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nonzerosum (45.55)

Solar stocks at inflection point



September 28, 2010 – Comments (4) | RELATED TICKERS: SPWRA.DL , LDKYQ , JASO

DISCLAIMER: this is not investment advice.  I’m posting my personal thoughts to get feedback from the community.

Ken Fisher recently declared that the solar game is over.   That’s a bold statement to make when many solar companies are racking up revenue gains in excess of 100% YoY.  Actually, I think solar stocks such as SPWRA, SOL, SOLF, YGE, LDK, TSL and JASO are at the beginning of a multi year bull market because solar has become economically viable at the margins and investors haven’t noticed.  It is one of those very rare situations where sentiment about the sector is very poor while revenue growth is sizzling hot.   

Why is sentiment so bad?  Firstly, everybody knows that solar is not economical.  If you got a quote on a residential system where you live you’d probably come up with a payback period of 70-100 years (government subsidies aside).  No wonder the media labels solar as “too expensive”.  The key error with this analysis is that it examines retail residential pricing of solar systems in an average electricity market.  If you look at the marginal situation you may come up with a surprisingly different conclusion.

Secondly, solar stocks have done very badly in recent years.  If you purchased SolarPower (SPWRA) in 2008 you’ve probably lost more than 90% of your money.  Oil is half of its 2008 peak and short interest is high on most stocks in the sector.  Ask your friends about solar stocks and you will most likely get a case of rolling eyes.  Everyone hates the sector even though they loved it when it was overpriced in 2007/8.

Solar is economical at the margins because the wholesale/bulk price per Watt for panels is around $1.65 and dropping.  The key is to look at the marginal situation because that is where any new technology first gets sold.  Look at locations where electricity is very expensive and where sun is plentiful, like Hawaii (Big Island) where consumers pay $0.38 per kWh.  Other examples include Israel and parts of Europe like Spain.  

Another marginal scenario is for peak power generation in southern parts of the USA.  In these regions peak demand is driven by air conditioning load and follows peak sun closely.  If a utility puts up solar panels with a west-facing bias it can avoid the expense of a natural gas turbine that gets used only a few hours a day in summer months.  Solar is competitive with a gas turbine under low utilization, especially when you consider that it has no future risk of carbon taxes and easier environmental approvals.

Yet another marginal case involves strategic/security considerations.  For example, military bases are willing to pay a premium for electricity production if they can avoid energy inputs outside of their base.  Transmission lines and gas pipelines are easy targets, after all.

Back to the marginal case.  As a rough example, consider a location where wholesale electricity is 16.5 cents a kWh and where there are 2,000 hours of sunshine per year.  If you assume that inflation cancels out the maintenance costs, the payback time is about five years on the panels.  That makes sense all day long.  “What about other infrastructure costs?” you say.  Fine, so make it a 10 year payback.  That’s still a good investment when you can borrow at half that rate.  And the business case keeps getting better because the price per Watt continues to drop.  Several manufacturers have the holy grail of $1 in their plans in the next 12-18 months.  We are in the midst of the inflection point!

Not convinced about the macro analysis? OK, then, just look at the revenue numbers.  Most solar stocks are growing revenues in excess of 100% and several even collect on their receivables (LDK, YGE, SOL).  The whole sector is experiencing growth which tells me there is an industry wide shift taking place. 

The amazing thing is (and this is the part that worries me) is that valuation are excellent.  Too excellent:  PEGs below 0.1 in some cases! There’s obviously a China discount happening here, although I find it re-assuring when a company sells internationally and has reasonable receivables with a big 4 auditor watching things.  Why?  Because I don’t think it’s likely for a German utility to be part of a stock fraud scheme.  Or perhaps valuations are being hurt by investors worried that subsidies are ending.  I’m not worried about subsidies because the marginal business case will hold its own.  What do you think? Tell me in the comments section.

As far as risks go, my major concern (aside from Chinese governance) is capex or liquidity driven dilution.  SOL and LDK report current ratios less than 1 in their most recent quarterlies so they are likely to be passing the hat around soon.  At these growth rates you would expect some serious capex from all these companies, but if my overall thesis proves correct then its not the worst problem to have.

In summary, I think that investing in solar stocks represents an attractive risk reward tradeoff because they are priced very modestly despite rapidly growing revenues and profits.

4 Comments – Post Your Own

#1) On October 05, 2010 at 10:07 AM, nonzerosum (45.55) wrote:

News about the military  wanting solar for strategic reasons - this will takes years to make practical, but it illustrates the need for fossil fuel alternatives, i.e. solar is not dead.

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#2) On October 08, 2010 at 10:34 AM, nonzerosum (45.55) wrote:

I sold SPWRA because their earnings quality is not as good as the others.


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#3) On October 19, 2010 at 10:17 PM, nonzerosum (45.55) wrote:

Ahmar Zaman from Piper Jaffray recommends the solar sector:

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#4) On September 20, 2011 at 2:04 PM, mountaincouger (28.34) wrote:

Actually on the military- if you look across the street from the Air force academy they have built a solar farm covering several hundred acres. Also, in my humble opinion, as the world becomes more unstable in the next few years(combined with dropping watt costs), I think solar will look even more important and attractive strategically. However, in a more unstable world would you still buy chinese? They have the best bargin prices right now, but I am not convinced that their supperior cost advantage can be kept for the next ten years considering yuan appreciation, a increase in shipping costs down the road, and trade conflicts with the US five years from now? I think people are rightfully cautious about solar stocks for the wrong reasons. After what happended to solyndra, I would not buy american, period...until they have a domestically made product that will outcompete sales with foreign competition.

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