The Profitless Solar Growth Story

Includes: FSLR, LDK, STP, TSL, YGE
by: Shareholders Unite

Well, we argued a couple of times (here and here) that the solar modules are effectively a commodity (or in any case a near commodity), warning about over-optimism of those investors pointing to overall market growth. Instead, we argued that it would take the industry some time to digest a near 50% fall in module prices last year, and that volume growth, even in the more optimistic scenarios, wouldn't be sufficient to make up for that.

After seeing the figures from bellwether companies, Trina Solar (NYSE:TSL) and First Solar (NASDAQ:FSLR), cost leaders in the crystalline and thin film sectors respectively, this point has been forced on investors. Both companies made rather steep losses in Q4, First Solar quite unexpectedly so.

LDK Solar (NYSE:LDK) is expected to announce losses between 50 and 91 cents per share for Q4 (but it will gain from the production cuts of polysilicon in China, although these seem to have been priced in already).

Yingli (NYSE:YGE) disappointed on shipments and earnings but at least it was still profitable for the year (2011). Suntech (NYSE:STP) is suffering steep losses mostly through write-downs. And what's more, a turn-around for any one of them might not be that imminent.

For that to happen, at the minimum the average selling price (ASP) needs to stabilize. This is crucial to break the following downward cycle:

  • Cost cutting and efficiency gains proceed at less than 10% a year, if ASPs falling faster there will be further margin erosion and
  • Further inventory write downs and dumping, which erodes ASPs further

Here, from the Trina Solar (TSL) Q4 CC:

As our quarterly cost reduction was not sufficient to offset low ASPs, this adversely affected our profitability.

There isn't much more to it.

There is another cycle going on, and that is the dynamic between falling ASPs and the reduced need for subsidies and increased cost effectiveness of solar energy vis-a-vis other energy sources:

  • The more ASPs fall, the more countries can reduce their subsidies, which many (mostly in Europe) are doing with some gusto
  • However, if ASPs fall enough, the geographical area where solar can, without subsidies, compete with other sources of energy increases, so there is light at the end of the tunnel here, even if opinions differ quite substantially about how competitive energy from solar cells really is.

Here is what Trina had to say on this topic (again from the Q4 CC):

Solar now compares favorably against other alternatives, such as wind and is below user rates for an increasing number of markets and user categories. We believe this as a positive trend, improved (inaudible) a great opportunity for our company and the solar industry in the future.

Some interesting market implications
Not everybody agrees with that view from Trina above. See the rather scathing opinion from Bjorn Lomborg, on the cost of the German solar policy, paying three times as much for electricity as the Americans, leading to a cost of $175,000 per job created and a negligible reduction in greenhouse gasses (according to Lomborg). Cost might not be the most important disadvantage solar energy has to overcome.

However, solar is getting wind energy in sight, as it is virtually impossible for the latter to reduce prices by 50% in a year (efficiency improvements run in the low single digits and the market is much more balanced, precluding the kind of price swings we see in solar).

Also, within the solar sector itself, there are a few remarkable things going on. The shifting competitiveness of photovoltaic versus concentrated solar power (CSP) is getting the latter in trouble, but this has been going on for some time. Both CSP and wind energy are unable to make this kind of quantum leaps in price (even if it comes largely out of margins).

The most notable development is that erstwhile cost champion First Solar is coming under pressure. While the crystalline producers suffer from bad quarters (or years) profit wise, at least the first tier producers keep their plants occupied and a few, like Trina, manage to surprise on the upside with shipments. Companies like Yingli (YGE) have serious expansion plans, it aims at increasing capacity by over half this year.

For the top of the crystalline segment demand is still growing, they can keep their plants busy, work off their inventories and legacy polysilicon contracts. However, whether they will be turning a profit remains very much to be seen, that really depends on ASPs stabilizing.

This is the best part of the solar sector, at the thin film segment where First Solar is operating, things look distinctly bleak. According to an excellent article by Seeking Alpha contributor Robert Dydo, they do no longer seem to have a cost advantage over the top tier crystalline producers. Since their cells are some 30% less efficient in conversing solar light to electricity, this put them at a distinct disadvantage.

No wonder that First Solar is not producing at full capacity:

First Solar expects to run its existing factories in Ohio, Germany and Malaysia at just 60 to 70 percent capacity this year, amid weak demand for solar panels and a glut of panels on the global market

If the likes of Yingli can expand by half this year, we're really not convinced weak demand is the problem. It looks like First Solar is hitting a serious bump in the road and with their more mechanized production process, it's difficult to see whether they can keep up with the crystalline sector.

What would benefit First Solar no end is a bump in polysilicon prices. A couple of years ago, the shortage of polysilicon and associated sky-high prices gave the thin film sector a distinct competitive advantage over the crystalline sector. But poly prices have fallen by some 90% in a couple of years and the shortage has turned into a glut.

Such a glut, in fact, that the big Chinese poly producers are cooperating to restrict supply, but this will not be more than a temporary measure.

With unexpected losses and factories operating well below capacity, First Solar's woes seem all to real. However, there are studies arguing that American solar producers (where thin film technologies in general and First Solar in particular dominate) have a cost advantage of some 5% over the (largely crystalline) Chinese producers if you include shipping cost. These findings could lead to the slapping of tariffs on Chinese solar imports. Trina Solar is already reserving $3.3M for this eventuality.

Stabilizing ASPs
How to stabilize ASPs is basically a collective action problem not unlike the one facing OPEC. All the players have an incentive to cut capacity expansion and reduce output, however, each individual company has an incentive to renege on such arrangement and to win future market share at the expense of the competition.

ASP has now fallen enough to:

  • Make most solars unprofitable, even bellwethers like First Solar and Trina Solar
  • This leads to stark losses and forced expansion reductions
  • A shake out in the industry, where smaller, higher cost players cannot stay afloat
  • Collective action like the joint production cuts of Chinese polysilicon producers
  • And, as we already mentioned above, lower ASPs lead to a more competitive position for solar photovoltaics

Trina is expecting ASPs to run in the high 80 (cents per Watt) this year. They need about mid teens in terms of gross margin to break even. That remains to be seen. A bright spot is the growth of the Chinese market, where more than 50 players have stopped producing and the market demand is seen to grow to 5GW, according to Trina. On the other hand, ASPs are a bit lower there.

On the other hand, with the likes of Yingli (50%+) and Trina (30%+) capacity expansion plans for this year and further feed-in tariff cuts in Germany (and elsewhere in Europe), it remains very much to be seen whether the industry can get the supply/demand imbalance back to normal.

Besides China, there are a few other bright spots. Demand outside Europe is still increasing nicely (places like the Middle East, South Africa, India and the like). The inventory overhang in the sales channel in Europe has been cleared out, according to Trina. The best news comes from Deutsche Bank though, according to which solar panel prices are close to the bottom.

But it will take some time to absorb the 47% fall in these prices last year. After an exuberant start to the year (as if the old days were back again), the solar stocks have fallen back. The simple truth is, with solar panels being a near commodity the supply-demand balance is the most critical variable by far in determining profitability.

But with the incentives working on individual companies to expand to profit from the market growth and attempting to take market share from higher cost producers, there isn't any guarantee that the market will balance and the ASP bleeding will stop.

If one really beliefs in solar energy, perhaps the best scenario is for capacity to keep on expanding and ASPs falling further. The shake out will drive the most inefficient capacity from the market and the resulting price falls will grow the market faster. Perhaps it's what the planet needs, but whether investors in solar stock need this is quite another matter.

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