Italy's GSE Announcement and Solar Stocks: Bull vs. Bear Cases

by: Rash Menaria

Last week, I wrote an article discussing the potential negative impact of Italy’s GSE announcement on the solar stocks. Although most of the solar stocks have reacted negatively to the news, Wall Street analysts still seem to be divided into two camps on the validity and potential impact of this announcement.

While most of the analysts believe this data will have a negative impact on stocks (and they are right so far), analysts from Jefferies (JEF) and Piper Jaffray (NYSE:PJC) don’t think the pain is justified and stocks should recover once sanity prevails. While the analyst from Jefferies has questioned the validity of the data from GSE, Piper Jaffary’s analyst thinks even if the data is true it’s a positive for the stock and not negative.

This article provides further clarification and analysis on the subject.

What happened?

On January 25 GSE, an Italian government-owned entity promoting the development of renewable energy, provided an update on 2010 grid-connected solar PV plants as well as on solar PV installations not yet connected to the grid. GSE estimated 1.85GW of new grid-connected capacity installations in 2010. By the end of 2010, GSE had also received notices from about 55,000 PV plants with total capacity of around 4.0GW that reported completion of equipment installation. These plants target grid connectivity by June 2011 so they can qualify for higher feed-in tariffs (FiT).

Market's reaction
The 1.85GW of operating plants stated by the release were in-line with the market expectations. However, the surprising figure was the 4.0GWs capacity of PV plants that submitted notices to GSE. The bear camp is assuming that these additional 4GWs plants were almost complete at the time of submitting notices. Thus, increasing the total installed capacity (both with and without connection to the grid) by 1.85 GW + 4 GW or ~6 GW. This 6GW of installation in 2010 along with 1GW installation expected to be added in 1Q11 takes total capacity to 8GW which was Italy's target for 2020. The market reacted negatively to this new as Italy (which is the second largest market) might now decide to cut the subsidy for the solar energy companies.

Why the Jefferies analyst doesn’t agree with the above analysis

The Jefferies analyst believes that it is uncertain according to the release whether all of the 4GW has achieved mechanical completion before year's end. He believes that it is likely that the applications filed with GSE represent more of a "land grab" to achieve the higher tariff as filing a notice before 31 December would make a PV plant eligible to qualify for higher tariff. Thus, the 4GW do not reflect actual installs and the stock sell off is due to inaccurate analysis.

Why the Jefferies Analyst might be wrong

In order to understand the level of completion of PV plants for which the notices (or applications) are filed with GSE, one needs to understand the application process. The applications for feed-in-tariff (FiT) are filed with the GSE online and installers have to attach documents with the applications that show that the plant is ready to produce electricity and ready for connection to the grid. As part of the application process, the project developers have to provide module serial numbers, independent engineer assessment, permits and other relevant documents. The engineer assessment includes attestation that the plant is ready for electricity production.

Bottom line: Based on the above application procedure and the fact that developers have to provide individual module serial numbers for the project, it is very likely that the data reported by GSE is actual installation data as opposed to only applications that could get constructed over time. Even if some of these applications were incomplete because of lack of panel availability in Q410, the probability of most of these projects getting completed before the April/August 2011 deadline is very high. Again, even in such a scenario, the Italian market would reach the “8GW by 2020” target set by the government in 1H11.

Why is this data reflecting higher installation a negative and not a positive?

While on the face of it appears that news about more installation in Italy should be a positive as it suggests good growth, the devil is in the details. The following are some of the reasons why this data is negative:

(1) With Italy’s target of 8 GW by 2020 to be hit in 2011, its FiT program is likely to be adjusted and steeper FiT cuts in 2011 are almost a certainty now.

(2) Likelihood of even more severe measures, such as a hard cap or other major restrictions gets a boost. This is important as Italy is the second biggest market for solar companies and any caps or restrictions there would severely affect their business.

(3) The data also implies Italy drove the bulk of global demand in 4Q10 and helped underpin module pricing. With material headwinds there, 2H11 and 2012 demand and module pricing are likely to be negatively affected.

(4) With virtually all solar panel manufactures adding capacity in 2011, it is expected that the sector will see pricing pressure and volatility going forward as Supply- Demand imbalance is likely.

We continue to believe that there is a near-term downside risk to the solar stocks. Specifically, stocks with exposure to the cell market (JA Solar Holdings (JASO)), China Sunergy (CSUN)) and to the spot market (LDK Solar Company (LDK)), and high exposure to Italy (Power-One (PWER), Energy Conversion Devices (ENER), and Evergreen Solar (ESLR)) may underperform going forward.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.