Tom Konrad CFA
With project financing and plenty of
photovoltaic (PV) modules, a shortage of projects with credible
off-takers seems likely to lead to further falls in module
prices. How can investors best profit from this trend?
PV module prices
have dropped 70% since 2008, when the financial crisis sent demand
tumbling, with Chinese multicrystalline silicon module prices currently
as low as $1.49 per watt, according to Bloomberg
New Energy Finance’s (BNEF) Solar Spot Survey. In part, this was
an example of “the Bubble giveth,
and the Bubble taketh away.” For the three to four years ending
in 2008, the long-term downtrend of PV prices, which had been driven by
the learning curve and imporving technology, stalled due to strong
demand. Then,
when the financial crisis suddenly removed the availability of cheap
financing, demand vanished, and prices plummeted.
Today,
it’s
clear that financing is back. I recently attended the 8th
Annual Renewable Energy
Finance Forum-Wall Street (REFF), co-hosted by the
(ACORE) and Euromoney Energy Events. At REFF, the room was packed
with
financiers ready to fund PV projects with credible developers and
quality off-takers, such as utility Power Purchase Agreements (PPAs),
solar and wind developers, and attorneys ready to draw up deals between
them. Notabl
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absent
among
attendees
were any utilities or other
large power
buyers.
I find the absence of power buyers telling. Yes, there are
utilities, businesses, and institutions signing PPAs with renewable
energy developers, but it’s a sign of the end-customer’s market power
that they don’t need to come to networking events like REFF Wall St to
get the word out.
Matthay, VP Environmental Finance at Wells Fargo sees the
distributed solar PV market as limited not by the supply of panels or
finance, but by the lack of good deals. For Wells Fargo, a good
deal requires a quality developer, with experience and a strong balance
sheet.
Wind is following a similar pattern. According to
Eilers, Managing Director at Madison Dearborn Partners who spoke at
the conference, the locations of new wind projects in the US is driven
more by the availability of PPAs than the wind resource. I even
met a wind developer who is following a new model because of the lack
of PPAs with favorable pricing, his firm is building wind farms to sell
electricity into the spot market: They don’t intend to sign a PPA until
pricing becomes more favorable.
Meanwhile, PV
module supply continues to grow rapidly. According to BNEF’s
projections, even an optimistic projection
for PV demand is likely to fall short of supply in 2012 and 2013.
We last had a PV
module oversupply in 2009, after the financial crisis destroyed many
customers’ ability or willingness to borrow leading to a rapid fall in
demand.
Prices promptly fell, which in turn lead to a rapid resurgence in
demand. After falling short in 2009, demand slightly exceeded
supply in 2010. In other words, over a period
of
about a year, PV demand has shown itself to be remarkably elastic and
quick to respond to falls in the price of PV.
I expect the
current and projected glut of solar modules will create lower prices
and a new demand boom. BNEF’s projections for demand in 2012 and
2013 will likely prove to be too conservative, although many PV
manufacturers will be unable to make a profit at the lower price levels.
Market power will
shift from
solar manufacturers to solar customers. The biggest
winners are likely to be end users, who will be able to get solar
installations for much lower prices than ever before, and those solar
installers able to reach out to the new classes of customers.
Where will the
demand come from? According to
Andrew
Murphy, Executive Vice
President of NRG Energy, it will come from the maturation of the
industry. He sees a growing customer awareness of electricity and
where it comes from, many more companies such as Wal-Mart,
(GOOG),
and Whole Foods are not only investing in distributed generation
themselves, but presenting it to their shareholders and customers as
a value proposition. Those stakeholders, seeing that value
proposition then see the value in adopting distributed generation,
which usually means PV.
If there is a profitable opportunity in solar stocks, it will be in the
stocks of developers able to adapt to the needs of the new classes of
solar customers drawn in by rapidly falling prices. I believe
that solar manufacturers see this, and that’s why many are integrating
vertically down the value chain by buying up solar developers, such as
(SHCAY.PK)
of
Recurrent
Energy, and
Solar’s (FSLR)
of
NextLight last year.
A more recent development was the merger of two of the strongest
regional solar developers, when
Goods
Solar
(RSOL) agreed to
with
leading
Northeastern
solar
integrator
Alteris in an all-stock
deal. As prices fall, typical customers are more likely to want a brand
they can trust and a one-stop shop for design, build, and
financing. I expect
solar integrators such as Real Goods that have a history of
successful acquisitions should do well, along with strong local
brands. But that does not mean that Real Goods’ current high
trailing P/E of 38 is justified. Solar integration is a low
margin business, and growth from all-share acquisitions such as that of
Alteris comes at the price of dilution of existing stock holders.
As I concluded in my recent
survey of solar industry integration, the industry is more likely
to produce steady cash earners than high-margin, quickly growing high
flyers.
Conclusion
While I expect the downstream portions of the solar industry to be
solid earners over the next few years due to the rapid growth of the
industry, that growth does not justify paying high multiples for a low
margin business. If I had to pick a solar stock today, I’d be more
likely to opt for the higher margin vertically integrated manufacturers
which are currently trading at depressed prices due to the current
glut. My colleague Garvin Jabush considers
Street’s
current
hatred
of
solar
stocks to be irrational. It’s not
that he thinks module prices will not fall, but that such a fall in
prices is more than adequately reflected in stock valuations. I’m
inclined to agree.
While Real Goods has only a 2.6% operating margin, and a 4.0% return on
equity (ROE), it trades at a forward P/E of 11 based on 42% expected
annual
growth in revenue. Among manufacturers, cost leader First Solar
trades at an 11 P/E, but has a 28% operating margin and 19% return on
equity, numbers which seem much better able to fund the 27% expected
annual revenue growth internally.
pick,
Solar (LDK), is also a vertically integrated
manufacturer/developer, and has a forward P/E of a minuscule 2.9, based
on
no expected profit growth and 12% annual revenue growth, which can
easily be funded by the company’s 20% operating margin and 38% return
on equity.
Margin
growth
It’s always useful to understand future trends in the market, but
profits come from understanding the market’s reaction to these trends,
as well as the trends themselves. Right now, investors seem
spooked by solar manufacturers, even though many of these manufacturers
have worked to integrate vertically along the supply chain making them
less sensitive to shifts in market power along the supply chain.
Too often, investors in Renewable Energy get carried away by a positive
growth story, rushing to buy at any price. This time, the
opposite seems true, and it’s the selling that seems to have gone too
far. I’ve never been a solar cheerleader, and have always been
cautious about
the
growth
of
the
industry
with opportunity for the existing companies.
Yet
right now, many solar stocks seem priced for long term zero, or
even negative growth. That, to me, seems to be taking the case
too far.
DISCLOSURE: No positions.
DISCLAIMER: Past performance
is
not a guarantee
or a reliable indicator of future results. This article contains
the current opinions of the author and such opinions are subject to
change without notice. This article has been distributed for
informational purposes only. Forecasts, estimates, and certain
information contained herein should not be considered as investment
advice or a recommendation of any particular security, strategy or
investment product. Information contained herein has been
