Solar Energy Shakeout Begins

11/13/2008 12:00 pm EST


Josh Wolfe

Editor, Forbes/Wolfe Emerging Tech Report

Josh Wolfe, editor of Forbes/Wolfe Emerging Tech Report, says oversupply and the credit crunch have caused the solar energy bubble to burst.

This month, it began to seem like there would be no end to the carnage on Wall Street. Unlike the prospective solutions, the cause of the crisis was very simple. Too many investors had begun to believe that some things always go up—like the price of a house or a barrel of oil—and other things will forever stay down—like the cost of capital.

[Now,] despite expectations for rising sales, steadily growing demand over the long term, and another year of exuberant investment from venture capitalists, the solar bubble has been increasingly overdue for a correction.

The prospect of diminishing government subsidies, an oversupply of modules, rising materials costs, and the freeze [in] credit markets help explain why solar stocks over the past 52 weeks and even since October, have taken a steeper dive than the Nasdaq Composite index, on which most of them trade.

While solar technology is poised to continue its impressive growth streak, a perfect storm is on the horizon as a wave of supply converges with diminishing government subsidies and a very chilly credit market. This will require solar manufacturers to reduce prices to compete and could spell trouble for smaller module makers or companies overly reliant on credit.

The average selling price (ASP) for solar modules has been inflated by generous subsidy programs, mostly in Germany and Spain. This arrangement appears increasingly expensive, however, as more and more solar installations come online. Germany and Spain—the largest solar capacity markets—are now reducing or even capping the subsidies they pay.

Another casualty of diminishing subsidies could be the solar sector's historically stellar margins. Normally high margins are a good thing, but they may come back to haunt suppliers as government budget committees pull out the red pen. It helps that manufacturing costs continue to decline about 10% each year. But [several analysts concluded] that ASPs will need to decline closer to 20% in 2009 to absorb excess inventory, and as much as 25% the following year.

Again, the balance sheet of companies like Arizona-based First Solar (Nasdaq: FSLR) can probably survive that kind of margin compression, although the impact on their share price will not be pretty. Predicting worse-than-expected ASP declines and contracting multiples, Goldman Sachs’ Michael Molnar downgraded FSLR's stock from a Buy to a Conviction Sell, and slashed its target price from $365 to $103. (It traded near $110 Wednesday—Editor.)

Molnar wrote that [even] First Solar and California-based SunPower (Nasdaq: SPWRA) “will face headwinds in a market that is oversupplied with modules."  He [also downgraded SunPower’s] stock to Sell from Buy, and adjusted its target price to $43 from $100. (It changed hands below $25 Wednesday—Editor.)

Even in the current economic climate, solar opportunities are always shining somewhere. But we remain cautious on the sector as a whole and maintain our Hold rating on First Solar. We believe there will be opportunities for long-term investors to buy shares well below $100 in the near future.

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