Five Hot Solar Plays: The Fundamentals

Yesterday, in part 1 of this article, Larsen Kusick overviewed the top five solar power plays, including First Solar(FSLR Quote), Energy Conversion Devices(ENER Quote), SunPower(SPWR Quote), SunTech Power(STP Quote) and Trina Solar(TSL Quote). In part 2, he looks at the companies on a valuation basis.

Looking at valuation on a price/sales basis, you can see how wide the range is among these names. I used consensus estimates for full-year 2008 and 2009 for these calculations. Remember, historical data is useful for painting the backdrop, but when doing valuation on a stock, we need to use forward estimates.

The lesson here is that price/sales appears to be of limited use in valuing these solar plays. If nothing else, we can see how the thin-film names (First Solar and Energy Conversion Devices) are well ahead of their polysilicon peers in terms of earnings and higher price/sales multiple. The numbers also suggest that Trina is extremely cheap, but I'm still doubtful that this metric is useful in making decisions over whether any of these names should be bought here.

Since I'm not satisfied with the valuations generated by price/sales, let's move on to the tried-and-true price/earnings ratios.

Now -- these numbers look more useful. In the column all the way to the right I added the expected annual growth rate on the basis of 2008/2009 earnings estimates. ENER stands out as the most expensive of the group, according to 2009 P/E, but as I said before, we can attribute this partially to the likelihood that analysts are still playing catch-up with respect to the company's improved business prospects (i.e., the market believes current estimates are too low).

We can't say for sure that the market is right, but ENER's amazing run since January should serve as an indication that the company has made a lot of progress, and the expectations are quite high.

First Solar, on the other hand, is trading at almost 50 times 2009 expectations. This multiple may seem attractive relative to the high rate of expected earnings growth of over 96%, but I'm more concerned with the sustainable five-year earnings growth rate. Can FSLR sustain a 50% growth rate, so that a PEG ratio (P/E divided by five-year earnings growth) would be around 1.0? I'm not quite sold on the health of the solar industry over that long of a period, and although you can make a case that the market leader deserves a premium multiple, it looks awfully steep to me. I also have to agree with Jim Cramer's concerns over the large insider sales by CEO Michael Ahearn.

Annual EPS Estimates
Ticker	Recent Price	Market Cap*	2008	2009	Price/Earnings 2008	2009	2009 earnings growth
SPWR	81.39	$6.36	$2.16	$3.37	37.7	24.2	56.0%
STP	41.55	$6.89	$1.58	$2.57	26.3	16.2	62.7%
ENER	79.19	$3.21	$0.01	$1.48	NM*	53.5	NM*
FSLR	288.22	$23.0	$2.96	$5.82	97.4	49.5	96.6%
TSL	36.74	$0.92	$3.15	$4.17	11.7	8.8	32.4%
* ENER's P/E ratio and earnings growth are not meaningful based on an earnings estimate of 1 cent in 2008