Bullish on Solar Energy, Bearish on Solar Stocks

While dependence on oil, coal, and natural gas for energy source remains a harsh reality for the next thirty years, the trillion dollar question on the next viable energy source remains open. Solar energy, as a renewable power source, zero greenhouse emission, lowering cost, presents a viable and strong alternative.

However, the bulls seems to have run ahead of themselves on solar stocks. Stocks like Suntech Power (STP) and First Solar (FSLR) have retreated from their 52 week high but I forsee further correction in solar stocks in the next few months. I find three important reasons why these two solar stocks are overpriced: irrational growth expectations, margin compressions, and technological challenges.

Demands from Germany have fed into revenues for solar companies, FSLR (95% of sales) and STP (45% of sales) in particular. Companies such as SunPower AG (SPWR) and Conergy AG (CGY) are the biggest customers for STP and FSLR. Both these companies have been beneficiaries of German subsidy programs, which may decline by almost 10% next year. Let us look at some numbers, with $135m in 2006 sales and $300m in YTD 2007 sales, First Solar is currently trading at 43x revenue. With $598m in 2006 sales and $386mm in YTD 2007 sales, SunTech Power is trading at 20x revenue. With all due credits as growth stocks to these companies, can they really pulloff year after year 50-100% growth from Germany alone?

STP and FSLR post gross/net margins of 30/17 % and 40/4 % respectively in 2006. Such attractive gross margins have and would attract many more solar companies into the fray suppressing margins. We have to keep in mind that these companies are produce and integrate modules, where most of the competition in solar has entered and is continuing to enter with improved technology, increased funding from venture capitals and other investors.

Conversion efficiencies of mono/multicrystalline silicon for STP ranges 14-16% while that of cadmium telluride for FSLR close to 10%. These are the lower end technologies and cost efficiencies due to long term supplier contract and non-silicon raw material choices have allowed both STP and FSLR to scale up their operations. CIGS, Polycrystalline Silicon (used by SPWR), and multijunction concentrators provide 2-5 times conversion efficiencies.

Can FSLR and STP improve their technologies and geographic focus? Maybe. In the near future? No, because currently they are focused on selling more of what they have. The U.S, the heavyweight that can provide geographic diversification, is slow to embracing solar for now in terms of federal regulatory support.

Disclosure: none

Comments

[SmartGuySto...:]

I think you are correct. Although high fliers can act irrationally for a very long time, solar stocks face mounting issues in the face of absurd valuations.

2008 Jan 14 01:11 PM

[David White:]

I am not sure where you are getting your data from. The solar power conversion hierarchy is polysilicone (highest), CdTe, CIGS -- at least so far. CIGS has the potential to be higher than CdTe, but it is not so far.

2008 Jan 14 01:15 PM

[kevintx:]

needs improvement with typos, out-of-date financials, mixing together unrelated concepts (polysi, CIGS, and multijunction 2-5 times efficiency of CdTe and mono/multicrystalline Si ?)

2008 Jan 14 01:19 PM

[Amit Kumar:]

An economist article, Bright Prospects, dated March 8th, 2007 published conversion efficiencies stats for the CDTe, CIGs, Sil etc. putting crystalline silicon on the top with 25+%.

www.economist.com/sear...

STP FSLR financials and efficiencies are quoted from their 10K 2006 and later quarterly statements. The data is obtained from the most recent filings.

Yes, there are a couple of typos.

2008 Jan 14 02:02 PM

[Harold Kramer:]

You can almost bet that after the November elections there will be a huge positive change in American energy policy. Then sooner or later China and India will come on board (maybe 3-5 years though).

2008 Jan 14 03:08 PM

[The small A...:]

You fail to mention supply problems for potential competitors. You recognize that STP has long term contracts securing silicon supply. Wouldn't new competitors have to pay substantially more based squeezing their margins and making entry a less attractive option? What are your thoughts? Have you done an entry/ margin analysis based on cost of obtaining silicon?

2008 Jan 15 05:10 PM

[Amit Kumar:]

Great point. In any growth industry, margins continue to get squeezed until no player can make an "economic" profit (except monopolies), hence 25-40% margins are not sustainable in the long term.
Silicon producers are beginning to bring capacity online now after watching steady surge in demand for over four years in the solar industry. If that does not happen, STP will suffer as well, from their 10-K : "we cannot assure you that we will be able to obtain supplies from them [long-term suppliers] or any other suppliers in sufficient quantities or at acceptable prices"
FSLR, on the other hand, has long term supply (2-3 yrs) contracts for CDTe but CDTe has one of the lowest conversion efficiencies.

2008 Jan 16 08:55 AM

[Energiel:]

Solar stock is our best hope for a better future, and that's why it's growing so fast!
Company like FSLR is on the right track and other too, what we want is solar panels everywhere ASAP!
Why do you think solar manufacturing are growing so much in Asia it's going to be big, they making big profits.
Get ready for the run !

Just a though from a field engineer

2008 Jan 17 05:03 PM

[The small A...:]

Amit, Thanks for the thoughtful response. Do you see SPWR as one of the better solar plays (once things work out in the markets in general of course)? Do they have enough capital to weather a recession/slowdown?

Thanks,

Reed

2008 Jan 18 01:33 AM