The Two Sides of Solar

01/02/2012 9:45 am EST

Focus: ENERGY

Jim Trippon

Editor-in-Chief, China Stock Digest

Solar firms were hammered by the end of 2011, but all is not lost for top-notch firms moving into 2012, writes Jim Trippon of Global Profits Alert.

We are living in a binary investment world: risk on or risk off; buy in or sell out; all in or all in cash.

The often black and white, yes or no view of investing, which has seen instant judgments made on stocks and whole industry sectors may not be just a tenor of the investing times, but the tenor of our times. That's another story.

For the markets, any bit of news is analyzed, digested, usually magnified, and acted on almost instantly. Earnings reports are snapped up and spit out, then the buying or selling begins.

One of the industries lately in the crosshairs of the heavy binary approach is the solar energy sector. The verdict by the markets has been almost entirely negative as investors have trampled the stocks.

So we have the bleak view on solar, which is winning the day, and another view that sees an industry with promise, a view that's definitely out of favor. The second view is China's view.

While the solar industry has had a series of bad things happen to it this year, it all got summed up in solar-energy device manufacturer First Solar's (FSLR) recent guidance.

The company further revised downward its earnings outlook for the full year in 2011, to $5.75 to $6 per share on revenue of $2.8 billion to $2.9 billion, from a previous outlook of $6.50 to $7.50 per share on revenue of $3 billion to $3.3 billion. Next year's numbers were projected as EPS $3.75 to $4.25 on revenue of $3.7 to $4 billion.

First Solar is also switching its long-term business model to large industrial energy projects, rather than small-scale projects which depend on government subsidies. Concerns from Wall Street were whether First Solar could successfully change from the technology and manufacturing end to the large-scale projects, and that in this transitional time, First Solar and the solar manufacturers who build the modules, cells, and panels are doomed to chase falling prices.

While FLSR was driven down more than 20% on the news, and has established a new low, hitting $31.45—a distant memory from its 52-week high of $175.45 in better days—China's solar stocks were also taken down.

Remember that binary thing? Well, there are even some voices, few and meek though they may be, that think First Solar is now undervalued.

But leave that alone for a moment. With the global industry affected by falling selling prices for modules and components, along with the drying up of once robust European demand, the China kicker is that its stocks have been sold off on this worst-case scenario prospect. Yet the Chinese solar industry, as well as First Solar and Warren Buffett, who has become a recent investor in the sector, sees better things ahead.

Given the rout of the stocks and what's going on in the industry, how, you may ask? With overcapacity, even a global glut of solar products, along with margin pressure, and almost all of the Chinese solar companies losing money in the third quarter—not to mention accusations by the US that Chinese government solar subsidies to its industry give it an unfair competitive advantage—where is the daylight?

But with prices being driven down—modules cost roughly $1 a watt, nearly only half of what they cost as recently as the spring—consolidation and efficiencies are on the horizon for the industry. While China's solar companies have been issuing bonds to raise funds, the China Construction Bank (Hong Kong: 0939) said in a Caixin report that although there were losses, the bank hadn't yet seen defaults.

Chinese maker of silicon wafers LDK Solar (LDK) took a $40 million charge for excess inventory in the third quarter, and though government investment bank China International Capital Corp (CICC) mentioned LDK as at risk, China's Suntech Power (STP), the world's largest solar panel maker, is pressing ahead with plant and capacity expansion.

Suntech is on the rapid path of improved efficiencies along with joint ventures, and still does $3 billion in annual sales, while LDK's CEO Yao Seng resolved that LDK would increase its sales and generate additional cash. The industry will head for wide cost cutting and consolidation as photovoltaic efficiency increases.

Trina Solar (TSL) and Yingli Green Energy (YGE) are other efficient producers who should be among the winners when the carnage is over. Even First Solar, despite its shrinking earnings, has been profitable in these worst of times and should be one of the companies still standing when the industry sees an upturn.

As for the markets? Right now the market says solar's dead. There's another view, though contrarian, led by China's commitment that says it's not, that solar will emerge tempered, stronger through these challenging times.

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