and the GreenTech sector as a whole.

3. I get flack for this all the time, but to discount the cultural and societal push, both domestic and internationally, towards Green solutions and Renewable Energy is foolish. History has shown again and again, culture is a powerful dictating force in enacting macro-infrastructural and economic evolution. I don't agree or disagree with this trend - as a realist, and an analyst, you simply must factor in, and it's a strong part of my predictive modeling for short-term GreenTech projections.

4. I am going to diverge with the consensus on China. There are some fundamental factors that both bolster the viewpoint that China is going to eclipse the United States and other European countries in Renewable Energy and GreenTech technology advancements and production capacity, to be sure. But China is taking a different approach than, say, Germany, a nation that has invested billions and billions not to power their nation with solar power (at an average of four sunlight hours per day, it's just not a practical environment for large-scale deployment yet - until leaps in energy storage make it so). Germany made that strategic investment as an intellectual property investment, and it is paying off. China is taking a different approach, an approach far more in line with their overall economic model - production capacity, production capacity, and then more production capacity. As a side note, this is a strategy that is frankly a forced policy - they simply do not have the engineering brain trust yet that the G10 nations do (no disrespect to China - they will get there for sure!!). The revolutionary technology advancements will, in my opinion, come from the U.S. and Europe, and China will be a major player in building the production capacity infrastructure necessary to deploy solar on a widespread, positive return-on-capital basis that will help make Q3-Q4 a real tipping point in solar - look at that time frame for the global, and domestic U.S., to reach critical mass, making solar absolutely viable from a Levelized Cost of Energy standpoint (likely without government and utility subsidies). Many variables, but my finger on the pulse for 2010 skews towards the positive projections.

Now, to quickly address SunTech specifically:

1. At this point in their startup evolution, their balance sheet is above average. Keep a close eye on how currency fluctuations are both benefiting and/or having a negative impact on their earnings. Forward-looking, I am 100% convinced that the dollar with strengthen, and I watch as an investor for SunTech to be prepared with strategies in place for this inevitable eventuality. Examples would include distribution models, tactical global production facilities (e.g. Phoenix was a positive development) and currency hedges.

2. There are many players in their particular vertical, again typical of a nascent technology environment in an accelerated growth phase. Keen eyes will be on their research and development revenue allotments. Are they continuing a firm commitment to advancing their technology, as opposed to allowing their current technology to carry quarterlies for the time being? Also, they are fairly deep in terms on their R&D talent base - look to see if they are able to hold onto this talent. R&D will be a big factor in determining the long-term viability and success of SunTech in this environment. Innovation, innovation, innovation! Key to this vertical, as it is with most technology verticals. Investment in R&D, even at the expense of lowering guidance for the next few quarters, may sound like career suicide, but is key to SunTech's long-term industry leadership positioning.

3. They are talking the talk on diversification in their sales channels - let's keep on eye over the next 6-12 months if the walk the walk. With feed-in tariffs and other government subsidies getting squeezed due to budget constraints as the need for further economic stimulus continues, an aggressive, intelligent diversification strategy will be a critical factor to maintain top-line revenue growth. Eastern Europe is starting to appear ripe for a market share grab. And the sleeping giant called the United States is slowly awakening - maintaining a large piece of the market share in the U.S. should be a critical component to SunTech's sales-mix modeling.

4. The Chinese solar market has gotten a lot of coverage as of late, and rightfully so. But I am stressing caution in the longer-term, 3-5 year time frame - China will absolutely not be able to maintain their current torrid GDP growth rates, and as we see globally, it's much easier to delay or shelve Renewable Energy projects to slow the rate of government spending. Coal is cheaper, and coal in plentiful in China. Despite the protestations to the contrary, the Chinese government's absolute priority is maintaining power, and when their economic growth rate inevitably slow, a lot of systemic troubles within both their government and banking system will be revealed. The Chinese are currently constructing one new coal-powered generation plant a week. The media coverage is fantastic, and it's absolute a positive to those of us in GreenTech. But the reality on the ground is China is committed to ensure their energy needs are met at all costs, and coal is still a cheaper alternative for the Chinese generation plans than solar or wind. So as we see their growth rates slow in the middle of the coming decade, and the turbulence that will go with that slowdown, expect a lot of these Renewable Energy projects announced with such fanfare to be delayed or shelved completely. SunTech needs to recognize this reality and diversify accordingly.

5. I am impressed thus far with SunTech's level of transparency and fiscal discipline. If this continues, and I have no reason at this time not to believe it won't, this makes them a far stronger player globally than much of their competitive set.

Bottom line: I think SunTech is a fantastic 3-5 year play. If you are looking for immediate returns, look elsewhere - volatility is the name of the game in Technology sectors such as GreenTech, still very early in their evolution. But I see a lot of positives in SunTech's fundamentals, and as a five-year strategy, I think they are a safe, strong investment in the GreenTech sector.

Disclosure: No holdings in any of the companies referenced in this article.