Why The Solar Industry Gives Low Investor Returns

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Includes: FSLR, HQCL, JKS, SPWR, SUNEQ, TSL, YGE
by: Sneha Shah

Summary

Solar Industry is highly dynamic with technological breakthroughs and sharp cost reductions leading to multiple bankruptcies.

Huge debt, unrelenting competition, technology obsolescence and government intervention have been some of the major reasons behind company failures.

An investor can benefit from the secular solar growth only if he does his homework carefully.

Bankruptcy and restructuring are not new in the rapidly changing solar industry. With solar technology making rapid strides and cost levels reaching record lows, the industry has seen many bankruptcies as well as acquisitions. The industry will continue to witness major consolidation and restructuring across major players and only the strongest will be able to survive this revolution.

The solar industry has a lot of potential with 16% of global electricity expected to be generated from solar energy by 2050 (as per IEA), up from 1% now. Even this is regarded as a very conservative figure by industry analysts some of whom think it could account for 50% by 2050. The solar stocks on the other hand has not witnessed a boom, as competition has remained high and supply exceeding demand. However, The industry set to witness major consolidations and restructuring across major players and only the strongest will be able to survive this revolution. The industry is experiencing record levels of low prices and according to ITRPV, the industry will further witness price improvements based on newer technologies and efficiencies. In this article I will try and analyze the solar dynamics - the past and the present and how can investors safeguard themselves from these fluctuations.

Why has the Solar Industry failed to give good industry returns

Though solar is a high growth industry, it should be kept in mind that these projects are very capital intensive. Unlike the technology industry the return on capital employed is relatively low, leading to low investor returns. In order to keep up with the high growth rates, solar companies have to keep investing large amounts of money in capacity expansion and many fall into a vicious debt spiral. There have been numerous instances in the past, where solar companies went bust owing to their huge borrowings (e.g. LDK, Suntech, Chaori, Q-Cells etc.). The years 2011 and 2012 saw a large number of exits after China flooded the markets with cheap solar panels and components.

The major reasons that have caused major companies to go bankrupt or quasi bankrupt are:

1) Large amounts of Debt

This has been the commonest theme across major failures. The industry has seen major solar companies go down due to large debt pressures. LDK Solar and Suntech used to be the largest companies in their respective solar manufacturing segments. Massive debt burden proved to be the main cause of their failure as the solar industry went through an excruciating downturn in the 2012 and 2013. Note Suntech was bought by Shunfeng and LDK has been acquired by a Chinese government entity.

2) Technology Obsolescence

In the earlier part of this decade, there were a number of solar technologies competing for prominence - different thin film technologies, CPV, solar thermal and crystalline solar. The mainstream silicon technology has made rapid strides, such that other technologies have more or less become peripheral. Many companies that ran their operations using these technologies have become bankrupt. Many thin film companies went kaput during those days. Some eminent ones included Miasole, Nanosolar and Solyndra.

3) High Cost of production

A relentless fall in the prices of crystalline silicon panels led to major thin film bankruptcies in 2011. A large number of thin film companies went bankrupt when polysilicon prices fell off a cliff, during the post Lehman crisis period. Compared to the mainstream silicon solar panels, the cost of thin film solar panels were still too high and efficiencies too low. Today, there are only a couple of survivors with their thin film panels reaching efficiency levels almost equal to silicon panels. First Solar's (NASDAQ:FSLR) thin film panels are now more or less competitive with the multicrystalline Chinese solar panels, with fleet average efficiency improving to 15.8% and the lead line efficiency averaging at 16.4%.

High cost of production had also forced Japan's Sharp and Germany's Solarworld to close factories and offices in high cost regions and shift to low cost regions. Most of the German solar companies which used to dominate the solar industry landscape have disappeared.

4) Government Support

The government of China has been notorious about lending funds to its domestic solar companies and also bailing them out by infusing funds, when they literally turned into "zombie companies". Not only China, but also other countries like France, Italy, USA perpetuated oversupply and distorted the solar economics. Constant intervention by the local governments did not allow bankrupt solar companies to go belly up. LDK and Suntech were kept alive for a long time by the Chinese Government.

The Present

Though there are numerous reasons for solar companies going bankrupt, the most important one today is high debt. Many solar companies have diversified into downstream solar project business, which is highly capital intensive. Also with huge demand for solar panels forecasted in the coming years, solar companies are expanding production capacities. This has led to these companies resorting to high debt. Yingli Green Energy (NYSE:YGE) was ranked second in terms of global panel shipments right after Trina Solar (NYSE:TSL) in 2014. Even though the company was successful in expanding its global footprint and reducing costs, its massive debt burden remains the main cause of concern. The company's annual report for 2014 raised concerns about it continuing as a going concern. YGE is now looking at restructuring its debt, through alternative financing options.

Another major RE player SunEdison (NYSE:SUNE) has been facing heat from investors because of its aggressive expansion strategy which resulted in the company resorting to taking on large amounts of debt. Both SunEdison and Yingli were industry leaders but got caught wrong footed by rapid industry change. However, most solar companies have learned their lessons from industry cycles and are becoming more prudent in their capex and liquidity management. They are being careful in capacity expansion and looking at third party sourcing for meeting high demand. Trina Solar, Jinko Solar (NYSE:JKS), First Solar have become careful about their cash expenditures. Some companies such as Sunpower (NASDAQ:SPWR) and Hanwha Q-Cells (NASDAQ:HQCL) have strong parents with a solid balance sheet.

Conclusion

With so many moving pieces, it is very difficult for an investor to safeguard himself from the volatility in the market. Today's leaders can have a hard landing tomorrow. Investors need to be acutely aware of what's happening not only with the company, but also with the overall energy sector as well as macro-economic conditions. Solar industry is a high risk sector and every news sensitive too. Investors need to exercise caution before investing their money. A thorough analysis of the financial statements should be a compulsory check point before investing. Knowing about the company's line of business and technology updates of peers is extremely important. For starters, investing through ETFs is also a good idea. Though the industry looks high risk one, it is also true that with high risks comes high returns. For example, some of the better solar stocks returned more than 30% in the last year itself. If an investor can do his ground work well, he stands a good chance to benefit from the long term double digit secular growth of the solar industry.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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