I love getting mail from readers.  The email from “horowme” this afternoon seemed worth re-posting for all to read:

Zach,
Could you comment on this article as it relates to your most recent podcast re: positive report on the solar industry and the Chinese governments intention to subsidize installation projects. Does this reported glut of silicon change your opinion regarding the near term changes in solar stocks?
Thanks

The article referenced was a Barron’s Online piece that I can only assume will be aired tomorrow.  The link should be active, but in case they change it, you should be able to search Barron’s for “Nightfall Comes to Solar Land”

Essentially, Barron’s is arguing that new supplies of polysilicon (the raw material used to make solar panels) is hitting the markets at the same time that end demand for solar power is waning.  Three factors are listed which cause solar demand to be light, and this light demand obviously leads to reduced profits for solar panel producers  Here are the factors:

1. Faltering Government Incentives – while governments around the world have promised to increase spending on renewable energy, some programs have been shelved, while other stimulus dollars have taken longer than expected to come to market.
2. Lower Oil Prices – Traditional energy has a foothold on the market.  But high prices of oil and natural gas gave energy users incentives to find cheaper alternatives.  Now that those traditional prices are lower, competition is also lower meaning less is spent on solar development.
3. World Financial Freeze – Access to capital has been restricted for months now.  Companies with plans to purchase solar panels (and thereby reduce their long-term energy costs) simply could not complete many transactions.  So its easy to see how the credit freeze has slowed demand.

Now it appears that all three of these issues are actually quickly improving which could have a big effect on the demand side of the equation.  The latest news out of China shows that the Ministry of Finance is ready to put a huge amount of money behind initiatives to help drive installation of large solar power systems.

Oil prices have lifted significantly off their lows from earlier this year.  While economic news has yet to indicate huge demand for traditional energy sources, a decrease in drilling projects may be having an effect on supplies which yields stronger pricing.

And finally the financial sector is beginning to thaw as crisp newly printed currency foods the system.  Rates are lower and lenders are being given every incentive to put this capital into action.  I expect access to capital will continue to improve this year – but with more responsible lending standards.

Is Low Cost An Advantage?

Barron’s points out that First Solar (FSLR) and Energy Conversion Devices (ENER) operated on a different plane than most solar manufacturers.  Both companies offered solutions that used less polysilicon as a raw material.  While there were some drawbacks (lower energy yield rates), the actual cost per watt of electricity produced was lower.

But now with polysilicon prices lower, that cost advantage is becoming more narrow.  If costs continue to drop, it could become largely immaterial how much silicon is used in production.  And so the technology offered by FSLR and ENER will provide little additional cost savings to end purchasers.

While I don’t argue that lower silicon prices will help traditional solar companies compete on a more level playing field, First Solar should still have somewhat of an advantage.  If demand picks up for solar energy (due to all three of the demand issues improving), we should see poly prices stabilize (or at least not decline as rapidly).  The increase in demand should benefit the entire sector, but low cost producers will continue to turn an effective profit on solar production.

Investments Offer Best Value in Some Time

Even if all the arguments Barron’s points out were accurate and had the expected effect on the solar market, investments in this area could still perform quite well.  This is because the stocks have already largely discounted a negative environment for solar energy.

Many traditional suppliers have dropped 80 to 90% of their value and while First Solar has held up better than most, its stock is still trading for less than half its value last year.  Energy Conversion Devices is less than a fourth of its August level.  Both of these stocks are trading for multiples that seem more than reasonable given their industry leadership and the expected growth over the next few years.

So in summary, I don’t dispute the facts of the Barron’s article, but I think I would come to a different conclusion based on the way the current stocks are trading and the encouraging signs in the industry.

Do you have a question or comment that you would like discussed here at ZachStocks?  Please feel free to send me an email (growth@zachstocks.com) or simply comment on an item asking your question.

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