Solar Headwinds, Part I: How Solar PV Is Like Ethanol

Includes: PEIX, STKL, VRNM
by: Tom Konrad, CFA

In May 2007, I published a competitive analysis of the corn Ethanol industry based on Michael Porter's classic Five Competitive Forces model. At the time, Ethanol stocks were flying high, but my conclusion was that "the prospective ethanol investor should be very careful about investing in corn ethanol producers at random." If anything, I understated the case.Ethanol Stocks

This chart shows three ethanol stocks that have survived since 2007. As survivors, they are among the best performers in the industry; several others have declared bankruptcy.

Corn ethanol is not a great business to be in; it's too competitive. If you buy assets at the right price, you can do well, but it's all about timing. A passive buy-and-hold strategy will under-perform the same type of strategy in a less competitive industry. Companies in less competitive industries can maintain higher returns on capital for longer periods.

Solar Manufacturers

It's not a secret that I'm no fan of investing in solar stocks, although I understand why enthusiasts are seduced by the sector. Unlike corn ethanol, solar PV will likely be a significant part of any future sustainable energy mix, but that is not the same thing as saying that today's solar stocks will be good long-term investments. Americans watch more television today than ever before, but were network television stations a good investment over the last 20 years? No, because new entrants came in and stole their audience: the industry has become much more competitive than it was 20 years ago.

Thinking that today's solar stocks will do poorly over the long term is not the same as thinking that the solar industry will flop. Rather, it is the belief that increased competition will drive down returns at existing companies. This will be great for buyers of PV panels, but not so great for owners of PV stocks.

Porter's five competitive forces model of competition bears this out, just as it did when I analyzed the corn Ethanol Industry in 2007. The next article in this series will take a look at the five forces, and how they apply to solar PV manufacturers.