Solar - Worth the Risk?

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 have significant problems, which explains their low valuations. Their dependence on government funding, either through large government projects or through government-subsidized private investment, is precarious in an era of austerity. Good intentions are often abandoned in emergency situations, so renewable energy spending gets scaled back when the going gets tough.

Many solar companies will end up pioneering new business models or liquidating. We will consider which, if any, are priced low enough to justify braving these risks.

Canadian Solar’s New Business Model

Canadian Solar (NASDAQ: CSIQ) is expected to extend its operations to building solar farms since the prices of solar panels have dropped. The solar farms that will be built from their own solar panels will later be sold to power-producing companies. These projects are potentially lucrative investments since the continual sale of electricity provides long-run revenues. The company’s CFO Michael Potter spoke about the solar farm projects. According to Potter, “If you think about it, it’s a long-term bond at a higher yield because it’s an asset that generates income.” Canadian Solar hopes to get about $1.3 billion from the sale of projects being developed in Ontario.

Solar panel prices, which are seen to be the cause of this need to diversify, have been affected by a global oversupply. Prices declined by about 60 percent and led to reduced revenues. The company has also not booked profits over the past few quarters. The CFO expressed optimism in an interview. According to Potter, “Our decision a few years ago to go more into development has put us in a position where we have a much better chance of swinging back to profitability in the near term than a lot of our competition.”

Deutsche Bank has loaned about $139 million to Canadian Solar in order to fund the solar farms in Ontario. Ontario Power Authority on the other hand has signed 20-year contract agreements to purchase the projects and sell electricity. This may be the future of the solar panel company. It is also conceivable that the company may venture into buying and retaining power companies. Bloomberg New Energy Finance analyst Jenny Chase did not think it a good idea. According to Chase, “I don’t think it makes sense for them long term - a manufacturer to be an owner of assets – it’s two completely different asset and capital requirements.”

Due to lower labor costs in China as compared to Canada, Canadian Solar manufactures the panels in China. There are therefore plans to develop more solar farms there since revenue from solar panels sales may become insignificant in the future. China’s government, through China Development Bank, is funding solar manufacturers, and Canadian Solar may benefit from such support. In Japan the company is working on residential rooftops. Chief Executive Officer Shawn Qu spoke highly of the projects in Japan. According to Qu, “The country is a rapidly growing market and in this fiscal year we expect to experience healthy volume growth.”

Canadian Solar is not the first company to explore business models outside of photovoltaic manufacture. SolarCity, a company that has recently been offered to the public, does not manufacture solar panels but it helps customers to install and finance and explaining that to consumers helped to promote its work. CEO Lyndon Rive indicated that demand was increasing.  According to Rive, "We told investors that we sell energy not equipment."

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>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/</span><span>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>NA</span></p> </td> <td> <p><span>0.11</span></p> </td> <td> <p><span>0.38</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>NA</span></p> </td> <td> <p><span>0.99</span></p> </td> <td> <p><span>0.85</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>NA</span></p> </td> <td> <p><span>0.59</span></p> </td> <td> <p><span>0.93</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>NA</span></p> </td> <td> <p><span>0.13</span></p> </td> <td> <p><span>0.43</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>NA</span></p> </td> <td> <p><span>0.28</span></p> </td> <td> <p><span>0.4</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>NA</span></p> </td> <td> <p><span>0.25</span></p> </td> <td> <p><span>0.74</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>4.39</span></p> </td> </tr> </tbody> </table>

Unfortunately, all these companies are speculative. They are running losses and they eat cash instead of generating cash outflows. Without profits or free cash flows these companies are playing a waiting game where they hope their cash reserves and credit outlast unfavorable economic conditions.  Suntech Power, Yingli Green Energy, and Canadian solar are already financed more by debt than by equity. Their weak balance sheets make them dangerous.

The challenges facing these firms are not paranoia: They are real. Konarka, a thin-film solar cell manufacturer, filed for bankruptcy in June. Many potential customers are demanding third-party insurance with solar systems to make multi-decade guarantees more credible.

Though First Solar (NASDAQ: FSLR) is the largest solar panel maker by capacity, it has been the subject of negative comments from JPMorgan analysts, who mentioned First Solar as a stock to avoid in 2013. Analyst Christopher Blansett projected that First Solar’s stock prices would decrease by about 50 percent. According to Blansett, "We see the issues currently plaguing the Solar PV industry—significant overcapacity and declining demand in Europe which historically has been the largest market—continuing in 2013."

Trina Solar’s Problems

Trina Solar (NYSE: TSL) recorded a net loss bigger than analysts predicted in its third quarter. Like other solar panel makers, is has fallen victim to oversupply and low prices. The company Chairman and CEO Jifan Gao noted how shipments of solar modules fell nine percent from the prior 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 third quarter of 2012, 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 share on revenue of $298 million.

Trina Solar hopes to renegotiate lower silicon prices in order to cut costs. The company expects a fall in its manufacturing costs for fourth quarter. Don’t bet on it: Trina’s earlier attempts in the most recent quarter to cut costs failed and costs actually rose on a per-watt basis compared to the second quarter. Worse still, 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. Trina Solar is in a pickle since the company only has about $703 million in equivalents and cash on hand -- including restricted cash.


Investors should recognize that the solar industry is treacherous. These are speculative companies, and they have traded at lower price multiples in the past. Speculators should wait for solar stocks to trade at less than 50% book value with a debt-to-equity ratio under 1 before making a small speculative bet in the industry.

BillEdson11 has no position in any stocks mentioned. The Motley Fool owns shares of JPMorgan Chase & Co.. 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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