Investing

Why the Gloom on Solar-Energy Stocks?


The global credit freeze and a supply glut of polysilicon—the key raw material used in photovoltaic solar panels—have hurt solar-power equipment manufacturers' earnings this year. Over the long run, some analysts are hopeful the lower prices will make the technology more competitive with conventionally generated power and make these companies more compelling plays in the eyes of investors. But the road to solar riches remains bumpy.

Case in point: On Aug. 12, China-based LDK Solar (LDK) reported a second-quarter loss of $2.03 per American Depository Share (ADS) on a 48% drop in revenue, to $228.3 million, compared with a profit of $1.29 per ADS a year ago on $441.7 million in revenue. A writedown of $176.3 million on a plunge in value of its inventories accounted for most of the $216.9 million quarterly loss.

LDK, which makes multicrystalline wafers used in solar panels, also issued a third-quarter revenue outlook well below Wall Street expectations, sending its ADSs down 18% on Aug. 13.

Major Shifts in Market Share LDK's results came on the heels of two other Chinese solar companies that disappointed the market on Aug. 12. Wafer producer ReneSola (SOL) posted a loss of 3¢ per ADS, vs. earnings of 19¢ a year ago, on a 52% drop in revenue, to $82.6 million. The company's bottom-line results beat the market's consensus estimate of a 6¢ loss but missed analysts' forecast of $90 million in revenue.

Meanwhile, solar-cell maker JA Solar (JASO) recorded a loss of 18¢ per ADS, missing analysts' estimates by 12¢. That compared with a 1¢ loss in the second quarter of 2008, while revenue fell more than 51%, to $88 million. The latest loss included charges related to stock-based compensation and a hedging loss.

The move from shortage to oversupply of polysilicon in just around 18 months has caused a major shift in business models and market share. Panel manufacturers that locked in fixed-price contracts for polysilicon, which gave them an edge over producers that had to pay much higher prices in the spot market, now have to scramble to renegotiate contracts at lower prices or write down the value of their inventories.

Hurt by Spanish Collapse Another headwind for the industry: the unwillingness of banks to lend money needed for solar projects across much of the world. Indeed, the solar industry has taken lumps in a number of countries. For example, the market for solar gear in Spain, which had been one of the largest in the world, collapsed as a result of the Spanish government capping subsidies on solar-panel installation at 0.5 gigawatts after installations hit 2.67 gigawatts last year, according to analyst Edwin Mok at Needham & Co. in San Francisco. That severely limits the growth potential in Spain's market, since demand drops when subsidies aren't available. One bright spot: Germany's market has grown this year, though not enough to offset the contraction in Spain.

Some analysts expect demand for solar panels to rebound as early as next year. The drop in polysilicon, though hurting earnings now, will be beneficial over the long term to the extent that it makes solar a more competitively priced alternative to other forms of power and boosts demand. In an Aug. 13 research note, UBS (UBS) analyst Robin Cheng said she expects photovoltaic electricity to be competitive with power from the grid by 2010 in those parts of Europe and the U.S. that get more regular sunshine, and by 2014 in regions that experience more cloud cover. "Until then, the industry is heavily dependent on government incentives," she writes.

Incentives provided under U.S. stimulus programs have actually been a hindrance to solar sales for commercial usage so far this year, according to Rob Stone, an analyst at Cowen & Co. (COWN) in Boston. Although the Obama Administration was quick to announce that Treasury grants and loans from the Energy Dept. would be offered in lieu of investment tax credits that became less viable as investment pool capital dried up, the government was slow to provide terms and conditions and guidance for actual implementation, he says. That stopped many commercial solar projects in their tracks as builders waited for clarity on how to apply for this funding. Conversely, the fact that individual tax credits have not been affected by the financial crisis has meant that the U.S. residential market has been responding well to the drop in solar-panel prices.

LDK Balance Sheet Needs Overhaul For all its problems with inventory writedowns, LDK Solar's primary risk is its unwieldy 86% debt-to-capital ratio, says Colin Rusch, an analyst at ThinkEquity in New York. The company needs to restructure its balance sheet if it's going to survive, he says. Jesse Pichel, an analyst at Piper Jaffray (PJC), however, has maintained a sell rating on the stock for most of the past 18 months. Pichel is bearish because he doesn't see where the company will get the hundreds of millions of dollars in financing it needs to finish building a new polysilicon plant whose 15,000 metric tons of annual production is scheduled to come online in stages over the next year.

As long as it doesn't overspend to complete the plant, Rusch believes LDK may be able to save as much as $40 to $50 per kilogram of polysilicon by producing it instead of having to buy it on the market. That could result in "an extremely competitive cost structure," he says.

But Pichel notes that new polysilicon startups have so far not succeeded. Even if LDK's plant is successful, it will take at least a year to get the plant to full capacity, producing at a quality and cost level that's competitive with other international players, he says.

Utility-Scale Sector Hard Hit One pocket of strength he sees in the industry: High-quality and low-cost Chinese module producers such as Suntech Power Holdings (STP), Yingli Green Energy Holding (YGE), Trina Solar (TSL), and Canadian Solar (CSIQ), which "appear to be winning share in the global market because their costs are so much below [those] of Western or Japanese suppliers." Their cost advantage goes beyond just cheaper labor to include free land from the Chinese government to build factories on, subsidized electricity, tax breaks, and a much lower cost of capital from banks than is available in other parts of the world. "And all [their] component suppliers for glass and copper wire, what's called junction boxes, aluminum framing, and some of the chemicals that go into making solar panels are all benefiting from these same five or six things," he says. That enables suppliers to charge module manufacturers less for their products as well.

And while JA Solar, Canadian Solar, and Suntech are all pushing to improve the efficiency of their modules and should eventually be among the leaders in cell efficiency, it won't be easy for any of them to overthrow SunPower (SPWRB) and Sanyo Electric (SANYY) as the global market leaders, Pichel adds.

First Solar (FSLR) has the lowest-cost technology because of the thin film it uses in semiconductors to quickly convert sunlight into electricity, but the stock has stagnated as Chinese producers have become more competitive with the drop in polysilicon prices. First Solar retains its cost advantage but is hampered because its panels are used mostly for utility-scale systems, one of the hardest-hit segments of the industry due to the more daunting financing demands, says Pichel.

Lean Chinese Competition First Solar will have to cut its prices, which means its gross margins are sure to fall from the 57% level reached in the second quarter. "It's hard for stocks to go up when the margins are coming down" he says. He expects the stock to stay under pressure until the prices of polysilicon and the panels they go into stabilize.

Rusch at ThinkEquity and analyst Al Kaschalk at investment firm Wedbush Morgan are more positive. Rusch calls talk of the reversal of First Solar's cost advantage overblown and Kaschalk is "confident in the company's ability to manage growth, market development, and operating results" in the years to come.

Pichel favors the lean Chinese manufacturers over competitors in Europe and believes their cost advantage is sustainable. Western producers would do better to focus on high-end technologies and look for ways to form partnerships with China to get access to low-cost manufacturing. "The first company to combine high-cost technology with low-cost geography wins," he says.
Bogoslaw is a reporter for Bloomberg Businessweek's Finance channel.

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