Solar Demand Rally Has Legs, but Don't Expect Profits
By Eric Rosenbaum - 01/17/12 - 11:20 AM EST
NEW YORK (TheStreet
) -- As the solar rally maintains momentum, the key for investors is to not run out ahead of the sector fundamentals. Demand is only half the equation.
Recent projections that the solar market will grow this year after a 2011 crash have pulled solar stocks up to start 2012. Last week, Deutsche Bank became more constructive on solar stocks -- and Chinese module makers in particular -- based on the potential for demand to exceed expectations led by Germany and China.
Even noted solar bears like Gordon Johnson of Axiom Capital have removed sell ratings on solar stocks given the potential for surprise demand in 2012.
On Tuesday, Maxim Group analyst Aaron Chew forecast 30 gigawatts of demand in 2012, with China surpassing Germany as the world's biggest market, installing 5.5GW of solar ion 2012.
Yet key to Chew's more rosy demand outlook for solar -- and reservations voiced by other solar analysts about the change in sentiment on the beaten up sector -- is the caveat that earnings won't necessarily exceed low expectations, even as demand does.
A key market mechanism in the solar sector is price and demand elasticity: As prices go lower, demand increases. Lower prices imply attractive project returns for investors in regions where feed-in tariffs are used to finance solar, like Germany and China, which finally implemented a national feed-in tariff in late 2011.
Take Germany, the landmark FIT market. Double-digit returns used to be the norm in Germany, and that was because of generous FIT rates coupled with the lowering of solar module prices. Now, in a declining FIT environment -- Germany will slash feed-in tarriffs by 26% this year -- it's the cratering of prices in solar modules that will allow demand to pick up again in Germany.
Maxim Group estimated investors can still generate a return of 7% from a solar project in Germany -- beating European bond returns has always been a primary driver for investors to finance solar. There is also the threat that the recent surge in Germany brought on by lower solar module prices will lead the government to finally implement a "hard cap" on solar in 2012. The threat of a hard cap -- even if it's only a threat -- is expected to result in a rush to install solar projects in the first half of the year.
While demand elasticity is good news for solar, the best that can be expected for pricing is stabilization near current levels of 90 cents to $1 per watt, Chew predicted.
Solar is still an oversupplied sector, meaning profit margins, if they exist at all, will be razor thin.
Amid last week's rally in solar stocks, analyst Paul Clegg of Mizuho Securities commented that the most important driver for profitable solar will be when the Chinese government consolidates its solar industry, but until then the supply/demand imbalance in solar will continue to limit profitability.
"Even as we forecast demand upside in 2012, we note this trails our estimate for cell/wafer supply of ~40 GW and thus expect minimal earnings leverage for manufacturers as the implied margins at $1.00/W point to EPS losses," Maxim Group wrote on Tuesday, echoing these concerns.
and Yingli Green Energy
are expected to be long-term survivors on the Chinese solar landscape, the critical question being at what level of profitability and in what corporate structure.
If the Chinese government is going to cull solar capacity, the rational it will use to consolidate the industry remains opaque as does the potential repercussions for equity investors.
Yingli, for example, has its own polysilicon plant, unlike Trina, and that's a link in the solar supply that could make a strong case for it as a survivor. Trina has a strong balance sheet relative to Chinese solar peers, which makes its own case for the company as a long-term winner. Jinko Solar
buys all of its polysilicon at spot prices, and while that helped it during the past year as polysilicon prices crashed, it's less clear as a long-term survival strategy.
Jinko Solar has, on the other hand, done a good job of building distribution relationships in key markets like Europe in a relatively short period of time -- it tapped a former Trina Solar head of sales last year as part of its drive into Europe. However, as the solar market attempts to move away from reliance on Europe, Jinko's global reach remains questionable relative to its more entrenched peers.
The poster children for the needed consolidation in Chinese solar are the most heavily indebted players in the market: Suntech Power
and LDK Solar
. While Suntech Power is the Chinese module production leader and the No. 1 solar brand in China, it has a weak balance sheet and weaker cost model than either Trina or Yingli.
LDK Solar, with the scale of its polysilicon plant operations, may ultimately have as low a cost model as any vertically integrated Chinese solar company -- and it intends to pass Suntech as the biggest module maker in the world -- but its massive capacity expansion plan has made it one of the most indebted players in a currently unprofitable industry. It remains unclear in what form this company will survive.
LDK is expected to survive because of its relationships with Chinese banks and the jobs it is creating in outlier areas of China like inner Mongolia, far from tier 1 cities, but this doesn't mean that its equity shareholders are safe. A scenario in which LDK's current management is forced out and the company taken over by a state-owned enterprise in China, or restructured in some other fashion with current equity shareholders wiped out, is more than a remote possibility, analysts contend.
The forecasts calling for as much as 30 gigawatts of solar in 2012 are surprising -- and optimistic -- given that the consensus was for a flat year. However, if it's off to the races with demand (again), it's still unclear whether the legs of the demand rally are to run straight into profits.
-- Written by Eric Rosenbaum from New York.
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