Solar stocks have been hit by a perfect storm. Let us review just a few of the issues that are affecting the sector.
1. Subsidy cuts in Europe. Due to generous subsidies, Europe has been the biggest worldwide market for many solar producers. Fiscal woes have triggered budget cuts all over Europe and there are fears that more cuts could be in the pipeline. Given that solar power is currently uneconomic without subsidies, there is concern that sales of solar products could dry up entirely.
2. Solyndra bankruptcy. The California-based solar-panel maker declared bankruptcy last month after getting $535 million worth of loan guarantees from the Obama administration. Evidence of potential hanky-panky in obtaining the loan guarantees has raised broad questions regarding U.S. government support for solar companies. The entire solar industry is being painted by many in the media as a failed enterprise that can only survive based on cronyism.
3. Chinese accounting scandals. A series of scandals involving Chinese companies has caused the accounting of virtually all China-based companies to come into question. High profile cases such as Sino-Forest (TRE.TO) and China Media Express (OTCPK:CCME) have caused enormous damage to the reputation of Chinese companies generally. Interestingly, a great many of the complaints and lawsuits against Chinese companies are turning out to be unfounded. Chinese solar companies have been particularly affected.
4. Speculative liquidations. The above factors combined with the general market (SPY, DIA, QQQ) downdraft have provoked stop-loss orders and margin calls among proprietary traders and some hedge funds that held positions in these relatively illiquid companies. The lack of liquidity has exacerbated price declines in the context of forced selling.
With the exception of point number one, none of these factors fundamentally justify a large decline in solar stocks – much less of the magnitude that has occurred. Even in the case of European subsidies, not all has been lost. Furthermore, U.S. and Chinese subsidies are likely to be on the rise. Finally, points 2-4 have driven a general hysteria that is not necessarily relevant to the fundamental business prospects of the majority of publicly traded solar stocks in the long term.
Why Buy Solar Stocks?
The solar industry is not going to disappear any time soon. Neither are many of the publicly traded stocks in the sector.
- Long-term contracts. Many solar companies have locked in long-term contracts that will allow them to survive the lean years.
- Efficiency gains. The industry has made major strides in improving efficiencies. Many analysts believe that solar energy should be cost competitive with conventional sources of energy within the next five to eight years.
- Strategic national interests. Governments in oil importing countries including the U.S., Europe and China have a strong strategic interest both economically and from a national defense point of view in developing alternative energy sources. Among these, solar technologies seem to be among the most promising based on recent advances.
- The China factor. China in particular has made a huge bet on its solar industry. Historical patterns suggest that the Chinese will not abandon this national enterprise considered to be of great strategic interest any time soon. For strategic reasons, the U.S. will be loath to allow the Chinese to take sole position of the market.
Many solar companies are trading at remarkably cheap valuations relative to projections of long-term normalized earnings and cash flow. They are selling at liquidation values, with many companies trading magnitudes below their book value.
In sum, companies that are unlikely to be liquidated are trading well below the liquidation value of their assets.
Stocks For Consideration
I personally favor the Chinese solar stocks because I believe that the Chinese government will essentially place a “put” beneath the value of these stocks. Whatever excess production results from European subsidy cuts will be made up for by ramping up demand for solar products in China. Strategically this makes sense since prices for all sorts of solar products are falling precipitously.
Interestingly, since the prices of inputs such as silicon are falling as quickly as end-product prices, many of these companies may be able to remain profitable during their darkest hours.
Crucially, the three Chinese stocks I have purchased today have very large cash hoards that should allow them to ride out the cycle without having to resort to liquidation of assets.
These are the three Chinese solar stocks that I have purchased today:
Yingli Green Energy (NYSE:YGE). This company is a vertically integrated photovoltaic product manufacturer engaged in the design, manufacture and sale of PV modules and PV systems. I estimate that the stock trades at a P/BV of about 0.36x and a normalized PE of about 4.0x. The company has $1.10 billion of cash on its books. I estimate that the company’s annual fixed cost base is currently around $300 million (including interest expense) and could be slashed if necessary to withstand a prolonged slump.
JA Solar (NASDAQ:JASO). This company is a manufacturer of mono and multi crystalline solar cells. I estimate that the stock trades at P/BV of about 0.32x and a normalized PE of about 2.5x. The company has $624 million of cash on its books. I estimate that the company’s annual fixed cost base is currently around $130 million (including interest expense) and could be slashed if necessary to withstand a prolonged slump.
Suntech Power (NYSE:STP). This company is a broadly diversified producer of solar products and services. I estimate that the stock trades at P/BV of about 0.31X and a normalized PE of about 4.0x. The company has $648 million of cash on its books. I estimate that the company’s annual fixed cost base is currently around $450 million (including interest expense) and could be slashed if necessary to withstand a prolonged slump.
For diversification purposes and in order to gain broader exposure to the sector as a whole, I also purchased TAN which is an ETF that holds a diversified basket of solar stocks. The largest holdings in the fund are based in the U.S., Europe and Canada. However, roughly 15% of the holdings are in Chinese stocks.
Due to my higher conviction regarding the Chinese solar stocks I have purchased the three stocks mentioned in a 3:2 ratio relative to TAN. The overall solar position that I have initiated does not exceed 3% of the total portfolio. I would increase the position if the stocks fell substantially further. This could well occur as large holders have evidently not been able to liquidate their holdings. Furthermore, further general market downside in China (NYSEARCA:FXI) and global markets (^SPX, ^DJIA, ^IXIC, ^NDX, ^GDAXI, ^FCHI, ^FTSE) is not unlikely.
On a three-to-five year time frame I believe that these stocks will on average be four baggers (+300%) – at least. In the case of the Chinese stocks, this would not even represent a 33% retracement of levels seen earlier this year and less than a 10% retracement of all-time highs reached in 2008.
Disclosure: I am long TAN, YGE, JASO, STP.