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Deepak Kumar
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Individual investor with keen interests in equity markets. Currently I work as a managment consultant, focusing on renewable energy industry. With my engineering background and work experience in semiconductor and renewable energy industry, I focus on these industries for my investments.
  • Chinese Solar Manufacturers Offer Good Return Potential At Current Valuations.

    In 2013, Chinese solar companies were among the best performing equities. Some even increased by more than 500% over the year. This year, however, the same companies that performed so well in 2013 have not been able to hold their ground. The solar industry has gone through a massive transformation in last three years. Solar manufacturers suffered from a severe price decline of up to 70% from 2011 to 2013. Since 2012, companies cut costs aggressively and with increasing capacity utilization most of the manufacturers have been reporting positive margins since Q3/2013. This trend fuelled the rally in solar stocks last year. For most of the companies, this trend has continued into 2014 but stocks have not continued to appreciate. For any investor looking at solar industry at this point, the obvious question is whether this trend will continue or not. More important than this is the question whether these companies are still undervalued after the massive rally in stock prices last year.

    First of all any investor investing into solar should define its perspective and time-horizon. Looking at the short-term perspective, one needs to only look at the supply and demand dynamics of the industry to determine the trend of prices, which will ultimate determine the profitability of these companies over next 1-2 years and hence the market valuation of these stocks. To assess the short term opportunity in these companies, I have analyzed these dynamics and estimated reasonable valuations for the companies below. Regarding long term investors looking for quality companies, value can be compounded above market return only if these companies can build a significant sustainable competitive advantage and can generate return on equity, which is higher than the cost of capital. To determine long term competitiveness, I employ Porter's five forces to assess whether these companies can build and maintain a competitive advantage and whether a long term investor looking for quality stocks should consider this or not.

    Consideration for short term: Industry demand and supply

    Demand for PV installations has been growing at a double digit rate over the last few years. Total demand for 2013 was approximately 37 GW. Most industry analysts project demand to grow continuously going forward. Analysts expect demand for 2014 to be around 45 GW and increasing to above 50 GW by 2015. The declining cost of solar power generation is the main driver of this demand growth and has made it a very attractive source of electricity in many locations around the world. Solar power also helps countries to become increasingly self-sufficient in meeting energy demand, while reducing the greenhouse gas emissions. As the cost of solar power generation declines further, solar installations are likely to grow continuously over next years with some analyst predicting it to reach over 100 GW annually by 2020.

    As mentioned above, the solar industry saw a rapid increase in supply due to massive capacity expansion by Chinese manufacturers in 2009-2012, with estimates of a total of 50-60 GW of manufacturing capacity installed by 2012. With PV demand of only around 22 GW in 2011 and 30 GW in 2012, prices for solar panels plummeted by more than 65% from 2011 to 12. This led to the financial distress and closure of a large number of solar manufacturers, especially in Europe as these manufacturers had large cost base and too small capacities to compete with large Chinese suppliers that had the latest equipment. This cycle of industry consolidation had its toll even on Chinese manufacturers as even one of the largest Chinese manufacturers, Suntech, went bankrupt in 2013. With the rationalization of supply, liquidation of inventory and pick-up in demand, prices have stabilized since 2013. Prices have stabilized at low levels, however, meaning only companies with large scale and good cost structures are currently able to manufacture profitably. Most of the tier-1 manufacturers have been running at close to 100% capacity since Q3/2013.Because most of the large manufacturers have avoided any further capacity expansion, prices are expected to remain stable over next 1-2 years. In addition, there are two factors that will limit large increases in prices: idle capacity, which becomes productive at higher price levels, and demand elasticity as many emerging markets are price sensitive and any increase in price can cause growth in demand to slow down. Manufacturers will try to employ differentiated prices across different regions to ensure maximum profit by running factories at full utilization. This could result in a significant increase in prices in markets with low demand elasticity compared to markets with high sensitivity to prices. Overall, only in the case of a significant supply shortage, prices may go up in the next 1-2 years.

    With improving demand and rationalized supply, prices are expected to stay in a range that will allow manufacturers to make money over the coming years. Can these manufacturers increase their profitability further over the next years by taking advantage of the expected demand expansion?

    Sustainability of competitive advantage

    To assess the long-term profit potential of these companies, I analyzed their competitive advantages using porter's five forces. I will look at this from the perspective of large integrated Chinese manufacturers.

    Supplier power: Polysilicon manufacturers control the supply of polysilicon. But this industry has also been suffering from oversupply in last two years. At present, there are many suppliers of polysilicon globally with ample capacity and therefore prices are unlikely to increase significantly. Building a new plant, however, takes up to 2 years and large investment, so polysilicon supply bottlenecks are possible in the future. With numerous suppliers serving the market, I think supplier power is limited, but in medium to long term, this could change.

    Customer power: Solar modules are commodity products and most of the installers can choose among different products easily. Customers are very price-sensitive and can easily switch between module suppliers. Very high efficiency modules do command a premium in the market, but as more and more companies start offering high efficiency modules, these modules will also lose the differentiation they enjoy at the moment. So overall customer power is significant in this business and poses a challenge for PV module manufacturers.

    Threat of new entrants: Many suppliers entered the business in last years as technology was easily available and anyone with deep pockets could buy the turnkey lines from equipment suppliers. Technology is still readily available and new entrants can easily gain access to the module manufacturing equipment. With rise of multi gigawatt factories, however, new entrants will require large capital to achieve the economies of scale required to compete with incumbent suppliers. Futhermore, building a brand takes time and will require large investments from new entrants. These factors limit the threat of new entrants; therefore, I gauge this as a slightly positive factor for large remaining incumbents.

    Threat of substitute: Compared to other renewable technologies, solar is the most promising technology in terms of cost potential. Wind is cost competitive but can only be deployed in large scale and that will limit the scalability and reach of that technology compared to solar. With rising fossil fuel prices, solar is well positioned to become even more competitive in future. So overall I gauge this as a very positive factor for the whole industry.

    Competitive rivalry: Solar manufacturing space is very fragmented with large number of suppliers competing at each step of value chain. With limited innovation potential and little differentiation, industry rivalry is likely to remain high in future. Fast growing demand will reduce the competitive pressure occasionally, but in times of oversupply manufactures will compete on prices as the key differentiating factor. Overall I gauge this as a negative factor for the manufacturers.

    The Porter's Five Forces analysis indicates that the solar industry structure does not seem very favorable for the manufacturers. With this kind of industry structure, manufacturers are unlikely to generate returns above cost of capital over long period of time because any significant increase in margins, will attract new investments from existing players and will limit the profit potential in the long-term. That said, there will be winners and losers in the industry over time and investor returns will depend heavily on the ability to identify the companies that will be ahead of curve in the industry cycles. Companies with leading cost position, good capital structure to endure the rainy days and strategy to look beyond the immediate future are likely to survive and generate good returns for investors in the long-term.

    Valuation:

    Base case for valuation:

    Demand for solar PV is set to grow at double digit rates over next years. But manufacturers are unlikely to add significant capacity unless they can earn more than their cost of capital on those capacity investments. At current PV module price levels, it does not make sense to add significant capacity because the expected return on capital is not high enough. However this will have to change, otherwise there will be no new investment into supply to meet the increased demand. This can happen either through price increases or decreases in costs, which will make investment into new capacity profitable again. Under this scenario, one can look at the replacement value of the existing capacity to estimate the minimum fair value for these companies. In estimating this, we need to make sure that existing capacity is in good working condition and will be competitive in the future. In my opinion, this can provide a good base for the valuation of companies in such an industry, where demand is expected to grow significantly and supply can be added easily.

    Currently Investment for new capacity additions are in the range of $300M for wafer, $200M for cell and $100M for module lines of 1GW. With these assumptions, I derived the following valuations for the leading solar PV manufacturers.

    in $ millions

    Replacement value of equipment

    Debt-Cash at end of Q2/2014

    Implied equity value from mfg assets

    Yingli (NYSE:YGE)

    1840

    2009

    -169

    Trina (NYSE:TSL)

    1460

    383

    1077

    Renesola*(NYSE:SOL)

    915

    652

    263

    Canadian**(NASDAQ:CSIQ)

    810

    418

    392

    Jinko (NYSE:JKS)

    1000

    716

    284

    Hanwha SolarOne (HSOL)

    650

    655

    -5

    JASolar (NASDAQ:JASO)

    1200

    150

    1150

    * Polysilicon capacity was not considered due to lack of cost-competitiveness

    ** 700MW wafer capacity assumed

    Some of these companies are also developing solar projects and have large exposure to that business. This makes it complicated to assess the company value. To adjust for that, I have added the potential value of the existing project pipeline of projects mentioned in earnings reports by these companies.

    in $ millions

    Implied equity value from mfg assets

    Project assets on the balance sheet

    Estimated value of project pipeline for next 2 years

    Implied equity value

    Current market cap on 17/10/2014

    Yingli

    -169

    227

    400

    458

    497

    Trina

    1077

    51

    250

    1378

    744

    Renesola

    263

    73

    0

    336

    248

    Canadian

    392

    590

    900

    1882

    1519

    Jinko

    284

    381

    250

    915

    697

    Hanwha Solar One

    -5

    0

    100

    95

    179

    JA Solar

    1150

    0

    100

    1250

    481

    Based on this very coarse yet conservative analysis, I think Jinko, Canadian, Trina, Renesola and JASolar offer very attractive investment proposition to investors.

    Other considerations in valuation:

    For companies with a leading cost structure, one could argue that their capacity should be valued higher than less competitive players. This argument will certainly hold true in the case that the company can hold to this edge in future. Given the nature of PV manufacturing, however, it is normally difficult to count on that. Looking at the recent quarterly results, Jinko Solar appears to be an exception because it has been posting superior cost numbers for some time now. For the project development business, it is difficult to assess the future potential, but again from the track-record of companies, the strategies of Jinko and Canadian seem to have been the most successful. There are also other factors like quality of management, shareholder friendliness and business strategy that can differentiate these companies from one another. Based on the track-record of these companies, Canadian and Jinko have demonstrated better strategy and shareholder perspective in the past. Trina and JASolar also have good management teams in place and seem to be moving into the right direction. One downside of Trina and JASolar, however, is their history of diluting the shareholders in spite of having low debt levels compared to other Chinese companies. That might explain the large gap between the current market cap and implied equity value for these two companies. But given the large upside potential, these might prove to be a good investment.

    Conclusion:

    Given the vast growth potential of the solar industry and low valuation of some of the most successful companies, these companies offer attractive opportunities for investors. Holding these companies for the long-term might not work, but current prices certainly offer a very attractive opportunity for investors looking for an attractive return in the short-medium term. It will be difficult to predict the exact time period over which these returns can be realized, but given the continuously increasing demand for PV modules I expect this to be between next 3-6 months under normal market conditions.

    Disclosure: The author is long CSIQ, TSL, JKS, JASO.

    Tags: solar
    Oct 29 4:41 PM | Link | Comment!
  • Valuation Of Solar Stocks..a Simplified Approach

    Solar companies have been losing money in last two years and any forecast of future profitability relies on many assumptions on demand and supply. In this kind of environment, it is difficult to value solar stocks with any traditional methods like DCF or P/E multiples. But most of the industry analysts agree on one thing that solar industry will continue to grow due to increasing competitiveness of solar energy compared to other energy sources. With this assumption, one can safely assume that industry will need to increase the production capacity at some point of time in future, though exact timing of this will depend on the evolution of demand relative to existing supply. At current price levels, it will make not any sense to add capacity as returns on the investment do not justify new investments. But if demand is set to grow, this will have to change. This can happen either by increase in prices or decrease in costs, which will make investment into new capacity profitable again. Under these assumptions, one can look at the replacement value of existing capacity to estimate the minimum fair value for these companies. In estimating this, we need to make sure that existing capacity is in good working condition and will be competitive in future.

    Investment for 1GW of new capacity additions are in the range of $400M for polysilicon, $350M for wafer, $250M for cell and $150M for module lines. With these assumptions, I could derive following valuation for the leading manufacturers of PV modules.

    Company

    Replacement value of equipment in $ million

    Enterprise value as of July 27 2013 in $ million

    Equity valuein $ million

    Up/down side potential in equity value

    Yingli

    1830

    2669

    628

    -134%

    Trina

    1380

    1013

    525

    70%

    Renesola*

    1340

    996

    371

    93%

    Canadian**

    1110

    1162

    597

    -9%

    Jinko Solar

    900

    715

    286

    65%

    Hanwha Solar One

    845

    894

    293

    -17%

    JA Solar

    1245

    742

    344

    146%

    REC

    1800

    1365

    1073

    41%

    * Only 5000MT of polysilicon capacity assumed as new plant still not operational.

    ** 1GW of wafer capacity assumed though 600MW of capacity is in JV with GCL.

    This is a very simple analysis and does not take into account various factors, which can be significant in defining the profitability of different companies, but I think this certainly gives a first order estimate for the valuation of these companies. Except Yingli, most of the solar companies seem either fairly or under priced. In case of Canadian Solar, one also needs to consider their EPC business, which is quite large and can provide significant upside to the valuation. Based on this simple analysis, I can safely conclude that at current price levels, in spite of large gains this year, solar stocks are still largely undervalued.

    Disclosure: I am long TSL, SOL, CSIQ, HSOL, JASO, JKS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Tags: long-ideas
    Aug 04 11:11 AM | Link | Comment!
  • Valuing Solar Stocks

    Valuing stocks in the fast-moving industries has always been challenging and becomes even more challenging if the industry is less mature and still evolving. Solar industry fits to both of these criteria as industry is still new with most of the public companies with history of less than five years and industry moving very fast. This has direct implication on how market participants behave when it comes to stocks in solar industry. With little history and continuously evolving industry, market participants hold very diverse views on the industry's future and this has been the key driver of high volatility seen in the stock prices of solar companies.

    With solar energy becoming more competitive to conventional energy, fossil fuels facing the limitation in terms of meeting the growing energy demand and environmental concerns related to fossil fuels, there is a wide spread consensus on that deployment of solar PV will continue to grow in future. Though when it comes to how fast that growth will be and who will be able to profit from this, there is quite some difference in opinions.

    After the recent turmoil in the industry, largely due to the overcapacities built in China, I think valuation of the solar companies have to be based on the short-term survivability as well as on the long term profitability and growth opportunities for the companies active in this market. In this and few other upcoming articles, I will try to present my views on how these companies can be valued in the most reasonable way and will try to assess the current investment opportunities in this market.

    Short-term survivability is important and seems to be the most important criteria in the valuation of solar stocks lately. With massive price decline, most of the companies are barely able to cover the cash cost of manufacturing at the moment and hence are losing money at the moment. Since many of these companies had taken large debts before to expand capacities, ability to service that debt is the key to survive through the current market situation. Some of the companies like Q-cells and Suntech have already succumbed to this and few more might follow the path in next few quarters. So I will be looking very carefully at the current debt profiles of companies to assess the chances of their survival through this phase of industry. Even if company has no significant debt obligation in short-term, high debt levels will be the key to determine the equity value of companies as few of these companies have extremely high debt levels and large share of value generated in future might not come to the equity holders.

    Assessing the long-term profitability and growth opportunities for solar companies is the very challenging and is the key driver behind the current volatility in this market. On the growth opportunities, industry is likely to grow continuously in future with PV installations expected to reach more than 50 GW latest by 2016. Though PV products have become largely a commodity, companies surviving through current phase of industry will have the scale and operational capabilities to defend their market position against any future entrants. Once industry reaches full utilization levels, expected sometime in 2014-15 and needs further expansion, I think current players will be best positioned to benefit from that. Though this might be little far in future, it is important to note that capacity expansion will only happen when industry regains profitability and this might add significant value to these companies. To assess the value of this growth, one needs to determine the future profitability of these companies.

    So now we come to the most difficult part of the valuation, which is the future profitability level for these companies. Of course this varies significantly for companies active in different steps of value chain, so we will need a framework that can address different steps of value chain. Since most steps of value chain have enough number of players active in the market and behave like a commodity, earning windfall profit will be difficult in the long-term unless a company is able to hold a unique position due to its technology (like First Solar). Under this assumption, companies can only expect to earn a reasonable return on capital in the long term as any significant deviation from this will attract more capital within these companies and will reduce the margin. In the short-term for next 2-3 years, we can try to determine the profitability based on the expected development of cost and prices for different steps of value chain.

    In my next few articles I will use the above mentioned criterion to value different companies across solar value chain and assess the investment opportunities in this market. Companies I will cover in next weeks are First Solar, SunPower, SolarCity, Wacker, SMA, Advanced Energy, REC and several Chinese integrated PV manufacturers.

    Disclosure: I am short FSLR, SCTY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Additional disclosure: I am also long on SOL, JASO, JKS, CSIQ.

    Tags: long-ideas
    Jun 13 8:19 AM | Link | Comment!
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