Supply Glut Will Put the Heat on Solar Stocks

Gordon L. Johnson II, Solar-Energy Analyst, Hapoalim Securities By BILL ALPERT MORE ARTICLES BY AUTHOR AN INTERVIEW WITH GORDON L. JOHNSON II: An expert on solar-energy stocks, he sees gloomy days ahead for First Solar, SunPower and other names. 10:11 am ET September 26, 2009 Jim Walker wrote: I respectfully disagree. The solar industry is in its infancy, as measured by the man on the street. Me. Drive past 10 houses in any suburban neighborhood USA and count the # of solar panels you find. About 0.01% , if that many. The Solar industry will only become flooded when its cheap and painless to install a complete solution. For example, I went to Home Depot 2 weeks ago to buy solar driveway lights for $49. Self installed in about 10 mins. Just the stick in the ground and pull the tape off the batteries and presto! I now have nighttime driveway lights. I look forward to the day i can light, heat my house, run my frig w/ a similar easy to plug in solar solution that reduces all my other energy cost. We should be so lucky to find its only 3 yrs away but more like 15 yrs away. Solar collection devices may come down in price a bit , but for a consumer and the world, its the total purchase and install price that a bottleneck for adoption. I disagree with Jim because FSLR is more about the commercial side of the business, which is lagging (recessionary). And the reason the Solar industry is still not the top priority of any government administration (Bush, Obama, etc.) and not the favorite industry for subsidies, which it needs badly to build earnings growth. Reply to Gary Lee Coleman 09:17 pm ET September 26, 2009 Jim Walker replied: Gary, Thks for your comments. FSLR is in business to sell solar products. Not sure they care who eventually buys /uses them: Commercial or Consumer. It currently costs $70k (pre-tax breaks) to install a solar system in a residential home or roof of an office building. That its a big ticket sale that FSLR would be happy to have. But the holy grail of solar is thin film technologies that can cheaply coat my home's roof with solar elec. generating capability. (Check out Nanosolar and others who do this. Just re-interating my point that we are in the infancy of the solar mkt. Reply to Jim Walker 09:23 pm ET September 26, 2009 Orlando Perez wrote: I would like to know why Evergreen Solar is never considered on the "list" of companies regardless if they have been in the red. It seems to me that the mainstream does not mention the company intentionally for some suspicious reason. Does anybody know why? He talked about excess capacity. how much incremental demand is needed to soak this up and how can this be gauged? i was in italy this summer and i saw many solar farms along the autostrada that did not exist one year ago. the build out in solar is so potentially enormous. Reply to John Jay Gebhardt 01:42 pm ET September 27, 2009 Richard Miller wrote: With all due respect to Jim, the business model will not work at these rates irrespective of the customers. There are long term solutions that are cheaper per KwH than this solution at these prices. Government intervention will not solve the problem. And with respect to those lights from Home Depot, half of mine stopped working within one month. How are your's working? Reply to Richard Miller 02:11 pm ET September 27, 2009 John Jay Gebhardt replied: solar is not being driven only by price but also in order to combat GLOBAL CLIMATE CHANGE. Reply to John Jay Gebhardt Add a Comment All comments will display your real name. We welcome thoughtful and respectful comments. Please comply with our guidelines. + text size − print email Share Digg facebook twitter LinkedIn StumbleUpon Yahoo! Buzz MySpace del.icio.us NewsVine Mixx single page reprints get rss Subscribe Now With these readers: Or copy the rss link: SOLAR-ENERGY STOCKS HAVE BEEN MORE volatile than the broad market in the past year, and one of the most influential commentators on the group has been Gordon L. Johnson II -- the first analyst hired when Israeli firm Hapoalim Securities started a U.S. research group in 2008. Johnson's investigation of the solar industry's supply-demand problems led him to issue a bear call on the sector, which brought him flak until industry disappointments proved him right and the stocks retreated. Lately, the stocks have reignited. So, in a phone interview, we asked: What's up? Barron's: Do you have a few moments to get famous? Johnson: I don't know. The last time we spoke, First Solar [ticker: FSLR] was below 120, and I didn't think it was going higher. Now, it's 153. I was loved by my clients then. Now, people are scratching their heads. Matthew Furman for Barron's "It takes three years to construct a polysilicon plant. Now all these plants are coming on line, but the solar bubble has burst." --Gordon L. Johnson II What happened? Nothing changed fundamentally. But First Solar made a couple of announcements. The current stock price is going to be a great entry point for short sellers. The stock is definitely overvalued. Before we get into that, let's discuss your background a bit. I grew up in Ohio and went to school at Morehouse College in Atlanta. I got accepted by a couple of really good schools, but my grandmother thought that Morehouse was the best college on earth. I studied business after I noticed that the guys in the business department were wearing suits. I wanted to wear suits, and eventually I decided that I wanted to be an investment banker. When I graduated, it was a tough year for investment banking, but I was one of only two guys at Morehouse who got multiple offers. I started out at JPMorgan Chase, in the investment-banking unit. Later, I decided I wanted to go into research because that seemed like what my skill set really was. I worked at Credit Suisse for about three years, then I jumped over to Bear Stearns and then went to Lehman Brothers, where I covered semiconductors and, later, solar stocks. After Lehman went under, I moved to Hapoalim Securities. Your first call there was in October of last year? Yes. I rated the solar industry Underperform in October 2008. One stock I covered was Suntech [STP], which is based in China and at the time was at 24; it proceeded to go down to 5. I was worried about the financial crisis and the fact that Spain, which had become the largest solar-power market, would be cutting back. That created a massive oversupply, hurting a lot of solar-module manufacturers. At the time, people said that I was just trying to make a name for myself. In fact, someone from Suntech sent my CEO an e-mail saying that I was crazy, there was no oversupply coming and that Suntech stock was going to 30. Basically, that person was trying to get me fired. Did you change your recommendation when Suntech did fall to $5? I kept my Sell rating, but I did say that, at $5, this is probably as low as it gets. That was my price target. Okay, let's look at the big picture for a moment. What kind of global supply-demand picture do you see this year and in 2010? For the photovoltaic sector, supply this year is going to be about 7.1 gigawatts [or billions of watts], and supply next year will be about 10.8 gigawatts. That's total supply. And that excludes all of the thin-film manufacturers, including First Solar. If you include them, the supply gets even bigger. As for demand, it will be about 4.3 gigawatts, maybe 4.4 gigs or 4.5 gigs. In 2010, you'll have demand of roughly 6 gigawatts. So, things will remain challenging for the solar companies. What about crystalline polysilicon itself, the basic material for some solar cells? Polysilicon guys must run their factories at 70% of capacity to break even. In 2005 and 2006, there was an eruption of solar demand due to aggressive incentives in Germany and then Spain. Polysilicon spot prices-which averaged roughly $30 to $40 a kilogram before 2005-went to $450. So, a lot of guys said, "Oh, my God. This is a great market to be in" and built plants. But it takes three years to construct a polysilicon plant. Now all these plants are coming on line, but the solar bubble has burst. Demand is down. Polysilicon is $60 and, in some cases, $50 per kilogram. The price to make this stuff is $25 to $28, so if prices go to $40 or even $35, these guys would still make great margins. But prices will trend toward and maybe below the break-even level. In 2009, we expect total polysilicon supply of 96,432 metric tons and demand of 68,563 metric tons. That doesn't sound good for poly producers like MEMC Electronic Materials [WFR] or Wacker Chemie [WCH.Germany]. Right. People were saying last week that MEMC would be acquired by Wacker. That makes absolutely no sense, and MEMC said just that. Then an analyst said that Wacker had negotiated 20% higher wafer prices, which suggests that demand is strong. In reality, Wacker Chemie hadn't said that. So I have a Hold rating on MEMC. In 2009, they should make 8 cents. MEMC just negatively pre-announced Q3, because of this supply issue. They had production missteps at their Pasadena, Texas, facility. They always call it a one-time event, but they've had a number of production missteps. MEMC is now at 17.68. What's your price target? Nine bucks. What's sent solar stocks up lately? People got excited by China's announcement of a new feed-in tariff. Feed-in tariffs require utilities to subsidize solar installations by paying above-market prices for solar-generated electricity, right? Yes. But it wasn't a national tariff. It was a local one. Nonetheless, a lot of people thought there was going to be massive demand in China for solar modules this year and next. So the day of the announcement, all the Chinese solar stocks were up 30% or 40%. Suntech is one of the stocks that's up. Since I upgraded Suntech to a Hold, it's been in a range of 12 to 18. This year, I downgraded it to Sell again because I saw accounting and other risks there. What kinds of risks? In the first quarter, Suntech created an off-balance-sheet entity called GSF -- for Global Solar Fund. In their SEC filings and on a conference call, they described this as a separate entity that is buying Suntech panels. However, what they said shortly thereafter in questioning was that Suntech has an 86% interest in GSF. Suntech basically took modules out of its inventory and put them into the inventory of this off-balance-sheet entity and then recognized revenue on those modules. Beyond that, Suntech's costs aren't as low as those of the other Chinese module manufacturers. It has the largest commitment to purchase polysilicon at prices above where this material is trading today. Unless they renegotiate those contracts, they are at a structural disadvantage to guys like Yingli [YGE] and Trina Solar [TSL], which didn't sign long-term contracts at these predetermined prices. Another issue: To make a solar-power system, you take polysilicon, put it in a wafer, make solar cells from this and then assemble those cells into a module that can be installed on a roof. Trina and Yingli are vertically integrated all the way up through the wafering process; Suntech outsources its wafering. It's more expensive to do that. Wafering means sawing the raw silicon ingot into thin wafers, right? That's right. And Suntech has a ton of debt that has a pretty high interest rate and as a result they can't price their modules as low as their competitors can. What are your earnings forecasts for Suntech? For this year, seven cents a share; for next year, 12 cents. Suntech's now 16. What's your target? My target is $9. What about other stocks you cover? First Solar was able to come into the market and quite impressively scale up a thin- film manufacturing process that allowed them to produce modules at a significantly lower cost than the crystalline polysilicon guys. At the time, polysilicon prices were at $200. I was saying they are going to $50 in 2009, and people said I was crazy. I said that photovoltaic module prices are going below $2. That's a major risk for First Solar, because First Solar modules have to be priced at a roughly 40-cent discount, given that they are less efficient than the crystalline polysilicon modules, and so you need more of them. Table: What Johnson Would Shun This was when First Solar was in the 180s. Lo and behold, polysilicon prices went to $50 and First Solar's stock went to 90. It hit my price target, and I probably should have upgraded then. But, structurally, nothing has changed. Now the stock is back at 153. We're in an environment of $50 polysilicon right now and I would argue $30 by the end of this year, with photovoltaic-module prices of $1.80-to-$1.50 by the end of this year. At a $1.50, First Solar has to price its thin-film modules at $1.10. Their costs are 90 cents. So, that's not a 50% gross margin. Last quarter, they came out and announced this rebate program and basically proved my thesis correct. The stock plunged and then it recovered. What made people get bullish again? Basically what happened was First Solar started issuing press releases just to get its stock up. They came out and announced a memorandum of understanding to do a solar project in China It's an agreement with a city in Inner Mongolia. It's the equivalent of me signing a deal with a city in Indiana and making it seem that I have an agreement with the U.S. government. They don't have financing. It's contingent on a national feed-in-tariff, which China has said isn't going to happen for two years. It took the Chinese six years to evaluate wind-energy plants and determine that a feed-in tariff for them was warranted. They've only evaluated one solar project. You see First Solar earning what? For 2009, $6.56 per share on revenue of $1.8 billion, then in 2010, $3.07 per share on revenue of $1.9 billion. Are there other solar-energy stocks that we should discuss? One is SunPower [SPWRA]. In the second quarter, sentiment was at an all-time low, and they beat the expected numbers. It surprised me and a lot of other people on the Street. The stock moved massively higher. The issue with SunPower, which is based in San Jose, Calif., is very simple. Their costs to manufacture a panel are significantly higher than the Chinese guys'. But because it was of better quality, they could sell their product at a premium to the other guys. Now the quality of the Chinese modules has gone up, while selling at significantly lower prices because their cost structure is so much lower than SunPower's. What are your numbers for SunPower? For 2009, $1.3 billion in revenues and 98 cents in EPS. Now these are earnings that don't meet GAAP [generally accepted accounting principles], which is what the Street uses to value SunPower. The problem I have is that SunPower has among the highest stock-option expenses in the industry. If you look at SunPower's non-GAAP number, it is around 32 cents, that's how high their equity-option expenses are. For 2010, I see them with $1.8 billion in revenue and $1.11 in EPS. But with stock-option expense, 2010 is closer to 50 cents. And you have a Sell rating on the stock, which is now around 30. A Sell and a $15 target. What about Trina and Yingli? I had Buys on them ahead of the big move. It was a pretty good call. I just realized that the Street wasn't factoring in the gross-margin upside. Then in Q1 and Q2 they guided to higher margins, and the stocks just ripped. They are definitely better-positioned because they have lower costs. This is a commodity market, and they eventually will be the winners. But even among the Chinese, there's competition. Trina is probably the best-positioned. They've worked through a lot of their inventory. However, for Yingli, there is significant risk of an inventory write-down, for Q3 or Q4. They've built significant amounts of inventory, and they've yet to write it down. And there is risk in their accounts receivable -- they are giving their customers price protection. So I'm a little more negatively biased on Yingli. So with Trina now at 32 and Yingli at 12, your recommendations are... Hold. And I have price targets of 24 for Trina and 9 for Yingli. As we speak, you're at a solar conference, correct? Yes. The European Photovoltaic Solar Energy Conference in Hamburg, Germany. And what have you learned there? That Q3 is definitely stronger than Q2. There has been resurgence in demand in late August, early September. So a lot of people are saying this is the time to buy solar stocks. But people aren't really looking at Q4 and 2010, so they are setting themselves up for a potential disappointment. Thanks.