Solar Stocks Pioneer New Business Models

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

New business ventures require high rates of return to compensate investors for their high risk. Companies that change their business models must also compensate investors for joining them as they trek into new territory.

Many solar companies are changing their business models from manufacturing for home and business installations to launching solar power plants. Some are even repositioning themselves as electric power utility companies.

We will consider which solar stocks, if any, are priced low enough to justify the risks inherent in pioneering new business models and enduring the challenges of photovoltaic manufacturing.

1345 SunPower Deal

SunPower (NASDAQ: SPWR) has entered into contracts to build two California-based solar projects for a MidAmerican Energy Holdings, a subsidiary company of Warren Buffett’s Berkshire Hathaway. The company would receive between $2.0 billion and $2.5 billion in revenues from these projects. MidAmerican Energy Holdings would pay the company for the Antelope Valley solar projects, which has a capacity of 579 MW, and for designing, constructing, and installing them.

The construction of the plants will commence in the first quarter of 2012 and is expected to be completed by 2015. The projects are thought to be the world’s largest photovoltaic power development projects. The projects would sell power under two long-term contracts to Southern California Edison, a California-based utility company. The plants are part of California’s plan to reduce emission of planet-warming greenhouse gases by 2020 to 1990 levels. Other renewable energy projects would be needed to achieve the plan’s long-range goal of an additional 80% reduction in emissions by 2050.

Tom Werner, the Chief Executive of SunPower, said that the company should appear more credit-worthy based on these MidAmerican Energy projects and the expected cash flows from them.  However, many remain skeptical. According to Marshall Adkins, an analyst at Raymond James, the monetization of projects will not change the fact that SunPower retains a high-cost structure and razor-thin margins in respect to an extremely oversupplied market.

Unfortunately, there is another problem with building large-scale solar farms for utilities: more and more companies are doing it.  Many solar firms are repositioning their products. For example, SolarCity does not manufacture solar panels, but instead helps customers finance and install stystems. CEO Lyndon Rive indicated that demand was increasing.  According to Rive, "We told investors that we sell energy not equipment."

Canadian Solar’s New Business Model

Canadian Solar (NASDAQ: CSIQ) is also planning to extend its operations to building solar farms for sale to utilities. These projects are being pitched as good investments since the continual sale of electricity provides long-run revenues. Canadian Solar Chief Financial Officer Michael Potter said, “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 that 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. However, 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 loaned $139 million to Canadian Solar to fund the Ontario solar farms. Ontario Power Authority has signed 20-year contract agreements to purchase the projects and sell the electricity they produce. This may be the future of the solar panel company, and it may venture into buying and retaining power companies. Jenny Chase, Bloomberg New Energy Finance analyst, remains skeptical. She said, “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.”

Low Valuations

Clearly solar companies are trading at low price multiples:

<table> <tbody> <tr> <td> <p><strong><span>Ticker</span></strong></p> </td> <td> <p><strong><span>Company</span></strong></p> </td> <td> <p><strong><span>P/E</span></strong></p> </td> <td> <p><strong><span>P/S</span></strong></p> </td> <td> <p><strong><span>P/B</span></strong></p> </td> <td> <p><strong><span>P/</span><span>FCF</span></strong></p> </td> <td> <p><strong><span>D/E</span></strong></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>0.13</span></p> </td> <td> <p><span>0.5</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>0.94</span></p> </td> <td> <p><span>0.8</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>0.56</span></p> </td> <td> <p><span>0.87</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</span><span> Power</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.12</span></p> </td> <td> <p><span>0.4</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>0.33</span></p> </td> <td> <p><span>0.46</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>0.27</span></p> </td> <td> <p><span>0.8</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>4.39</span></p> </td> </tr> </tbody> </table>

Call me old fashioned, but I prefer stocks and industries where accounting profits and free cash outflows are commonplace. These solar companies are running net losses and are sucking in cash. This is why they uniformly have “NA” listed for their price-to-earnings and price-to-free cash flow ratios.

The threats facing these firms are not imagined, and they are not always overcome: they are real. Konarka manufactures thin-film solar cells and had to file for bankruptcy in June. Savvy solar customers are demanding third-party insurance bundled with solar systems to make multi-decade guarantees credible.

Clearly all these companies are speculative. When you invest in any of these stocks you are betting that the cash reserves and credit of a company can 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.

What about the solar stock with the least debt financing? First Solar (NASDAQ: FSLR) has been the subject of negative comments from JPMorgan Chase (NYSE: JPM) analysts. JPMorgan mentioned First Solar as a stock to avoid in 2013. JPMorgan Analyst Christopher Blansett expects First Solar’s stock prices will drop 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."

Conclusion

The solar industry is in terrible shape. These are speculative stocks, and many of them have traded at lower price multiples in the past. Since these are risky stocks in a competitive and risky industry, investors 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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