Anyone who has followed the solar sector over the past couple years knows that it has been quite a roller coaster. The performance of the sector as a whole has been completely erratic and has been heavily influenced by gyrations in public policy regarding the subsidization of the industry.
Even the top stocks in the sector have not been immune. First Solar's (NASDAQ:FSLR) stock price has ranged from just above $100 up to $175 over the past year, while Trina (NYSE:TSL), a leading Chinese module manufacturer, has seen its stock price range from $20-32. Jinko Solar (NYSE:JKS), an upstart Chinese player, has seen its stock price skyrocket from its IPO price of $11 last May up to $40, back down to $20 before settling in the mid $20s recently.
Clearly, investing in the solar sector is not for the faint hearted and there are a lot of risks when investing in such a nascent industry that gets its livelihood through regulatory incentives. Bulls would argue that the worst is behind us as the drastic reductions in European FiT (feed in tariffs) has already been priced into the stocks, while bears would argue that the impact of rampant oversupply has not yet filtered through the system, and that the industry must brace itself not only for lower demand but also lower prices. As Italy, Spain and Germany reduced their subsidies by lowering FiT much more than most had originally anticipated, prices have come down roughly 25% this year. Current module prices are estimated to be under $1.40, a level most analysts had not expected until later in the year. There's no doubt that module prices will continue to come down as more capacity comes online, but one of the longer-term positives is that the lower prices will lead to more demand as solar power's cost/watt approaches grid parity in many regions. Of course, grid parity will be easier to achieve in regions with a combination of higher electricity cost and more sunshine (like California and Italy) vs. regions with either less sunshine or lower electricity cost (e.g., U.K. and Australia, respectively).
The industry overall had rampant overbuilding in the past two years as generous subsidies throughout Europe drove insatiable demand for solar modules. Though the U.S., China and Japan will help soften the reduced demand in Europe, oversupply will continue to drive down prices faster than manufacturers can lower costs throughout this year and possibly next year as well. This should lead to some additional demand than previously expected, but more importantly, it will favor manufacturers with the lowest cost of production that will be able to withstand the price wars the best. With continued overbuilding of module manufacturing capacity, polysilicon and wafer manufacturers should benefit as there is not enough low-cost polysilicon supply to meet the demand. Because of these two factors, I believe First Solar and GCL-Poly are the two top solar plays.
The difference between the largest low-cost manufacturers and the Tier 2/3 also-ran companies is starting to emerge. A couple weeks after First Solar announced first quarter results that were ahead of consensus estimates and maintained guidance for the year, China Sunergy (NASDAQ:CSUN), one of the smaller Chinese manufacturers announced dismal results. Even Trina, one of the solar darlings last year, wasn't spared - though sales were not far from analysts' expectations. Margins were hit by lower ASPs and higher than expected costs. Trina expects the trend to change over the course of the year as input costs fall.
First Solar has long maintained a huge cost advantage on a per watt basis over all other module manufacturers. Whereas the Chinese manufacturers produce modules in the $1.10-1.30 range, First Solar's estimated cost per watt is around $0.75. Some people feared that First Solar would not be able to match the cost improvements of the Chinese as they built scale, but First Solar has proven that it can continue to reduce costs by 8-10% per year, allowing the company to continue to underprice almost every other manufacturer and still maintain industry-leading margins. In a year in which few solar companies are able to produce any meaningful growth after being hammered by reductions in FiT throughout Europe, First Solar has maintained its full year guidance and analysts on average expect nearly 50% revenue growth and about 25% earnings growth this year. In 2012, analysts see revenue increasing over 25% and EPS rising over 10%. This is due to the fact that the company has over 2GW of utility scale contracts in the pipeline, not to mention another 1.3 GW that that are possible but not included in its projections.
First Solar recently obtained a DOE loan guarantee for its Agua Caliente project that will include 290 MW and is awaiting approval for at least three other projects - Antelope Valley, Topaz and Desert Sunlight. These three projects represent over 1.3 GW, which could contribute $1.3 billion of operating income, representing approximately $10 per share over the term of the contract. The company should receive word on some of these projects by June 15, which could be a catalyst for share price gains if word is positive. Though the company trades at a premium to its peers, it boasts the highest margins and consistent growth backed by long term contracts, unlike its peers. Trading at 13x this year’s EPS and 9x EBITDA are reasonable given the company's operating performance. In comparison, Trina trades at less than 6x this year's earnings and ~6x EBITDA, but there is considerably higher risk in Trina's ability to achieve those estimates.
My other pick is GCL-Poly [HKG:3800] (GCPEF.PK). After a recent 20%-plus stock price correction, investors finally have a buying opportunity in this high flying performer. GCL-Poly, China's largest polysilicon and wafer manufacturer, is undergoing a massive expansion that is positioning the company as the world's largest polysilicon supplier and one of the only mass-scale integrated polysilicon/wafer plays. Scale is critical in a commoditized product like polysilicon/wafers, and GCL has emerged as the lowest cost option that module makers are turning to in order to reduce their own cost structures.
One may ask why I would want to invest in a commoditized market that is in the midst of a price war. It’s because I believe GCL will emerge as the winner of the price war. The reason LDK's stock price has been halved in recent months is because companies like LDK cannot compete with GCL. Polysilicon prices had held up pretty firmly for a while, remaining in the mid $70s, but in recent months, prices have plunged to the mid $60s and analysts believe prices could fall to the mid $50s by year end. GCL already has fixed contracts in place and was selling polysilicon in the low- to mid-$50s before the price wars. Its ability to produce polysilicon at an estimated cost of less than $25 per kg has allowed it to undercut most of the competition and maintain healthy margins. Even before doubling its capacity, GCL was competitive with larger polysilicon suppliers such as OCI, Wacker and Hemlock. By year end, its capacity is increasing to 47k MT vs. 21k MT last year, which will make it the largest - ahead of OCI at 42k MT, and Hemlock and Wacker with 36kMT each. Another 40% expansion next year will ensure GCL stays ahead of the pack.
Such capacity expansion in an environment of slower demand could appear dangerous, but the fact is that other suppliers cannot compete on price against these big four, and the big four produce less than 90% of the total demand. More importantly, over the past year, GCL has transitioned to focus on integrated sales of polysilicon and wafers. As the only fully integrated poly/wafer solution, GCL's costs are 25-30% lower than the competition, allowing the company to undercut pricing by 5-10% and maintain its margins. Even better, nearly 100% of its forecasted wafer production is under long-term 3-6 year contracts, providing strong support for its sales projections. The stock fell over 20% after a strong rise over the past year over concerns regarding ASP erosion throughout the solar ecosystem as well as company-specific cost concerns that are likely overdone. GCL is expected to grow revenue by over 60% this year and 30% next year. EPS are expected to double this year and grow another 20% next year. Despite such tremendous growth potential, the stock is trading at just 10x this year's EPS, cheaper than both MEMC (WFR) and Wacker. The company will provide an update on its expansion in July, and the time to get into these shares is now, on this rare weakness in its share prices.
The basic theme here is to go with the lowest cost suppliers who will endure price wars better than the competition and emerge as winners in the battle for solar dominance. The two clear leaders are GCL-Poly (as the lowest-cost supplier to solar module makers) and First Solar (as the lowest-cost end market solution). Both companies have a strong pipeline backed by long-term contracts.
Though the solar industry is enshrouded in uncertainty, I think the worst is behind us as the Europeans should be done taking drastic measures against FiTs that contributed to the boom in solar. Lower prices and increasing demand in the U.S., China and Japan should help offset the European weakness. In any case, the pessimism is built into these stocks already, and they should be near their support levels and work their way back up if they can execute on their growth plans. Given First Solar has not been below $100 in over a year and bounced off a support around $105 multiple times last year, one can sell $100 or $105 puts and collect the premium.
Disclosure: I am long GCL-Poly.