NEW YORK (
) - The market junk of 2011 have become the market jewels of 2012, whether it's
Bank of America
, or just about any stock in the solar sector.
Is the rally merited in solar, a sector where supply is still running ahead of demand, and profitability -- even for the best-run manufacturing operations -- could be slim to none in 2012?
The bullish trend in solar stocks is a recipe made of three primary ingredients:
1. Recent demand beating expectations. That's a trend expected to continue in the first quarter, predicated on an installation frenzy in Germany ahead of subsidy cuts.
This also implies the action in solar stocks is a subsidy-driven trade that may not be more than a quick profit opportunity in the sector.
In other words, "The worst thing that could happen is that demand gets so hot in Germany that everybody thinks it's good times again," said Steve Simko, Morningstar analyst.
The subsidy trade gives as good as it gets. As Aaron Chew, analyst at Maxim Group, noted on Monday morning, subsidy policy overhauls in solar's two largest markets of 2011 are yielding diverging outcomes with (1) German demand beginning to swell ahead of expected cuts in 2Q but (2) Italian demand restrained with both the 2012 subsidy spending cap for large projects already surpassed and financing markets closed.
"Even as we foresee shipment upside in 2012, earnings leverage for the solar manufacturers is unlikely given the 15% gross margin and EPS losses implied
for most of the sector with module ASPs of ~$1.00/W," Chew wrote.
Also helping solar returns (just look at the performance of the MAC Global Solar Index ETF above) are:
2. Expectations that the Chinese market finally takes off in 2012.
The CEOs of
recently told the press that China will grow to as big as 4 to 5 gigawatts this year -- recent Wall Street estimates forecast the same growth -- meaning China might be the largest market globally for solar in 2012.
Remember Chinese solar companies revised guidance lower throughout 2011 after beginning the year with some heady expectations. Chinese government support for solar demand has lagged its manufacturing support historically, but that might be about to change.
Responsible for creating the current glut in the sector through its generous lending to solar manufacturers, China should start absorbing more of solar supply if it wants its solar manufacturing sector to thrive, and right now,
simply survive with slim margins.
3. Solar stocks being oversold based on last year's crash.
There are some stocks in the solar sector, whether U.S. or Chinese stocks, where
balance sheet concerns are so serious it's hard to rate a stock as oversold when equity shareholders could still be wiped out long after the short-term demand pop has fizzled.
recently spoke with Morningstar's Simko about
that have recently rallied and whether they are solar stocks for 2014 -- once all the short-term pain in the sector is sorted out -- or whether the rally in these companies to start 2012 will sooner or later result in pain for shareholders and possibly doomsday for these companies.
First Solar shares are up 31% this month.
For First Solar to be worth more than a 10 times multiple -- at $44 it is currently trading at about 11 times the mid-point of its 2012 guidance -- the top line has to grow considerably from this year's expectation and the cost equation has to drop in a way that improves the bottom line considerably more than can currently be assumed.
First Solar's earnings power today is still based on power purchase agreements with utilities that won't be replicated in terms of profitability, as well as Department of Energy loan guarantee economics, making it difficult to frame the financial equation in 2014 and beyond.
"Once you get past 2012, First Solar has to remain low cost and grow at a double-digit rate. First Solar is worth more than $40 if they can get their cost structure down to the 50-cent per watt range, and make balance of systems cost reductions," Simko said. "There are black holes in that road map, and right now with a risk adjusted outlook for the stock, it doesn't seem great given the challenges and the market."
If First Solar grows at 15% a year in the next 5 years that implies it is at an 8 gigawatts to 9 gigawatts market share a year, and that could lead to operating leverage and expense reduction, and an earnings scenario that is much higher than the $3 annual earnings which is now the bottom line view for the company.
However, Simko said, "The greater than $40 scenario is not one I would advocate here." He wants to first see the company reach the 65-cent per watt cost target by the end of 2012 and bring manufacturing to 100% capacity.
On the other hand, "It doesn't scream overvalued to me at $43 compared to other names, and based on the pipeline and positive income statement. There is much less cash flow than before but it's still there, so to me that makes it less of a screaming short than other names," Simko said.
Suntech Power shares are up 55% this month.
Suntech's Chinese solar peer
is usually held up as the poster child for excessive debt and bankruptcy risk in solar, and Simko agrees, but thinks that it will be important to watch Suntech income in the coming quarters to monitor its balance sheet situation.
"Suntech is the second worst," Simko said.
The Morningstar analyst said that there is widespread belief that the national prominence of Suntech's CEO Dr. Zhengrong Shi will keep the company in the good graces of the government. Something similar is said about LDK: that it has created so many jobs in China it can't be allowed to go bankrupt. While these arguments may be true, they don't ensure that the government and banks in China won't take over the companies and wipe out equity shareholders.
It's impossible to assess that risk, so Simko says an investor has to focus on what Suntech has promised in regards to its balance sheet when it reports in 2012.
The analyst noted that Suntech has talked up its ability to monetize its Global Solar Fund pipeline and reduce working capital and expenses, all of which could lead to $400 million or more in improved cash flow.
If that's true, then no matter what happens in solar, Suntech net debt stabilizes, at least.
"I'm skeptical that's how it plays out, but it will be a tell," Simko said. He added that Suntech could get an extension of credit facilities from existing Chinese bank partners if it's able to stabilize its balance sheet.
Suntech had approximately $946 million in cash and $3 billion in debt as of its last quarterly earnings report in November.
SunPower shares are up 16.5% this month.
Unlike First Solar, Simko has little hope for this company.
"SunPower is in a horrible situation. To me, it's a huge problem and a Total executive recently pegged it right when he said it would be bankrupt without the investment by Total."
took a majority stake in SunPower in the middle of 2011, and
recently upped that stake in exchange for SunPower buying its European-based solar company Tenesol.
As for the remaining SunPower shares that trade publicly, Simko says that SunPower is in the same boat as the high-cost European solar panel makers that find it difficult to compete in today's low-priced panel world.
Simko said SunPower's recent track record of underwhelming financial results speaks volumes: SunPower lowered its 2011 guidance three times over the course of the year.
"The last time they made money was in the fourth quarter of 2010 and that was it for them," Simko said. The fourth quarter of 2010 was a huge boom quarter for solar stocks when Italy installed more solar projects than anyone had foreseen. Yet to show how quickly the situation reversed itself, Italy's demand outlook is now a headwind for solar and SunPower has had to write off much of a solar project pipeline it bought in Italy.
"They get no benefit from that pipeline now," Simko said.
At the end of the day, the key difference between First Solar and SunPower -- the two largest U.S. solar panel makers -- is the cost structure. Even if First Solar can't make much money, if any, selling modules, it is saved by the pipeline business. SunPower, with Total's backing, may develop a project business that does better, but they haven't shown the ability to make profits in the new solar reality.
"Lots of promises and nothing delivered," Simko said. That is, except for one very timely acquisition by an oil major, but that doesn't help holders of the outstanding SunPower shares now.
Energy Conversion Devices
Shares of Energy Conversion Devices are up 469% this year. Yeah, you read that right. Of course, for a stock that began the year trading at 20 cents, a big swing on the heels of solar's rally isn't surprising. Yet the question remains, will Energy Conversion Devices even exist as a company a year from now?
Energy Conversion Devices continues to lose money on every panel it sells and while the company has done a good job of limiting cash burn, it's got a big financial High Noon still on the horizon in 2013, when holders of convertible notes come calling. The fact that the convertibles aren't due until 2013 means that the company can probably survive 2012, but that's still not a whole lot of breathing room.
"You can make a credible case they can make it through 2012, but the problem is if they can't refinance the converts," Simko said.
Energy Conversion Devices has a $1.50+ per watt cost structure in a world of sub-$1 pricing per watt.
Simko said the company is in a bit of a Catch-22, and its executives have said so. "To get where they are cost competitive requires investment and to invest they need to refinance the converts, but the bond holders aren't going to let equity holders off the hook," Simko said.
"Energy Conversion is about as volatile a solar stock as you get, and the stock quadrupling in value is a little crazy with no positive outlook," the analyst said.
Daqo New Energy
Daqo New Energy shares are up 58% this year.
Simko has a different view of the Chinese polysilicon producer. "This is another company in big trouble," the analyst said.
The problem for Daqo is, like the panel makers that are struggling, about cost structure. However, in the case of Daqo it is about the market price for polysilicon versus its production price.
Polysilicon prices -- which once upon a time were as high as $300 per kilogram -- recently stabilized at around the $30 range thanks to the German demand pickup. Polysilicon prices were below $30 per kilogram just a month ago.
Daqo New Energy can't do enough to reduce its cost structure.
As Collins Stewart analyst Dan Ries recently wrote, "While Daqo is expanding and retrofitting its polysilicon product facilities to reduce costs...the polysilicon industry is facing a multi-year period of excess capacity. DQ's attempt to reduce its dependence on polysilicon with expansion into wafers and modules seems unlikey to payoff, as those business are extremely challenging even for vendors with brand and scale. If all goes well (production cost reduce to $21/kg from $29-30/kg today), DQ may return to profitability in CY13, but even then, earnings would be minor and its debt load high. We see little value in DQ's equity."
Daqo had cash of $60 million and debt of $269 million as of its last quarterly report in November.
Simko said it's hard to see how the Daqo story pans outs.
"To me, it's one more solar company where we don't know what happens, and it's better to stick with bigger companies with better financial statements."
Overall, Simko's outlook is to proceed with caution. "Solar could become like wind turbine manufacturers. Everyone uses the same technology and wind turbine margins disappear. When supply and demand is out of whack, it's a brutal business and there are very few companies left at the end of the day," he said.
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-- Written by Eric Rosenbaum from New York.
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