First Solar (FSLR) shares rallied 13% on news of LA County Department of Public Works approving their solar cells in the construction of a 230 Megawatt plant in Antelope Valley. Prior reports of First Solar retaining a factory in Germany (instead of closing it down) was widely considered a positive demonstration of resilient demand for photovoltaic cells and sent First Solar shares 21% higher. Unfortunately, investor exuberance based on these events is misplaced. Austerity at the national and municipal level will curtail investment in such projects. Moreover, problems faced by First Solar and by its industry should give pause to solar bulls.
Solar Industry Burns Investors
The solar industry is treacherous for investors. For example, consider how the thin-film solar cell producer Konarka filed for bankruptcy in June. Other firms are expected to follow suit. This was not a one-time event, and many would-be customers need some assurance that service and warranties are made good in the future. Third-party insurance coverage is now being sought by clients to cover the multi-decade guarantees offered by financially shaky solar firms.
First Solar is not immune to project short-falls. First Solar's AV Solar Ranch 1 is behind schedule and has been asked to replace some of its cells by the L. A. County supervisor. One hundred and twenty of the two hundred forty person staff have been furloughed from the project.
Geocentric Solar Economics
Solar systems are an alternative to marginal sources of electrical energy, primarily coal and natural gas. Hydraulic natural gas fracking presents a real challenge to the economics of solar, which is predicated on flat or growing energy prices, rather than declining ones.
Worse yet, the price of installing solar systems may rise, curtailing sales. The precipitous decline in photovoltaic cell prices is not destined to continue indefinitely. In the words of the economist Herbert Stein, "If something cannot go on forever, it will stop." The price of deploying solar systems is likely to go up based on US tariffs on foreign solar cells, which will be a problem for firms which depended on Chinese cells or Chinese components in their systems. Many firms have proposed strategies to cope with this external shock. For example, Suntech Power (STP) plans to avoid US tariffs by using US-made cells. Prices for solar systems will also go up as commodity inputs for specialty semiconductors go up. Spending on solar power systems is likely to be curtailed based on likely future increases in system prices.
Oddly, tariffs may not dissuade foreign suppliers. Chinese LDK Solar (LDK) intends to continue supplying solar cells to the United States, regardless of the tariff. The consequences of the tariff are not clear, and the past trend in declining solar cell prices may be interrupted in the near future.
The thesis for private-sector solar investing is not likely to strengthen. Instead, solar manufacturers are dependent on government subsidies in an era where advanced economies are being cornered into austerity programs.
Given these headwinds, solar firms should be consolidating operations. Layoffs, furloughs, and restructuring are hard, but are often the best courses of action for shareholders. Yes, layoffs are terrible for employees. However, busywork and redundancy is ultimately bad for the economy as a whole. Unfortunately, businesses often fall short of laying off employees according to plan. First Solar is no exception, and has reversed a decision to close down a German plant. The closing of this facility was supposed to be part of a global cost-cutting play which would reduce staff by 30%. Investors should be concerned about management discipline.
Alternatives to First Solar
The review of price-to-earnings, price-to-sales, and price-to-book ratios reveals that most other solar firms which are less attractive than First Solar:
Yingli Green Energy
The one company which sticks out as a cheap, safer solar stock is SunPower. This firm has a lower price-to-sales ratio than First Solar and a comparable price-to-book ratio. More importantly, it was profitable over the last twelve months, making a price-to-earnings ratio calculation possible. (None of the other firms on this list had positive earnings over the past twelve months, which resulted in incalculable price-to-earnings ratios.) Like First Solar, SunPower is a safer alternative to most of the stocks on this list because it has a much lower debt-to-equity ratio. It is also domiciled in the United States, which makes it less vulnerable to the political risk of protectionist policies.
Investors should note that actual profits and price-to-earnings ratios are common among conventional energy stocks:
Each of these conventional energy stocks is attractively priced. Chevron, which dabbles in solar installations, is attractively priced and has a solid balance sheet. Chesapeake is trading below book value. ConocoPhillips is trading at price-to-sales multiples which is lower than those of First Solar or SunPower. Clearly, investors do not need to expose themselves to the distress of the solar industry to find bargain prices in energy stocks.
Macroeconomic headwinds of cheap conventional energy and government austerity adversely affect solar firms. The operations and profitability of SunPower during these difficult times have demonstrated that it is a more resilient investment than First Solar. Investors who which to play the energy sector should consider cheap, conventional energy stocks and SunPower as components of their portfolio.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.