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Almost all of the solar stocks took another hit recently due to the February 20 miss by Suntech Power (STP). This miss was largely due to the higher prices of polysilicone. A notable exception was MEMC Electronic Materials (WFR), which manufactures its own polysilicone. If you are looking for a solar stock to own, this might be it.

However, if you want to play fluctuations, Solarfun Power (SOLF) is a particularly interesting case. On January 24, 2008, SOLF announced the pricing of $150,000,000 in convertible notes. These were priced at $19.13 (about 7.8 million shares at this price or about 16% of the outstanding stock). At the same time, they lent 7.8 million shares to Morgan Stanley to sell to the bond investors to hedge their positions. For instance, bond investors could collect the interest on the note, but short the stock close to the $19.13 price to prevent themselves from losing money as the stock went down in a down market. Apparently this is what has happened. 11.3 million shares are currently shorted. This amounts to about 20% of the float (55.95 million shares). This is a 300+% recent increase in the shorted shares. By contrast, LDK Solar (LDK), whose reputation has been smeared recently, has had a slight decrease in the number of shares that are shorted. Trina Solar (TSL), Canadian Solar (CSIQ) and JA Solar (JASO) are in about the same boat as LDK Solar. STP is only +30% in shorted shares due to its recent miss.

To me, this sets up SOLF as the classic short squeeze play. Some people are pointing to SOLF’s high PE, which Reuter’s quotes as 39.6. However, this is an illusion. The company is a recent IPO, which has only reported 3 quarters of earnings. The first reported quarter EPS were negative. The next two quarters have been progressively better. TD Ameritrade’s mid-range estimate for 2008 EPS is $1.30. For 2009, the mid-range estimate is $1.82. This is taking into account high polysilicone prices. At the close of extended hours trading Friday, February 23, the price of SOLF was $13.85. Using the above estimates, this means the stock is trading at $13.85/$1.30 = 10.65 2008 earnings. For 2009 earnings it is trading at a FPE of 7.6. This is a very low multiple for a fast growing stock. It seems clear to me that it should be trading at a higher multiple. Let’s do a quick comparison to some other solar stocks.

NOTE: Data are from the close of trading Friday February 13, 2008 (from TD Ameritrade).

click to enlarge

What is likely to happen? When the new solar stocks finally get around to reporting earnings for the December 2007 quarter, the EPS estimates for 2008 and 2009 will become more visible. All (or virtually all) of these stocks seem to be on the same fiscal reporting calendar, so comparisons are easy to make. LDK will report today after the close. It sells its product far ahead. It also contracts for polysilicone reasonably far ahead. It should report a meet or beat Q4 for 2007. This should stabilize the solar market. The future earnings figures should start to sent the solar markets higher. As you can see from the table above, SOLF is one of the most undervalued of the solar stocks. It is the most highly shorted of the solar stocks on percentage basis. This is partially due to the fear that the convertible notes (due in 2018) may soon be exchanged for stock. They would then dilute shareholder value by about 16%. However, the stock has clearly gone down much more than this recently. On January 4, 2008 it hit a high around $38. That is probably unrealistic in today’s market. However, a 2008 PE of 20 seems reasonable. This would translate into a stock price of $26. Even if you subtract 16% from that (all of the possible new shares due to the convertible notes), you get a stock price of approximately $22.

You can buy SOLF (or SOLF options) before LDK reports, or you can wait to ensure that LDK’s results are good. Either way you will likely make money on this play. SOLF is one of the best current values in the solar arena. Even with the extra 16% of shares possible due to the convertible notes the PE values for 2008 and 2009 are excellent. The values in parenthesis are values calculated based on 16% more shares of SOLF stock. The hedgers are penny pinchers. They are trying to get their 3.5% out of their convertible notes. They will buy back their shorts as soon as the price of SOLF starts to rise. They will not want to take a chance on losing money. It is probably a good idea to stop listening to those trend following folks (fools?) at Fast Money about SOLF right about now. SOLF is just too big a bargain. LDK supplies some of SOLF’s wafers in fixed cost long term contracts. Those prices will not go up, even with higher polysilicone prices. SOLF sentiment should benefit from an LDK meet or beat result. This should lead to quite a buying spurt. Those hedgers account for about 70% of the short interest in SOLF. I should note that even conservative Standard and Poors gives SOLF a 4 star rating.

LDK, TSL and CSIQ look like good plays too. They should all benefit from LDK’s earnings report. They all have extremely good future PEs. They all are growing quickly. JASO’s numbers are not quite as good, but JASO is well liked by the analysts. It should do well also. However, none of these four stocks have the short squeeze set up that SOLF does.

Disclosure: Author holds a long position in SOLF

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This article has 32 comments:

  •  
    LDK beat EPS estimates and revenue estimates in their announcement this afternoon. LDK reported EPS of $0.44 vs. and expected $0.41 per share. The revenue was also a beat with $192.8M vs. an expected $183.1M. Last quarter LDK got knocked after reporting good earnings for their margin loss. This time their margin loss was expected. The margin results were pretty much inline with analysts expectations. There was a decrease in gross margin in Q3 2007 to Q4 2007 of 0.7% (30.8% in Q3 vs. 30.1% in Q4). This is a far cry from the margin erosion that took place between Q2 and Q3. The fact that the margin erosion is slowing or stopping is excellent news for LDK and for the industry in general. This news ought to buoy the solar market, specifically the polysilicone based solar market. It ought to be good news for SOLF. I will hope my short squeeze scenario plays out. As always this will to a great degree be dependent on the performance of the overall market. However, the picture is looking good at this point. LDK and TSL were both up nicely today. SOLF was up slightly. My thinking is that SOLF and CSIQ will join the parade in a more major way tomorrow if the overall market performance allows. At the least this result should kill any further downward movement. Buying the SOLF stock itself is probably a great risk/reward play at this point.
    2008 Feb 25 04:53 PM | Link | Reply
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    LDK also guided higher for Q1 of 2008. Further YOY revenue was up 212% from Q4 2006 and profit was up 119% from the same period. Guidance for the full year was unchanged. Still you have to keep in mind that LDK is being ultra conservative in their guidance these days. After the accusations of last fall, they have to be. If you read between the lines, this likely means that LDK will beat their full year revenue and earnings estimates for 2008 by a fair ways. Good news for LDK and for solar stocks!!!!
    2008 Feb 25 05:39 PM | Link | Reply
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    You probably aren't paying attention to the 10+% growth rate in the Chinese economy lately. There is very little fraudulent about most of the Chinese companies. The labor is relatively cheap, and they work relatively hard. Many of their top scientists and engineers are U.S. or European trained. The Chinese solar stocks are much better values than most U.S. solars. Just compare the 2008 PE's to get a good picture. In hard times people look harder for value. They shop at Costco and Wallmart. They buy bargain Chinese solars as opposed to expensive U.S. solars.

    This play is relatively simple. Some people bought convertible SOLF bonds when the market especially the solar market was going down. Since these are convertible into stock (i.e. when redeemed they will dilute shareholder value), they knew that this would tend to drive the price of the stock downward in a downward trending market. To ensure that they didn't lose a lot of their equity, many (if not most) then sold short the shares supplied to Morgan Stanley for this purpose. They felt safe in doing this because they knew that the extra shares flooding the market would drive the price of the stock down still further in a down trending market (a double whammy). They got further help from a miss in earnings by STP.
    Now the situation has changed. LDK has reported a beat with a guide upward for Q1 2008. The price of SOLF stock is now a relative bargain at say 11 times 2008 earnings. The market has stabilized a small amount. The actions by the Fed and the Congress are having some effect. Some people are now unsure at least that the economy will fall apart (see Phillip Davis's article today on SeekingAlpha). The solar companies are global companies. The U.S. business is not even a large part of their business. Europe is a bigger customer. The Chinese economy is chugging along at a 10+% rate. The global business model, fast growth stocks with bargain basement valuations are positioned to go up in value. Examples would be the recent move up of such stocks as DRYS and TBSI. With oil prices very high, it is time for the bargain valued solar stocks to move up. The bond buying shorters will likely as a group decide to take their profits at this point. They will buy back their shorts as value buying kicks in. Combine the short covering with the value buying; and then SOLF should make quite a quick jump in price in the near term. If you buy the stock instead of options, it is a solid long term buy. You can be reasonably certain that you will be able to sell it for a profit in the not very distant future.
    2008 Feb 25 08:30 PM | Link | Reply
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    Are you sure about the EPS numbers? Weren't those listed in another currency?
    2008 Feb 25 08:47 PM | Link | Reply
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    No SolarFUn for you Baby. Stick with STP or FSLR
    2008 Feb 25 10:57 PM | Link | Reply
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    User131880: I am sure these are the estimates on TD Ameritrade. They are definitely in U.S. Dollars. The estimates on Yahoo Finance for 2008 earnings are in yuan I believe. The Yahoo Finance EPS figures for 2008 are 8.68 (I presumed U.S. Dollars when I first read it). The TD Ameritrade figure for 2008 EPS is $1.30. Quite a difference. Don't ask me why Yahoo is doing what it is doing. I believe the TD Ameritrade 2008 EPS figure is accurate (although still just an estimate). Hence the 2008 PE I calculated based on it is accurate also.

    I should further point out that the bond holders will likely cover their shorts because they believe in the stock. They would not likely have bought the convertible bonds in the first place if they did not believe that the stock would in the near future pass the $19.13 level. They are just making extra money by shorting at an opportune moment. Most will not want to try to hold out for a lower low to buy back. They will want to bank their "certain" profits on a stock that they believe has great long term potential. This should provide the short squeeze.
    2008 Feb 26 01:07 AM | Link | Reply
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    DSX Lover: STP had a big miss recently. It is hardly a solar stock to brag about right now. FSLR trades at the highest multiple in the industry. Further there is a scarcity problem with Tellurium, which may impact growth in another year or two. This would make it very hard for FSLR to bring their multiple down within reason. Further Nanosolar (just beginning to produce product) and Miasole (schedule to start production in October 2008) will eventually take the lowest priced honor away from FSLR. They will be competing with all solar makers. However, they will compete more directly with FSLR because it has a much lower energy conversion efficiency than polysilicone solars (and because FSLR is the current price leader). CIGS (Nanosolar and Miasole) are slightly less efficient than thin film CdTe (FSLR). They are much less efficient than polysilicone. Businesses will likely still prefer polysilicone because longer term it is a more cost effective use of their roof space, especially as other energy sources become more expensive.
    2008 Feb 26 01:17 AM | Link | Reply
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    DSX Lover: I further point out that LDK has a lower 2008 PE than STP. There is an even greater beat in 2009. LDK has a lower PEG ratio. LDK beat Q4 2007 earnings estimates. STP had a big miss. With all the accounting attention LDK has gotten recently I am more inclined to believe their figures are accurate than I am to believe those of STP. Why do you think STP is so much better? Was it because it was touted by Cramer? If so, I think he has changed his tune recently to a more value oriented approach in the current hard times. This would mean he might favor LDK, TSL, CSIQ, and SOLF over STP. Perhaps you should ask him.
    This article mostly deals with the short squeeze situation I believe is being presented by the previous recent actions surrounding SOLF. It was hurt by the general market and the solar market downturn. It was hurt by the likely future dilution of the stock when the convertible bonds are converted (about +16% more shares). It was further hurt when investors (probably a lot of whom were convertible bond holders) used the shares lent to Morgan Stanley to effective dilute the stock another 16% by shorting all of the lent shares. This last dilution does not really exist. The market will have an easier time realizing this after the good result from LDK, which should counteract the relatively bad miss by STP. The SOLF growth and earnings numbers are excellent. The stock should move up based on these. When it does so, it is likely that the entire extra 7.8 million shares shorted (over the normal shorting) will be redeemed in order to lock in profits. This will provide an extra boost to the upward movement of the stock. The risk/reward of this short term SOLF options trade is very good. It also does not have to be a short term trade. This is essentially a good buying point for SOLF stock for the longer term also.
    2008 Feb 26 01:41 AM | Link | Reply
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    David,
    You talk of the dilution of the stock if the bond holders redeem ... but is it really dilution? In redeeming the shares they move the bond liability off the balance sheet. This means that the shareholder equity of the SOLF goes up by the amount of the conversion. Hence, the value of an existing is not really diluted. After conversion there are more shares, but there is also more equity. Am I missing something?
    2008 Feb 26 02:07 AM | Link | Reply
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    "David, ur an idiot. You can't trust these chinese gooks and fraudsters: "
    Racist slurs on an investing board?
    2008 Feb 26 12:11 PM | Link | Reply
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    need to be a buyer of SOLF here...

    scott
    growthportfolio
    2008 Feb 26 06:20 PM | Link | Reply
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    David, would appreciate your (and others opionions) on increasing my position in Solar stocks (SOLF, etc) by liquidation of ERTS & or Take Two (Gaming stocks). long term (3 years) where is the better money?
    2008 Feb 26 11:19 PM | Link | Reply
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    User 157068: I actually think LDK is one of the better long term plays. There is a currently private company called Nanosolar. I am guessing it will go public this year. It should do well. It is partially funded by Google. It is another Stanford startup.
    2008 Feb 27 08:17 AM | Link | Reply
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    Bad news today. SOLF, JASO, YGE, and TSL were all downgraded by BAC. SOLF has taken another hit. There seems to be some justification for this. It hasn't yet announced when it will report earnings for Q4 and full year 2007. JASO is scheduled to report on 3-12-08. TSL is scheduled to report on 3-4-08. Both of these results could possibly lead to an upturn in SOLF (or not). The bad mouthing of LDK by the analysts seems to have prevented that from having a very positive effect on SOLF. It was touted as having a positive effect on STP, which missed badly recently. Go figure! STP does have a longer history. To analysts that means it is a more substantial company despite its relatively worse numbers. Hopefully the market will manage a bit of a run up to allow SOLF to recover. Analysts like to downgrade stocks as they are going down, even if they haven't put much reasoning behind their worse ratings. The short squeeze play is still as valid as it was before, probably more so now.
    2008 Feb 27 08:31 AM | Link | Reply
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    User 157068: WFR is another solid stock that has the advantage of the analysts liking it. It is a U.S. company the manufactures solar and semiconductors. It is not a pure play, but it has some of the best margins in the industry. You might want to watch it for a while to determine what price you want to try to buy it at. It has fluctuated in value a lot lately with this wild market. It is currently getting closer to its near term high. It may retreat from its current position.
    2008 Feb 27 08:37 AM | Link | Reply
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    Anyone know if BAC bought any of the convertible bonds (and is shorting SOLF)? This whole situation sounded very professional in nature.
    2008 Feb 27 08:39 AM | Link | Reply
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    User 130899: You are of course correct. The bonds were used for expenses for the company. Converting them would retire debt. However, investors have a tendency to look at the situation differently. They first see only that their interest in the company as represented by their stock shares has been decreased by this action (assuming all shares are converted). Also the pricing of the bond conversion price tends to put a lid on the value of the stock for the near term. It can go above this, but usually not by much. It generally takes anywhere from 3-6 months for the market to forget (or get used to the idea). SOLF could still go up easily to the 18-20 range. The bond buying shorters would likely still buy back their shorts at a much lower price to lock in their profits on the short positions they took. This might drive the prices of the stock above $20. If the general market recovers, SOLF can go substantially higher.
    2008 Feb 27 08:49 AM | Link | Reply
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    User 157068: I should point out that the reasons I like LDK and WFR long term are: 1) they both have substantial long term contracts; 2) they both have high margins relative to the industry; and 3) they both manufacture their won polysilicone (or soon will in the case of LDK). The last should allow both of them to better control costs. This is also generally considered to be a vertical monopoly business model, which usually provides a competitive advantage. Nanosolar is the low cost leader.
    2008 Feb 27 03:32 PM | Link | Reply
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    SOLAR NO FUN BABY. David you're an idiot. Too bad I can't short that Chinese JUNK to Zero. Look at STP yesterday moron!!! That is what you call a Shortsqueeze. When do I buy SOLARFUN now?????? WFR is going down too because of Profit taking, but worth the Risk. Don't bet on Chinese JUNK with Phony Financials, and tricky convertibles with hidden Surprises.
    2008 Feb 27 06:59 PM | Link | Reply
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    LDK is truly setting itself up for a shortsqueeze, just like STP yesterday. Be ready to take your profits on LDK and run.
    Buy FSLR 40 points lower.
    2008 Feb 27 07:01 PM | Link | Reply
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    David: SOLF went down to $12.18 today. Do you think it will go up again to the $18-20 range as you say? Or continue go down more....
    2008 Feb 27 08:02 PM | Link | Reply
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    As long as SOLF is showing earnings of over 8.50 a share that's my biggest concern. Nothing else we can do for now but wait for the quarterly report.

    2008 Feb 28 06:53 PM | Link | Reply
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    Anyone know when they issue the Q4 report?
    2008 Feb 28 07:25 PM | Link | Reply
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    From what I've heard, March 6, 2008
    2008 Feb 28 09:06 PM | Link | Reply
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    Hi David, very interesting article about the potential of SOLF. I'm currently thinking of investing in this or another company in the same industry but am very attracted to SOLF by this short squeeze you mention, so i was wondering if you could kindly address or at least comment on a couple of issues that are bothering me about this company.

    1. I looked at the figures on TD Ameritrade that you quote above and they seem to me to be a little optimistic for SOLF, given that the company had failed to reach TD Ameritrade's predictions in previous 2 quarters. As we are poised on the edge of recession and with the polysilicon supply problems the industry is facing, would you consider that these earnings forecasts are over-optimistic? Can the company really grow earnings by such a large amount on the backdrop of recession, polysilicon supply shortages (and hence high prices) and the fierce industry competition likely to occur in FY08?

    2. In times of recession i gather that investors take a much more cautious approach and look at companies that have achieved good earnings and tend to disregard companies who trade on very high current earnings multiples, usually due to predictions of future explosive growth. With its price currently around 40x expected FY07 earnings could it not be argued that this company may fall even further, and for that matter other similarly highly priced solar companies?

    I realize you are focusing on the short-squeeze issue but i would like to think that even if this short-term opportunity didn't come to fruition that i would still be holding shares in a decent company that isn't over-valued and has longer-term growth opportunities, otherwise i'd just be wasting dealing fees.

    I apologise if my questions are missing something elementary but i have just (a few months) started researching this industry for my own personal investments and i'm not an industry professional.

    Thank you for help.
    2008 Feb 29 02:14 AM | Link | Reply
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    There's been an update on SOLF's earnings. They're now estimated to be at 7.86 for its fiscal year.

    The only thing I can say about that is, someone's keeping an eye on it. So all we need is for this thing to just meet expectation.

    There may not be hydrogen filling stations so far yet to generate interests in buying a fuel cell vehicle, but people can always convert their homes to solar anytime.

    For about the same price as buying a fuel cell car with no place to fill it.



    2008 Feb 29 10:05 AM | Link | Reply
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    SOLF is an ADR representing common shares that trade also in China. The 7.86 estimate is in RMB's, the Chinese currency (yuan) .... to convert to US dollars, divide by 7 .... hence the actual EPS estimate is $1.12.
    2008 Mar 02 10:10 PM | Link | Reply
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    From Wikipedia:

    An American Depositary Receipt (or ADR) represents ownership in the shares of a foreign company trading on US financial markets. The stock of many non-US companies trades on US exchanges through the use of ADRs. ADRs enable US investors to buy shares in foreign companies without undertaking cross-border transactions. ADRs carry prices in US dollars, pay dividends in US dollars, and can be traded like the shares of US-based companies.

    Each ADR is issued by a US depositary bank and can represent a fraction of a share, a single share, or multiple shares of foreign stock. An owner of an ADR has the right to obtain the foreign stock it represents, but US investors usually find it more convenient simply to own the ADR. The price of an ADR is often close to the price of the foreign stock in its home market, adjusted for the ratio of ADRs to foreign company shares.

    Depository banks have numerous responsibilities to an ADR holder and to the non-US company the ADR represents. The first ADR was introduced by JPMorgan in 1927, for the British retailer Selfridges&Co. The largest depositary bank is the Bank of New York Mellon.

    Individual shares of a foreign corporation represented by an ADR are called American Depositary Shares (ADS).
    2008 Mar 03 11:19 AM | Link | Reply
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    Big Tone: A recession in the U.S. by itself should not have too big an effect on most Chinese solar stocks, SOLF included. The reason is simply that most sales are not currently to the U.S.. Typical Chinese company solar sales are less than 10% to the U.S. (5% might be a good ballpark figure). Of course, if the recession spreads to Europe, that is a completely different matter. A recession in Europe would likely hurt SOLF significantly. Right now it looks like the polysilicone prices are going to be the determining factor. Still we keep seeing subprime problem at European banks too. It is anyone's guess what will end up happening. Perhaps Ben Bernanke has a good idea.
    For the moment SOLF looks like a good long term buy, with a great growth potential. It also should get a big lift from the short squeeze when it occurs. If a recession materializes in Europe, I might change my evaluation of the situation.
    2008 Mar 10 07:30 AM | Link | Reply
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    2 David White : Do you have an information about LDK's sources of investments required for construction of a new mill ? If I'm not mistaken they will need abt 1 B for the new mill ...
    2008 Mar 10 02:26 PM | Link | Reply
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    Any signs of a shortsqueeze comming?
    2008 Mar 10 05:54 PM | Link | Reply
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    David, would appreciate your current view on the stock and yesterdays 9M transaction. Thanks.

    AH 16:21 $ 20.24 9,019,611
    2008 Jun 21 08:21 AM | Link | Reply