Suntech Power (STP) is in the business of manufacturing solar modules and is the largest provider of such modules globally. The operating niche for STP is in the middle of the Photo-Voltaic [PV] supply chain. STP is dependent on suppliers to provide Ingots and Wafers, which are essential components in building its modules. The Ingot suppliers in turn depend on solar grade silicon suppliers. The modules produced at STP are then distributed to a variety of business partners including electric utilities, system integrators, installers, and distributors. These modules are primarily used in the On-grid and Off-grid applications of PV systems.
Recently in an interview with Motley Fool’s Rich Smith, Suntech CEO Zhengrong Shi confirmed that the company is on track to achieve a production capacity of 1GW by 2010. This translates to a growth rate of about 28% in production capacity in the upcoming 3 years. Further, lowest-cost production and the best relative technology were touted as competitive advantages. Shi was especially bullish in the company’s long-term prospects. His vision of Suntech claiming 2% of China’s energy needs by the year 2020 is indeed high octane. Based on that, SunTech’s revenue from China alone in the 2020 timeframe will be in the $12 Billion range. These claims are overly optimistic given China’s energy strategy is all but clear. Hydroelectric power generation might turn out to be a big part of renewable energy strategy, per the indications from the National Development and Reform Commission (NDRC) in China. A bear-case scenario zeroing in on the potential overcapacity and demand slowdown in Germany following reduction in subsidies is available at CBS MarketWatch.
The following table is a look at the geographical mix of Suntech’s revenues:
At the EOY 2006, Germany accounted for 42.5% of the revenues and SolarWorld AG singly accounted for 21% of it. German sales as a percentage of total revenue are down from 72.1% in 2004. Sales in Spain picked up significantly to compensate for part of the German slowdown. The 2nd quarter 2007 financials from the call transcript indicates a further shift in the revenue base. Germany and Spain together accounts for 88%, USA accounts for 7% and the rest of the world including China accounts for the remaining 5%. The constant shifting is a result of the company attempting to track government subsidies globally.
Pricing power is a big issue for Suntech because the industry relies on government subsidies. Customers largely base buying decisions on the economic feasibility of installing the PV module. The installed cost of the company’s PV modules is upwards of 35¢ per KWh. This is well above the local utility rates in most areas with a few exceptions (e.g Hawaii). Another factor impacting Suntech’s pricing power is the average sunlight available at any location. For the business model to remain viable, Suntech needs to factor in these variables when deciding on global expansion initiatives.
Silicon wafer shortage coupled with the company’s dependency on it as the base raw material is another challenge for Suntech. To its credit, Suntech has been aggressive in securing long-term supply contracts. Currently 50% of the supply comes from supply contracts and the remaining 50% from the spot market. This supply is projected to grow to 80% from supply contracts by 2010. This strategy works very well in an environment of increasing raw material prices, but can prove disastrous once the trend reverses. Wafer shortage is expected to ease with the acceleration in large scale production in China. The following table summarizes the projected minimum obligations from supply contracts (taken from Suntech’s 2006 annual report) and is an indication of the significant risk associated with the strategy:
The MSK acquisition in July 2006 was expected to pave way for Suntech’s entry into the BIPV (Building Integrated Photo Voltaic) space globally as well as for its expansion in Japan. The 2nd quarter 2007 report indicates that BIPV revenues along with sales in Japan are insignificant. The global revenue from BIPV has the potential to accelerate in the coming years, but growth in Japan is a moot point.
The following table recaps Suntech’s growth since its IPO on 12/14/2005:
NE – Not Estimated
Growth in Revenue, Net Income, Production Capacity, and Production Output are all expected to shrink next year. Production Capacity and Output Growth are expected to be in the 25% range down from about 50% this year. Gross margin has buckled over the last two years as raw material prices as well as competition increased. Suntech’s growth rate should be in the vicinity of 25% annually, given the capacity projections for 1GW by 2010. This would give the stock a PEG ratio well above 1, qualifying as a fairly rich valuation.
Suntech’s products exclusively based on PV cells made of thin film deposits of silicon semiconductors are second-generation technology. Globally, research is underway on the third and fourth generation PV cell technology that could potentially leapfrog Suntech’s technology in both efficiency and price. However, commercial viability of such products is projected to be years away and so this threat can be categorized as a wildcard scenario. To offset such threats a strong R&D commitment is critical. The table below shows how Suntech’s employee count is split up across the organization:
6.2% is a number insignificant for a business that needs very strong R&D. The only silver lining is Suntech’s relationships with certain universities doing research in newer technologies.
All in all, given the magnitude of Suntech’s business issues, under-allocation of resources in the R&D area, and the rich valuation, a long-term investment in Suntech can be expected to yield only average returns.
Disclosure: Author has a long position in STP