Best in Class: Everybody Loves Trina Solar; Should You?
NEW YORK (
) -- Solar energy stocks are notoriously volatile investments. Take the daily swings in the technology sector and multiply by three times, and it's a fair approximation of trading volatility in solar, or so goes the conventional wisdom.
This trading volatility hasn't hurt -- maybe it has even helped -- to make solar energy stocks a Street favorite.
Just consider that U.S. solar energy stock bellwether
First Solar
(FSLR) - Get Report
has twice as many analysts covering it as does
General Electric
(GE) - Get Report
.
If there's one solar stock that has become the darling of the Street, however, it's not First Solar.
As the largest solar stock on the block, First Solar is still tops in terms of sheer amount of analyst coverage. However, in terms of analyst fawning for solar stocks, everybody on the Street love China's
Trina Solar
(TSL)
.
There's just no contest right now in terms of the bull herd mentality from the Street for solar stocks: all are charging after shares of Trina Solar.
Consider this: of the 22 analysts covering Trina Solar, there is one lonely sell recommendation in the group.
Even more striking is the fact that 19 of the 22 analysts covering Trina Solar rate the Chinese solar stock a buy -- 11 analysts rate Trina Solar a strong buy, specifically, according to
Yahoo! Finance
.
At the other end of the solar-love spectrum, of the more than 40 analysts covering First Solar, fewer than half rate the U.S. solar energy stock a buy.
The Street clubbiness on Trina Solar has been signing up additional members, too.
In 2010, Wedbush Securities added coverage of Trina Solar with a buy rating. Notable in the Wedbush initiation of Trina Solar coverage was the fact that Wedbush was making a big push into coverage of Chinese solar stocks because it continues to see an uncertain outlook for the U.S. solar pack, led by First Solar.
Macquarie Securities also just returned from a trip to China was these words for investors: "We still like Trina -- a lot!"
The Macquarie view of Trina Solar echoes a general thesis that Chinese solar stocks will continue to gain market share on U.S., European and Japanese competitors.
The Trina Solar story is predicated upon a general -- and now well-worn thesis -- that the cost advantage of the Chinese solar stocks will continue to eat into the market share of U.S. and European solar companies -- and there's been considerable proof that the thesis is grounded in prior fact given recent market share gains by Chinese solar companies.
By the end of 2009, Chinese solar module makers including Trina Solar represented more than 50% of the global solar supply.
Is it Trina Solar's fundamentals that have resulted in the Street migration to a buy on Trina's shares, or is it a process of elimination in a quickly changing alternative energy sector -- i.e. root out the most uncertain companies in an uncertain sector and see what you're left with.
It may actually be a bit of both in answering this question about solar stock favorites.
Take the other leading Chinese companies in the solar sector. It's a process of elimination that gets Trina solar to the head of the class. One reason that Trina is a favorite among solar stocks is because it is one of the few truly vertically integrated solar companies from China, meaning it doesn't buy a majority of its solar wafers and cells from third parties, giving it more control of pricing and margin execution.
This vertical integration which shines a positive light on Trina is also the case with
Suntech Power
(STP)
and
Yingli Green Energy
(YGE)
. Yet, Suntech Power continues to be dogged by questions about its higher cost structure, when compared to Trina and other solar companies. Yingli Green Energy continues to be dogged by concerns that its ongoing construction of a polysilicon production plant will be a drag on earnings throughout 2010.
Even for the best of the vertically integrated from China, though, there is a question about the huge demand and its impact on margins in 2010. The record level of demand in solar may force Trina Solar and other vertically integrated players to buy more third-party solar wafers and cells to meet module demand. The need to buy more third-party wafers and cells -- and the fact that demand could keep prices on wafers and cells higher than expected -- could into the rosy margin expectations for Trina Solar, among other Chinese solar companies.
Nevertheless, for Street analysts and investors who like the thesis that the truly vertically integrated, low cost Chinese solar companies are best positioned, Trina is left standing alone as the bull story. There are other bull stories in Chinese solar, such as solar cell maker
JA Solar
(JASO)
. Still, it's not the niche play, but at the level of competing with vertically integrated First Solar, that the biggest arguments in solar take place.
Trina Solar has not disappointed in its recent performance. Trina Solar earned 74 cents a share in the fourth quarter 2009, easily beating a Street estimate of 60 cents per share earnings. The earnings profile of Trina has also been steadily improving, from 36 cents in the second quarter 2009, to 65 cents in the third quarter.
Gross margin is a key factor in the solar business. In fact, when Trina said that first quarter gross margins would not remain at record levels, its shares plummeted.
Still, the more important trend for the Street has been that Trina's margin profile strengthened, while First Solar's margins have been on a downward trajectory from a historic high level of 56%. The fates of Chinese and U.S. solar companies are not only intertwined, but the Street thinks that the paths are crossing.
No solar company comes close to First Solar in earnings power -- the Street expects $1.65 per share in the first quarter of 2010, versus 61 cents earnings per share for Trina Solar. However, while Trina Solar's gross margin ticked up to 32% in the previous quarter, First Solar's gross margin declined by close to 9%.
The multiples at which the leading Chinese and U.S. solar stocks are trading also shows the premium that First Solar has commanded as a result of its early dominance in the solar sector. Trina Solar -- as well as several other favored Chinese solar stocks -- are trading at multiples of 11 times to 12 times 2010 earnings. First Solar, on the other hand, is currently trading at 21 times 2010 earnings.
What's more, Street bulls say that Trina's guidance for first quarter gross margin of 26% to 28% was merely an example of the conservative nature of the company's management. This view of Trina Solar as being conservative stands out since the long-time knock on Chinese solar companies has been overly aggressive guidance.
This is not to say that Trina doesn't pull a trick or two that surprises the Street and investors from time to time, though.
In fact, in the first quarter Trina Solar completed a secondary equity offering within a span of 48 hours that stunned the Street and led to share dilution in the double digit range. There was little explanation from the Chinese solar company about the need for cash, though most of the Chinese solar firms have considerable levels of short-term debt.
There was a positive surprise for Trina Solar more recently that helped to offset the questions of financing brought about by the equity raise. The China Development Bank announced that it had signed a letter of intent to provide Trina Solar with more than $4 billion in a loan package -- one of the biggest loans ever provided to a solar company. The loan has not actually been doled out yet, and it's not guaranteed.
Nonetheless, the news of the big loan package coming Trina Solar's way elicited another theme in the solar sector that has helped to drive positive sentiment on Trina.
China is standing fast behind its alternative energy companies to a degree that the U.S. government has not matched. The rhetorical battle in the U.S. has reached a fever pitch when it comes to the U.S. lagging China in support for renewable energy. In solar specifically, the sentiment runs from accusations that the Chinese government is unfairly subsidizing its solar companies -- even at the level of providing the solar companies' plants with subsidizes water and electricity rates -- to general frustration that the U.S. government is not doing more to close the widening gap.
Yet when all the pieces are strung together, there is still reason to be cautious about the "no-brainer" bull case on Trina Solar shares.
Performance in the solar sector is completely dependent on subsidy support from national governments, led by Europe. Neither the U.S. nor China has what is known as a feed-in tariff (FIT) scheme, which is the main type of national government support for the solar industry, and essential for the sale of solar modules. Governments pay solar electricity generators a rate higher than conventional energy costs -- in Germany the rate is 8 times the cost of conventional electricity -- and the higher rates are passed on to electricity consumers.
Germany is set to announce the biggest reductions ever to its feed-in tariff rates in the immediate future, and other European countries are exhibiting increased pressure to cut the level of solar support. This all plays into the reason why the Street loves Trina Solar.
The Chinese solar companies have the cost advantage on most solar companies, excluding First Solar, and even on First Solar, the Chinese companies are quickly making up ground. The average price of a solar module will come down as a result of the reduced solar subsidies -- solar companies will need to reduce prices to keep solar project returns at an attractive level for investors once the FIT is reduced in Germany.
Germany is 50% of the solar market, and the reduction of the FIT means that the Chinese solar companies are crowding into Germany -- and crowding out higher cost solar companies.
Solar companies chase the highest FITs from country to country as the political climate changes. The expectation on the Street right now is that as the German FITs are reduced in the second half of 2010, solar companies will pack their bags full of solar modules and head off to countries like Italy and France and the Czech Republic, where feed-in tariffs remains at very attractive levels.
Yet, there are no guarantees that these countries won't one day soon decide to cut their FIT schemes in the manner which Gemany is doing, and as Spain did before Germany. There's also no guarantee that the FIT reductions in Germany won't place greater-than-anticipated pressure on solar pricing power.
The boom-and-bust climate of solar has been fomented by the FIT, which is political by nature. At some point, even low-cost Chinese solar companies like Trina can't benefit from an environment in which major markets have sapped the means of attracting investors to solar projects.
The risks in the solar sector of the reduction in average sale price outweighing even the cost advantage of the Chinese solar companies is instrumental in the view of the lone bear on Trina Solar. Mehdi Hosseini, analyst at FBR Capital Markets, wrote after Trina Solar reported record gross margins in the fourth quarter that the margins had peaked. For a solar bear, the FBR analyst was notably conciliatory on Trina Solar's performance, too.
FBR's Hosseini noted that Trina continues to have better-than-peer-group cost reductions and deserved a higher multiple based on its execution. The solar analyst conceded that Trina may experience upside due to management's better-than-expected ability to execute as the company aggressively increases capacity -- Trina is expected to join the elite club of solar companies with more than 1 gigawatt of solar capacity by the end of 2010.
Nevertheless, the FBR analyst continues to believe that pressure on average sales price will dominate the general thesis that Trina Solar's low-cost manufacturing will allow it to exceed Street expectations again in 2010. "ASP pressure will more than offset lower costs," the FBR analyst wrote, even after Trina reported record gross margins in the fourth quarter.
This is where the electrons collide in solar. It's the solar uncertainty principle. It's what leads the FBR analyst to think that earnings estimates for companies like Trina Solar are way too aggressive. First quarter earnings season kicks off for solar companies this week with a report from First Solar on Wednesday. Yet, it's really the outlook for the second half of 2010, when the FIT in Germany is expected to be reduced significantly, that will be the key to performance of solar companies.
Trina Solar first quarter earnings are supposed to be solid to stellar, driven by the immense demand in Germany ahead of the feed-in tariff reductions, but does the latest boom in the oft-exasperating solar business cycle mean consistent performance will be the rule by the end of 2010?
The Street has already answered that question when it comes to making Trina Solar the best in class solar company. Solar investors know, however, that best-in-class in solar can mean best among an unruly student body when it comes to providing consistent performance.
-- Reported by Eric Rosenbaum in New York.
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