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Mounting Economic Pressure Weighs Heavily on Solar Companies

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Solar companies are on sale for a reason. Yes, they are trading at cheap valuations. However, they are really risky companies. Their dependence on government funding, either through large government projects or through government-subsidized private investment, is very dangerous in an era of austerity. Regardless of good intentions, spending on renewable energy gets cut when the going gets tough.

Low Valuations

Clearly, solar companies are trading at low price multiples:

<table> <tbody> <tr> <td> <p><span>Ticker</span></p> </td> <td> <p><span>Company</span></p> </td> <td> <p><span>Country</span></p> </td> <td> <p><span>P/E</span></p> </td> <td> <p><span>P/S</span></p> </td> <td> <p><span>P/B</span></p> </td> <td> <p><span>P/FCF</span></p> </td> <td> <p><span>D/E</span></p> </td> </tr> <tr> <td> <p><span>CSIQ</span></p> </td> <td> <p><span>Canadian Solar</span></p> </td> <td> <p><span>Canada</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.09</span></p> </td> <td> <p><span>0.34</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>2.56</span></p> </td> </tr> <tr> <td> <p><span>FSLR</span></p> </td> <td> <p><span>First Solar</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.94</span></p> </td> <td> <p><span>0.81</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.15</span></p> </td> </tr> <tr> <td> <p><span>SPWR</span></p> </td> <td> <p><span>SunPower</span></p> </td> <td> <p><span>USA</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.35</span></p> </td> <td> <p><span>0.55</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.74</span></p> </td> </tr> <tr> <td> <p><span>STP</span></p> </td> <td> <p><span>Suntech Power</span></p> </td> <td> <p><span>China</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.07</span></p> </td> <td> <p><span>0.24</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>2.84</span></p> </td> </tr> <tr> <td> <p><span>TSL</span></p> </td> <td> <p><span>Trina Solar</span></p> </td> <td> <p><span>China</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.23</span></p> </td> <td> <p><span>0.32</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>1.25</span></p> </td> </tr> <tr> <td> <p><span>YGE</span></p> </td> <td> <p><span>Yingli Green Energy</span></p> </td> <td> <p><span>China</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.2</span></p> </td> <td> <p><span>0.6</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>4.39</span></p> </td> </tr> </tbody> </table>

However, all of these companies are speculative. They are running losses and they suck in cash flows. To make matters worse, Yingli Green Energy, Trina Solar (NYSE: TSL), Suntech Power (NYSE: STP), and Canadian Solar (NASDAQ: CSIQ) are financed more by debt than by equity. Their weak balance sheets make them precarious.

The challenges facing these firms are not some of an imagined macro boogieman. They are real. Thin-film solar cell manufacturer Konarka filed for bankruptcy in June.  Many potential customers need some assurance that service and warranty contracts are made good in the future. Third-party insurance is now being bundled with systems to make multi-decade guarantees more credible.

Trina Solar’s Problems

The woes of Trina Solar spread into its third quarter as it recorded a net loss bigger than analysts predicted. The Chinese solar panel maker has been a victim of an oversupplied solar industry with low prices. Company Chairman and CEO Jifan Gao noted that that shipments of solar modules fell about 9% from the second quarter. According to Gao, “Sales were hurt by the ongoing imbalance between supply and demand as well as the irrational pricing practices by some competitors.”

Trina lost close to $58 million for the quarter that ended Sept. 30, having lost about $32 million in the same period last year. Initially, FactSet analysts predicted a loss of 49 cents per share on revenue of around $347 million, while Trina’s reported loss stood at 81 cents per American depositary share on revenue of $298 million. In response to this, Trina has now cut its shipments guidance for the full year. Its revised full-year 2012 module shipment guidance is 1.55 to 1.6 gigawatts, down from a previous forecast of 1.75 to 1.8 gigawatts.

As part of cost-cutting, Trina Solar intends to renegotiate deals to buy silicon, a raw material in solar panel manufacturing. The company expects a fall in its manufacturing costs for fourth quarter. Investors should be skeptical because Trina’s earlier attempts in the most recent quarter to cut costs failed and costs rose on a per-watt basis compared to the quarter that ended in June. This, coupled with its increased borrowing, which pushed its interest expense to around $14 million during the quarter, saw Trina end the quarter with about $1 billion in bank debt. This is precarious since the company only has about $703 million in equivalents and cash on hand -- including restricted cash.

Economics Crushes Environmentalism

The economic crisis in Europe has greatly affected the EU’s (European Union) goals of curbing emissions from fossil fuel consumption and decrease pollution. The EU leaders have focused more on the region’s mounting multi-trillion dollar debt and double-digit unemployment rates while deprioritizing climate change.

Although the EU is expected to exceed its goal of reducing emissions by 20% in 2020, two factors reduce its member-nations’ zeal to go further: first, the need to shift focus on the economic slow-down, and second, their frustration that the first and second biggest emitters, China and U.S., do not intend to follow Europe’s example with similar actions.  The Polish diplomat Tomasz Chruszczow explained, “We cannot be held liable for the inaction of others. We can’t accept the excuses of the biggest economies of the world that they can’t do something before the EU.”

Each of the EU’s five biggest economies -- Germany, France, Spain, Italy, and the United Kingdom -- has either reduced or eliminated subsidies to renewable energy projects. Samantha Smith, head of the World Wildlife Fund’s global climate and energy program, said, “The financial crisis certainly is affecting how EU political leaders see their mandate.”

Participants from almost 200 countries gathered for the UN Climate Change Conference in November and December 2012. Faced with a challenge where all countries won’t be adopting binding emission targets until 2020, the International Energy Agency fears that the crucial 2 degrees target limit might be reached by 2017 if developed nations won’t cut emissions by 25% to 40% below 1990 levels. Even with the EU pledging to decrease carbon emission by 30%, Canada, Japan, New Zealand and Russia have not owned up to Kyoto protocol commitments, leaving Australia and other European countries the burden for the second round of cuts.

Solar Industry Burns Investors

Considering these challenges and the balance sheet weakness of many solar firms, investors should be cautious. This means being picky about which firms to speculate on, and allocating only tiny amounts of money to each bet.

SunPower is cheap based on its low price-to-sales and price-to-book ratios. It is precarious since its debt-to-equity ratio is high and because its Chinese operations make it sensitive to protectionism.

First Solar (NASDAQ: FSLR) is the most stable solar stock on this list. It is domiciled in the United States and has the lowest debt-to-equity ratio. However, it is also the most expensive stock on this list based on its price-to-book ratio and price-to-sales ratio.

Investors should keep away from this sector for the time being. Investors who just can’t resist speculating should consider making a small, speculative bet on SunPower.

BillEdson11 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend First Solar. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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