Solar and Cash: The Big Boys Have an Answer - Do You?

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Includes: CSIQ, FSLR, SOL, TSL, YGE
by: The-Yellow-Rose-Street-Beat

Solar stocks, for reasons such as global warming, increasing energy constraints, and a plethora of other factors, have the potential to offer tremendous opportunities. Their volatility can offer further opportunity, as well as significant frustration. A solid understanding of the factors that influence stock price is usually a key to success in trading and investing. This can be particularly true in the solars. This post therefore attempts to shine light into some key issues so that a better understanding may be achieved. On here I want to add some important points my original post "LT Bull Market Solar." I hope this is informative.

Many solar stocks are now cheap based on FY and FWD P/E ratios and PEG ratios. Yet that is not the whole story. Goldman pointed out on the last Trina Solar (NYSE:TSL) conference call that cash is important. They downgraded TSL largely because they are concerned as to how a rapidly growing business can fulfill its goals without substantial cash and cash flow. Here is an article written about this topic. Here is another take. And to be complete, here is a type of response on the issue.

Below is my take...

Some people may think that Goldman is playing a dirty game of knocking down solars so they can accumulate shares. This may or may not be true but I do want to say that in my opinion the cash issue is important. Very important. We are in the beginning stages of a global credit crisis. Rapidly growing companies, especially ones like TSL and LDK Solar (NYSE:LDK) that are aiming to expand greatly to achieve vertical integration, are going to need cash. Lots of cash. If they are not already generating lots of this, then where are they going to get it from? The answer has been stock offerings and debt financing. The problem is the winners and losers in the solar space are still unclear, and thus, as credit tightens, it is very possible that cash will be harder to get. Also, if companies choose the share dilution route this makes the P/E ratios too low as the earnings per share goes down with dilution. Thus the companies might not be as cheap as they seem and this must be taken into account.

What happens if growing companies can't generate enough cash?

The extreme scenario is they can't pay their employees/debt and they go bankrupt. Even the hint of this creates risk, and this is not a stock environment for risk! Even if we assume, as I think is true, that the industry is robust enough to preclude much or any bankruptcies, companies that cannot generate cash must slow their expansion. This means that the growth estimates will come down and the value of the stocks are lower then they appear. Just as importantly the risk... that is to say the uncertainty of how much a company can really grow, becomes higher if the company does not have much cash. Risk = lower stock price. Especially in this market. It is also important to note that perception is as important as reality. If the big boys are concerned about the cash issue, then regardless of whether the earnings in the future will generate enough positive flow to pay for expansion or no, the stocks with any hint of cash problems will likely be affected until the issue is shown to be unimportant.

So, in addition to the points I made on the main solar post, I want to add in that it is important to consider cash and debt when comparing the different solar companies. Another metric that is nice to look at is the operating margin. If selling prices come down for any reason or costs go up low operating margins may become an issue. So far, based on the relative performance of CSIQ to some of the other polysilicon solars this has not been so much of an issue. Something to watch though.

Here is a table that compares the most salient metrics of a number of solar companies that I am watching... use this in conjunction with the fundamentals table linked here and first presented on the main solar post.

It is very interesting to note that First Solar (NASDAQ:FSLR), the much maligned "overpriced" company, looks pretty good when you realize that it generates substantial operating flow, has substantial cash, and has a strong operating margin. It also has large institutional ownership. This tells me that in this environment especially the big boys, those that know how big this credit mess really is, are certainly concerned about access to funds for these solar companies. FSLR may offer the certainty that some of the polysilicons do not. It has also beaten earnings every quarter in recent history and is growing at a clip that may make... it hurts to say it still... a forward PE of 50 maybe not that bad after all.

For what it's worth, Zack's, a company I respect, has been bullish on FSLR a while with a price target I believe in the 320 to 350 range. Cramer is has also been bullish on the company. Please note that this is not a recommendation. It just aims to show that FSLR may be a much better stock than many give it credit for.

So how do I plan to play to solar issue?

The first thing you have to look at is the macro-picture. If the market is tanking solar stocks do not do well. It is also important to note that solar stocks tend to move together. Go to Yahoo Finance or other sites and compare the charts for a number of solar companies. They move together, with some more volatile, and some having done better than others. The point is that if the solars are getting sold off it is unlikely that many or any will do well in the short-term.

However, when the market goes into its next bear market correction (it will... perhaps as we get closer to the elections and the dog days of summer are over... but maybe sooner... no one knows), some of the more volatile, oversold, promising stocks will lift up just like it did in the last bear market correction. During that time, one of the strongest stocks, Canadian Solar (NASDAQ:CSIQ), doubled before falling back with the recent return to the primary overall bear market.(For more on Dow Theory and how secondary corrections work check out the post "It PAYS to be Trendy")

So right now I am not investing in solar but looking hard at what is out there so that when the opportunities arise I will have the understanding/knowledge to hopefully pick the winners. In the last bear market correction, I did not have this type of info on solars at my fingertips, and so I missed that opportunity. I intend to be ready the next time around.

Overall, I believe that management is the most important, seconded by the fundamentals, and also backed by the technicals. The cash and debt issues are also very important as are other issues. I always listen to conference calls before investing in a company.

Here are some preliminary notes I remember in researching...

  • CSIQ remains one of my favorites because I think their management is very solid. With TSL, there is some concern about the cash issue and rapid expansion... however perhaps they will continue to execute and the price will prove to be a bargain. For this company I think it is important to closely monitor whether financing becomes an issue as the credit crunch deepens. Until they are able to prove otherwise I think there will be pressure on the stock.
  • It is nice to note that JA Solar (NASDAQ:JASO) already had a major share offering and has cash with no debt.
  • The narrow operating margins of CSIQ and SunPower (NASDAQ:SPWR) may also be something to watch.
  • I got a chance to listen to the archived Yingli Green Energy (NYSE:YGE) conference call while I working out (hey, time is the most important resource... double tasking is key) and I heard a solid company with substantial RD to narrow the amount of polysilicon use. Of some concern is that over 50% of sales are currently to one country, Spain.
  • Regarding Suntech Power (NYSE:STP), I like the fact that they are big in industrial use of solar panels for farms and the like in China. I haven't had a chance to listen to any more, but if I have time I will. I will now look at FSLR as well. The compelling cash and operating margins may be more important to the guys that move the stocks then the P/E ratios...

Regarding the wafer manufacturers:

There are quite a few smaller ones popping up especially in China.

  • MEMC Electronic Materials (WFR) is interesting but is tied to the US semiconductor industry as well as solar. It's cheap and I am looking at it.
  • ReneSola (NYSE:SOL) looks good to me. The question is whether any margin erosion will occur as more manufacturers get into the business and as panel makers use thinner silicon. Still, someone is going to have to provide the wafers if the industry really grows so SOL is very much on my watch list.

Perhaps a combo of CSIQ and SOL or FSLR and WFR etc. may be in order... or SOL and Claymore/MAC Global Solar Index ETF (NYSEARCA:TAN), etc... I guess the point here is most of the solars are on the table but market conditions, industry conditions, and specifics of each stock need to play out in my mind for serious investment to be made.

There have been some great trades in the solar space on both the long and short side. As we move into the Presidential election, and Green very possibly becomes a buzzword, solar stocks may enjoy a very nice run. The issues brought up on this post may influence who wins and who loses.

On a final note:

  • TAN is a solar ETF that is interesting to look at. It involves some ADRs as I understand it that include some European companies. It is fairly new and I am not sure how well it relates to US listed solar stocks. It may indicate an upward trend and be a forecaster for getting into solars or it may be a nice, relatively safer play, in its own right. You should at least know about this vehicle...

If you agree, disagree, or just have something to say by all means comment. Just please be respectful...

Disclosure: none