Three Reasons Solar Sell-off May Be in Early Innings

by: Kelvin Schulle

Renewable energy had a great run over the last month when oil was seen stable at the $115 level. Suntech (NYSE:STP) gained almost 50% from $32 to $49, SunPower  (NASDAQ:SPWR) gained almost 40%, LDK Solar (NYSE:LDK) gained about 50% and Energy Conversion Devices (NASDAQ:ENER) is up over 110% since May 2008. Overall solar has been really outperforming in the past year when you compare it to other sectors, such as financial and retail, as both have been down big during the same period of the year. However, solar becomes a risky investment in the current environment. Here are three reasons the solar sell-off may just be getting started:

1. Crude oil breaks below $110 and the US dollar is strengthening

Perhaps the major reason solar became a popular alternative energy resource was soaring crude prices. In the last 12 months crude prices have more than doubled. Since crude peaked at $147, the solar sector has started its pull-back. However, solar investors were betting that crude would stabilize above $115. This turned out not to be the case. The US dollar has become stronger and stronger and global demand for oil continues to drop, which has pushed crude below $110 in the aftermath of a tamer-than-expected Hurricane Gustav. Crude is likely headed below $100 in the short term. This will eventually trigger a serious sell-off in renewable energy sectors including solar and wind. In fact, many analysts are predicting $80 crude in the next 6-12 months, all but assuring a sell-off in alternative energy sources.

2. McCain/Palin likely a final killer of solar energy

Sarah Palin is known as a supporter of "drill drill drill". McCain's pick of Palin sends a signal to voters that even cheaper oil is on its way with offshore and ANWAR drilling becoming reality if McCain/Palin win the election. Recent polls show McCain closing the gap with Senator Obama, and more voters are turning to the Republican position in favor of offshore drilling. If more drilling is planned under a Republican administration, the proposed federal solar subsidy may never be passed.

3. Solar stocks are not cheap

At current valuations, solar stocks are not cheap at all. Take a look at Energy Conversion Devices (ENER), for example. The company made 23c per share last quarter with revenue of $80M; its market cap is at a lofty level of $3.3B. Based on 16 analysts covering this company, 2008 earnings estimate is for $1.3 per share, equivalent to a forward PE of 57. Similarly high forward PEs can also be seen in other solar, such as First Solar (NASDAQ:FSLR) [FPE of 60] and SunPower (SPWR) [FPE of 41]. LDK Solar (LDK) stands out from the pack with a forward PE of just 19.

Without a turnaround in oil prices or an Obama win, valuations in the solar sector are likely to fall from current bubble levels, which is to say a long, long way from current levels.

Disclosure: None