Need Cash? See Suntech

Is Suntech (STP) the financier de rigueur for the solar industry?

It sure seems that way.

I have been trawling the internet trying to find details on Suntech’s minority ownership of and loans to a number of their suppliers. I have momentarily given up hope after reading a reference to a Credit Suisse research note on STP. The only comment by the CS analyst not taken directly from the earnings release or conference call was “We raise our DCF-based target price from US$48.0 to US$50.0.”  

Discounted Cash Flow, DCF, is a useful tool for analysing companies with reliable, reasonably predictable long term cash flow. This is pretty much the antithesis of Suntech. Using DCF to value a company like Suntech is ludicrous. There is no way anyone can reliable predict their earnings from one quarter to the next let alone the appropriate growth rates and cash flow over the next five to ten years.

Yet apparently, the CS analyst can predict these things so accurately that they found it meaningful to change their estimate by $2. They are havin’ a laugh, as my English friends would say. 

Why is DCF inappropriate? For a start, STP doesn’t actually have any cash flows. STP is flat out converting their earnings into minority ownerships of silicon providers at a time which surely represents peak margins for that segment of the industry. As I am overweight STP, I sure hope they are getting good deals. Therein lays my conundrum. I have no idea whether STP is investing our earnings wisely.

• Is that 18% investment in Glory silicon a good investment?
• How about that $100 million in to Nitol Solar or the $102 million in Shunda Holdings?
• How about the EUR58 million into the Global Solar Fund?
• Will the $49M in advances to suppliers or the $270M dues from related parties be shown to be wise investments?
• The $187M in long term prepayments may ensure silicon supplies, but will it end up being a good deal?

So many questions, so few answers and strangely no-one seems to be even asking. On the Q2 conference call, not one analyst asked about these investments or the long term loans and prepayments STP has been handing out to their supply chain. So am I jumping at shadows? 

I wish I knew.  

This quarter’s earnings were clearly superb, but in the long term what matters is that their investments in capital equipment and their supply chain continue to pay off. As we are only in the first innings of the world’s conversion to solar, among other alternative energies, STP remains a speculative bet. While Chairman and CEO Shi, as well as the rest of senior management, are clearly confident in the future (next year), I am left wondering why they need to invest so much in their supply chain partners. 

As I have shown disdain for applying DCF to STP, I guess I should say how I do value it. While I generally prefer multi-year time frames with my investments, I consider it folly to look further than one or two years ahead with a company like STP. I look at earnings and what investors are likely to pay for those earnings. I then examine the bear stories and determine when they can realistically become threats and what confirmations I should be watching for.

Lastly and most importantly is investor sentiment. Investor sentiment, not fundamentals, is what drives growth stocks. With growth stocks, I prefer to focus on the voting machine, not the weighing machine.  

The STP Q2 conference call was a bullish game changing call. The picture they painted was so rosy that I can see myself selling those extra STP shares I bought last week within a couple of months. 

I do like STP. I like their management depth, I like their earnings, their improving margins, Pluto and the rest of the R&D. I even I like their Australian connection. Just show me the money or some more details on the investments and loans, and I’ll be a happy camper. 

Does anyone have anything of use to say on STP’s investments and loans?

Disclosure: Author currently holds shares of STP

Comments

[EBud:]

STP is still a developing company. The major conversation about sales focus on the movement to Italy and other European countries. The largest growing energy need in the wotrld is China and then India -- about which there are no comments. I think putting the huge forward developement (and controll) of polysilicon production and the comment of grid parity in 3-5 years is aimed at this market. Yingli Green just announced a 10MW plant near Bejiing -- a toe in the water

2008 Aug 24 10:32 AM

[Wayfarer:]

Thank you. I think you have asked a bunch of very important questions. I don't have very many good answers. My feeling on the voting machine is near term the voting machine and a bear market will drag them down. Passage of a long term ITC will reverse this and begin a long term solar bull which will eventually evolve into the need for a weighing machine. Thanks again.

2008 Aug 24 10:44 PM

[gebby:]

if u think stp is speculative u can sell ur stock. i like the investments. if some dont work others will handsomely.

2008 Aug 25 01:29 AM

[Kinja Rules:]

There is a problem w/over capacity in solar silicon that is expected to cause a 43% drop in the price of solar silicon.

www.ecogeek.org/

3rd article down.

2008 Aug 25 03:37 AM

[ej san fran:]

Dean,
We can only hope that their investment in silicon supply is at a price that turns out to be too high. Why? That would imply there is abundant silicon at low prices that Suntech can mop up to make even more panels, at prices even closer to grid parity.
Grid parity is the key word.
Suntech talks about $0.50/W of 'other' costs on top of silicon costs. It seems to me silicon cost can go down to $0.50/W as well, getting them to $1/W total module cost. That's low enough to be real competition for fossil fuels, allowing the solar industry to ship enormous volumes. This way Suntech has a path to grow their revenue 10x.
Note that electricity prices in Europe are very high (due to the high Euro and the high natural gas price which is linked to the oil price), so grid parity in a country like Italy is not far off.
As of yet I don't see competition from thin film technologies that would derail this plan.
So what's a fair value for Suntech stock? Currently their profit runs at about $2/share; I think they're worth a P/E of 50, so the stock is worth $100/share, growing 50% per year for the foreseeable future.
What if their upstream silicon investments are a failure? It wouldn't change the fair value calculation much, as long as they can get cheap silicon elsewhere.
What about other risk? All sorts of minor problems can and probably will occur, but I don't see a big risk that can cause a total failure here (although it is likely that some day a new, better solar technology will make all current technology obsolete).
Full disclosure: I'm a shareholder.

2008 Aug 25 04:23 AM

[vitamin_j:]

Mr. Morel,

I am surprised that you are investing in Suntech yet seem blind to their strategy and to the demands of the silicon PV supply chain. Are you just reading those bearish (now bullish again) Motley Fool articles and wondering why you bought STP again?

I also wonder if we heard the same CC. Analysts did indeed ask very detailed questions about the investments you mention - how each was doing in production, etc., what some of the details of the investments were in numbers and terms - and the terms of silicon supply prepayments (going down significantly over the year, I'd note).

Whether or not these are "good investments" I suppose depends on your view of the silicon market and business, and of these particular suppliers. Have you looked into Nitol as a company? Glory Silicon? Hoku? Asia Silicon? I have (somewhat), and my impression is that Suntech is buying stakes in the best of the new wave of silicon refiners because it can afford to. These refiners are run by serious experts who are likely to successfully manage the difficult technicalities of silicon production.

I would also say that, while its margins will come down, silicon refining for the PV industry will be a growth business for years to come. So, in buying equity stakes in these companies, Suntech has wisely bought into its own growth along with the growth of the industry. It did this while avoiding having to itself become a refiner - build its own plant, etc.

The result of these recent investments, combined with existing long-term supply deals, is that Suntech will see 20% lower silicon costs in 2009, and costs will continue to decline thereafter. Given that silicon is 70% of a panel's cost, that means that total panel cost will be down roughly 14% in '09. With ASPs holding steady so far or declining in low single digits, that means a fatter gross margin for Suntech, which has secured 900 MW of silicon for its 1000 MW 2009 capacity. They will (along with every other module maker) continue to have significant capex, but these improved margins can only get them closer to being cash flow positive (which they were in 07, I believe). Other silicon PV solar companies cannot say the same for their silicon costs (see Trina), margin outlook, or the resulting ability to organically grow operations.

So my opinion is that Suntech is strongly positioned to succeed in the today's silicon PV business. They also have an admirable long-term orientation. They consistently talk about grid parity - that's when China and India will get in the solar game in a major way - and how they're going to get there. Other risks - a miraculous breakthrough by Nanosolar, a huge (contrary to projections and high demand) decline in the silicon per/kg spot market, drastic subsidy changes - could derail their strategy or put silicon PV out of favor. That's the speculative aspect of solar investing. But for today's money and today's knowledge, I think Suntech is one of the premier solar companies operating today.

Disc: long Suntech.

2008 Aug 25 11:26 AM

[naturallight:]

"For a start, STP doesn’t actually have any cash flows. STP is flat out converting their earnings into minority ownerships of silicon providers"

Little befuddled at this comment...STP does have positive FCF, they're spending it by making investments in other companies.

It's like saying "company X doesn't have any FCF because they used it to pay dividends."

2008 Aug 25 11:53 AM

[Solar Guru:]

Dean's comments are very insightfull. It is clearly foolish to invest in such a high level in upstream value chain when the market is at peak margin for the upstream players specially the poly silicon. Most players of poly silicon are upstart companies with very limited exposure to technology. Nitol, Shunda , Asia Silicon and Glory are all in the same boat. STP has simply over paid these guys just to get long term contract and would have got much lower levels of entries if only they had waited for few more Quarters. May be the pressure of seeing their stock price going down too much and they needed to shore up their supply specially after the disastrous start with Louyang poly silicon where STP was one of the first to sign up. Obviously they have not learnt from their experience and have their money locked up at much higher penalty. May be the slow down in supply from MEMC for last few quarters also might have had an impact on their strategic planner. Overall I find the silicon contracts of STP are all at higher prices than what one would consider as more reasonable long term contracts and during the next down turn in prices they would have lot more to explain. Poly clearly is at a high point for last few quarters and the peak probably was around March 08. With peak behind us the slide is likely to be lot more faster for poly prices and hence the impacts to STP
It is also worthwhile to note that the current peak is also due to multiple levels of poly contracting by cell, ingot and wafer companies which clearly has lead to the current situation of contracts being far in excess of the real demand.
I am neither long or short on solar companies at the moment but do expect the solar stocks to be available at bargain basement prices over the next 6 months and holding my war chest to pick at lower levels. I suppose I do not have to wait long!! May be 4 to 6 months at the max.

2008 Aug 25 11:32 PM

[Dean Morel:]

Thank you for all the thoughtful comments to my article. There are a couple points I’d like to discuss further.
My article was about one aspect of Suntech which concerns me. As a part owner I have weighed those concerns against the opportunity and as I said recently bought more. However, I am not a buyer at current prices.

First let’s talk about falling silicon prices. As ej san fran said solar will reach grid parity at some point. That is total given. The future quantity of solar panels/film/collectors... that are sold is clearly going to be huge. I see little if or buts about that. However, there are scores of industries which have had similar massive growth in volume and yet profitability has eluded most participants. Further for every survivor there has been ten fall by the way side. So volume growth is a red flag to me, not a positive. This is doubly true in a commodity industry like solar is or will become.

So growth will be huge, but as investor we should only care about profitability. Which brings me to falling silicon prices and where I disagree with ej san fran. STP has locked themselves into forward contracts which at current spot silicon prices look attractive. If silicon prices fall below the contracted prices rather than being a plus for STP it becomes a millstone around their neck. As competitors buy silicon at the lower prices they then sell their panels at lower prices. As this is a commodity business with little to no branding power STP is also forced to sell at the lower prices. This kills their margins and despite selling more and more product they fail to increase profitability and perhaps worse. Granted this is worse case scenario, but as an investor that is what I think about as the upside will always take care of itself.

If the upstream investments are a failure then we’ll see large write downs and earnings will be hurt.

As vitamin_j says in his confrontational manner STP is one of the premier solar companies operating today. I think they are the premier company, no argument there. I’ve already articulated my concerns and they have not been clearly addressed by any of the comments. Lots of opinions yes, but no facts, no links, no direct quotes…nothing solid.

I’m out of time so some quick final comments. A big thank you to those who thanked me for my input. It takes time and energy to write and share an article and your thanks is greatly appreciated. It doesn’t matter whether you agree or disagree with my thoughts, being polite and respectful is what matters.

Naturallight I love your handle. You said “It's like saying "company X doesn't have any FCF because they used it to pay dividends."” Perhaps if you look at a cash flow statement and think about that a little more you’ll see the error in your thinking. In short dividends are money in my bank, loans et al are a risk and could go to zero. The loans STP are making appear under operating activities while dividends appear under financing activities. Cash in bank versus possible waste of my money.

2008 Aug 27 08:13 PM