Renesola Should Shine

Solar has been one of the poorest performing sectors over the past month. Waning under the perception that the recent decline in the price of oil, global economic uncertainty and the removal of vital subsidies in key markets would put the solar boom of the last 3 years into a tail spin of falling demand and cost pressures.

Comments from industry insiders painted quite a different picture during Q2 earnings season, with the main players struggling to meet demand and forecasting margin improvements going forward as feedstock costs fell.

With or without the lingering effects of the credit crisis, I predict the picks of the industry to continue to stubbornly book 20%-30% quarterly sequential growth over the next 2 years. The most appealing of these is dual listed Renesola (SOL).

Renesola is a manufacturer of solar wafer's for the likes of Suntech (STP) and JA Solar (JASO). In supplying to the photovoltaic industry rather than the actual implementation of Solar projects, they operate on a different business model, which I believe at this stage at least to offer a more compelling investment case.

They listed on the NYSE on the 29th of January this year at a time when markets were weak. The proposed IPO price was slashed to $13 (roughly half it's UK peak of a year ago) and for the most part since then the company has continued to trade at a significant discount to the sector, despite boasting one of the best compound growth rates.

Renesola have booked an impressive track record of sustained quarterly growth from it's inception in 2005 with a $5m annual turnover to the $600m projected for this year. There was one hiccup during Q2 2007 when eps fell sequentially due to expansion delays and margin erosion. Since then they have beat guidance convincingly with each successive set of results.

The fall in eps between Q4 '07 and Q1 '08 from 0.34cents per ADS to 0.28 cents is explained by the non operational exceptional events of dilution from the NYSE ipo and the company losing it's tax exempt status from a tax rebate position at the start of the year.

A stand out quality from it's peer group is that despite the 500% rise in the principal open market raw material cost (polysilicon), the company has been notably increasing margins since Q4 '07. There are a number of explanations for this and the encouraging sign is that these cost benefits have further to run.

Firstly Renesola is shielded from the rise in polysilicon prices because they enter pre-priced supply agreements. Silicon unlike other commodities is for all intents and purposes is in infinite supply. The problem driving up the prices is the refining capacity which has failed to match the boom in solar demand. This has left at least for the short term an extremely lucrative market in polysilicon manufacture which Renesola will now also be exploiting.

It is hard to gage exactly what impact Renesola's polysilicon factory joint venture will have on the companies profits but with a total capacity of 3000 tonnes (Renesola have a 49% equity share) due to be complete by H1 '09 at the $600 a kg full market price for polysilicon, the potential numbers are quite staggering.

As their rapid expansion continues they are benefiting from economies of scale as their administration cost base declines in relation to turnover.

At the same time they have been making slicing efficiency gains with wafer's requiring 6.24grams of polysilicon per watt down from 6.5 grams per watt in Q4 2007. The company expects slicing efficiency to eventually reduce polysilicon requirement to 6 grams per watt by the end of the year.

By supplying to a multitude of customers with geographical operational spreads, and doing so on long forward orders, Renesola is less vulnerable to the risk of specific withdrawal or tax credit caps that are concerning the current 3 largest solar markets, Germany, Spain and the US.

Subsequent to the NYSE ipo, Renesola achieved a follow on ipo which in retrospect was attained at a comparatively healthy price of $20.5 per ADS. The $185m raised secures the necessary financing to increase production capacity to 1000mw by the end of 2009. With the pain of the dilution out the way, the uplift in earnings from these funds will start to materialize in the next reported results onwards, via increased production capacity and polysilicon production.

R/D costs jumped from $400k in Q1 to $3.5m. This seems a peak figure which will be boosting net margins by its decline going forward. It is hard to put a figure on what sort of payback these research endeavors will deliver, however the company hinted that they had made commercial discovery on the use of the far cheaper metallurgical grade silicon as a feedstock alternative. This has the potential to alter the face of the industry, halving costs and making solar an efficient fossil fuel alternative without the reliance on government subsidy. In such a climate demand would be insatiable.

Forecasts going forward seem extremely conservative – annualized production rate at the end of Q2 was 450mw which would equate to 112.5mw a quarter, yet they are guiding only 92.5mw for Q3. They are also guiding constant margins (as they did previously) this despite the impact of the points so far discussed, particularly the savings that are going to be derived from in house polysilicon production.

For 2009 Renesola is guiding up to 750mw of production. In Q2 of this year they produced 82.5mw which translated into earnings of 38¢ per ADS. They should be able to comfortably beat this target and with a fair wind be earning somewhere around $4 for 2009. That equates to a forward price earnings ratio of under x3, based on yesterday's close of $10.49. (Current broker consensus is lower at $2.41).

The industry profits from large one off investments, which presumably would reach saturation at some point in the future. That date seems a long way off.

Take the 100 giga watt solar 'desertec' project conceived for the Sahara to supply european countries with a portion of there energy demands. It would require the combined current output of LDK Solar (LDK) and Renesola 75 years to complete. I expect the Renesola growth story to continue uninterrupted for the next 5 – 10 years and have a medium price target of $50.

Disclosure: Long SOL