Solarfun Power: Classic Short Sqeeze Setup 32 comments
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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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Buy FSLR 40 points lower.
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.
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.
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).
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.
AH 16:21 $ 20.24 9,019,611