Chinese Solar Stocks: Sustainable Turnaround Or Dead Cat Bounce?

|
 |  Includes: HQCL, JASO, LDK, STP, TSL
by: Justin Kuepper

Chinese solar stocks are trading up more than 66% over the past month, according to data from Tickerspy. Yet the average price-earnings ratio for these stocks are just 1.8x, and they remain well below their 52-week highs. So, is this the beginning of a larger recovery or simply a 'dead cat bounce' before further declines in the coming months?

What's Driving the Rally?

Chinese solar stocks are being driven by a combination of record low valuations and improving fundamentals. Solar stocks were hammered throughout the economic downturn as many countries cut back on their solar subsidies. As a result, the sector was ripe to rebound on any good news that hit the wires, such as an unexpected improvement in fundamentals.

Recently, demand has picked up in Asia and the U.S. to offset weakness in the European market that had crushed the sector over the past year. For instance, China plans to develop three gigawatts of solar capacity this year. And the oversupply problem in the industry appears to be lessening, according to some recent earnings reports in the sector.

According to a Deutsche Bank analyst quoted in BusinessWeek,

Tier-one companies in China, Taiwan and Korea have rising orders and are running at 100% of utilization.

Three Turnaround Favorites

There are many companies operating in the Chinese solar industry, including popular players like LDK Solar Co., Ltd (NYSE:LDK), JA Solar Holdings Co., Ltd (NASDAQ:JASO) and Suntech Power Holdings Co. Ltd (NYSE:STP). As the industry bellwethers, these stocks tend to move along with the industry as a whole and are solid long/short bets due to their great liquidity.

Here are three solid picks in the sector:

  1. LDK Solar Co. Ltd - LDK Solar is one of the largest players in the sector, with a market capitalization of around $950 million. With about a third of its revenues coming from China, it's well positioned to capitalize on the region's growing subsidies. And the stock trades below its book value with a price-earnings multiple of under 14x, which could be cheap relative to its future growth prospects.

  2. Trina Solar Limited (NYSE:TSL) - Trina Solar is another larger player in the industry with a market capitalization of around $800 million. With a price-earnings ratio of just 4.5x, the stock is one of the cheaper options in the space, while its earnings are stabilizing thanks to its cost reduction initiatives. And the firm recently received a "Made in EU" certificate that help its cause in Italy.

  3. Hanwha Solarone Co. Ltd (HSOL) - Hanwha Solarone is a smaller player in the space that trades with a price-earnings ratio of under 4x. During the third quarter, the firm reported a more favorable revenue mix (Germany accounted for 45% of its sales last year) and maintained its solid balance sheet with $3.46 per share in cash and a book value of $9.68.

Some Risks to Consider

Despite the potential upside, there are a few risks to consider when investing in Chinese solar stocks. Three of these key risks include:

  1. U.S. Tariffs - The U.S. Department of Commerce could announce punitive tariffs on Chinese c-Si solar cells and modules on March 5th.This could hurt first quarter sales for Chinese solar OEMs and/or lead to an increase in cost of goods sold.

  2. More E.U. Cuts - Germany may be considered a solar incentive cut that it could make as early as April, according to Digitimes. The 7.5 gigawatts of installations in 2011 led the government to consider cuts to keep the market from overheating.

  3. Profit Taking - The solar industry's recent run-up could lead to some short-term profit taking by traders, which could drive these stocks down over the near-term. Investor may want to therefore consider building their positions over time to average in.

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