Protected: Your Cheat Sheet to Investing in Solar


“Iíd put my money on the sun and solar energy. What a source of power!
I hope we donít have to wait until oil and coal run out before we tackle that.”
~Thomas Edison

THE STORY: Warming up to Solar

Table of Contents
THE STORY: Warming up to Solar
WHY NOW? Embracing the Sun
First Solar, Inc. (FSLR)
SunPower Corporation (SPWRA)
Chinese and Other Polysilicon Solar Companies
LAST CALL: Solar’s Bright Future

Want to invest in the greatest source of power in the human universe: then look no farther than the sun! The transition to solar, while still in its infancy is occurring at a rapid rate in markets around the world. Making the switch to solar as an energy source offers three primary benefits.

The Sun is the greatest source of energy on Earth.

As long as people populate the Earth, the Sun will be our life-source. While fossil fuels are highly concentrated sources of energy, the Sun is by far the largest, continuous energy source in our Solar System.†The problem has always been how to take that dispersed energy and capture it in a latent, consumable way.

Any concerted movement from fossil fuels will almost certainly include a large use of solar energy. In the abstract, all energy is derivative from the Sunóit is the Earthís livelihoodóhowever, until recently it was highly inefficient to convert that energy into tangible, consumable energy. Technology is becoming increasingly more effective at harnessing the Sunís power and unleashing it in an efficient and cost-effective manner.

Solar does not pollute the air.

Whether one believes in global warming or not, there are tangible benefits from cleaner air quality, so long as the costs are reasonable. As cities continue to grow, metropolitan areas are increasingly burdened with the health problems, such as the increased prevalence of childhood asthma, that stem from unclean air.

Some people now think of oil in terms of costs that go beyond the simple supply/demand equilibrium, as negative externalities can inflict a significant cost on society that is felt beyond the market itself.†Negative externalities are what economists call costs that are borne by society outside the scope of the supply/demand equilibrium for a product or good.

Firms and individuals that purchase and install solar panels lock in cost certainty for decades.

While the prices of commodities-such as oil and coal-fluctuate in the futures markets, the price of converting the Sunís energy into a consumable form is a fixed, precise number known upon purchasing and installing a solar power system.†When consumers purchase a solar power module, they pay a fixed cost upfront, in exchange for a product that will produce an expected quantity of energy over its warrantied lifetime.†This affords consumers (both people and firms) greater cost certainty when planning other aspects of their budgets and provides a natural hedge against rising energy costs.


WHY NOW? Embracing the Sun

The solar market is growing at a rapid pace.

Global demand for solar in 2000 was a tiny 170 megawatts. By 2009 that level of demand had jumped to 7,059 MW. Projected demand for the full-year 2010 is 11,218 MW.[2] The year-over-year growth from 2009 to 2010 represents a 59% surge in demand. This continues to be a long-term trend and one that everyday investors can now take advantage of with investments in publicly traded solar companies.

The Gulf Oil Spill is one of the greatest man-made disasters ever in the US.

The Deepwater Horizon rig explosion on April 20th has set off a wave of negative sentiment towards energy expropriation in higher risk areas. As the supply of crude oil continues to shrink relative to burgeoning demand, oil exploration is increasingly pushed towards more expensive and higher risk supply sources. As is evident with the Gulf Spill, these higher risk areas are not necessarily more prone to disasters, but far more damaging and difficult to contain when mistakes do happen.

There is a growing carbon credit market in Europe motivating firms to use alternative, non-polluting sources of energy. The carbon credit/tax legislation in the US, while on the back burner for now, is likely to reemerge in some form in the future. This event, has many re-thinking our dependence on oil overall.

Over the past decade, oil and other fossil fuels have increased substantially in cost (and volatility), leading to greater economic volatility and uncertainty.

The price shock of 2008 left a bitter taste with many sectors sensitive to the price of fossil fuels.†Volatility of that kind makes it very difficult for anyone who needs to plan a budget to anticipate their cost structure.†When a consumer buys a solar module, they know exactly how much energy they will get over a fixed time period.†This provides both a hedge against rising energy costs and offers the consumer a stable price around which to allocate other expenses.

The cost of solar panels has fallen dramatically over the last decade while efficiency has soared.

There are two kinds of efficiency in reference to solar power: first is the efficiency at converting the Sunís power to consumable energy, and second, is the efficiency in terms of cost per unit of energy produced.†Solar technology is becoming incrementally more efficient at taking the Sunís energy and redistributing it in a consumable form.

The cost of solar relative to fossil fuels: Energy Costs 1 ton of coal at a cost of $36 = $0.006 per KWH 1 barrel of oil costs $70 = $0.05 per KWH.[1] In 2007 solar panels cost on average slightly less than $0.40 per KWH. Now solar panels can cost as little as $0.08 to $0.10 per KWH.

Solar stocks took a beating in the past year on concerns over subsidy cuts.

Those subsidy cuts have not been as drastic as many anticipated in Europe, and the US is looking increasingly favorable to accelerate its uptake of solar energy.† We now have a much clearer picture as to the true demand structure of solar, independent of these subsidies.† Demand remains high despite the subsidy cuts from Europe, with utility scale projects in the US catching steam of late.


KEY PLAYERS TO KNOW


First Solar, Inc. (FSLR)

History of the Company

From 2005 to 2009 the company focused on increasing its production capacity of cadmium telluride photovoltaic cells.[3]†In that time, the company expanded from a maximum capacity of 25 megawatts of production to 1,282 megawatts. This built out was a very capital intensive process that required the construction of production plants in the U.S., Germany and Malaysia. Much of the proceeds from the company’s IPO and subsequent new share offering went towards building up this infrastructure.†Now that the company successfully expanded its production capacity it can use its improved cash position ($9 cash/share) to invest more heavily into research and development–the true source of future growth for a tech company. In 2007, the company invested $15.1 million in R&D, by 2008 that number reached $33.5 million and in 2009 it more than doubled again to $78.1 million.

First Solar dwarfs the other pure plays on solar as an $12 billion company as of the end of July 2010. After trading over $300 per share in early 2008 during the oil bubble, FSLR share are half as expensive now following the decline of crude oil prices.

The Technology (What is cadmium telluride and why is it different?)

First Solar uses cadmium telluride rather than the traditional polysilicon prominent throughout the solar industry. In response to FSLR’s success, researchers have discovered that tellerium is a far more abundant element than originally thought. Previously tellerium supplies had come from mining extracts in search of copper.†To date, there have not been supply constraints on FSLR, and nor should there be in the near future. Large supplies have been located in China, as well as vast and plentiful supplies in undersea ridges which alone “could supply more tellurium than we could ever use for all of our global energy” needs.†While the undersea supplies will not be accessible in the near-term, the future potential in this area is enormous and when investing in technology, potential is worth a nice premium in price. Some scientists speculate that tellerium might just be the “most abundant element in the universe with an atomic number over 40.”

The efficiency level of First Solar’s thin film semiconductor has leveled off, in contrast to silicon. However, before First Solar there was no commercial use for tellurium nor were there significant investments into further developing the thin film wafer technology.†Prior to First Solar’s commercial success few scientists focused on enhancing the efficiency of cadmium telluride in converting the Sunís energy into energy fit for consumption.†Cadmium telluride “has the optimal band gap for single-junction devices” and could achieve efficiencies in excess of 20%.[4]†This would make the technology even more cost efficient and could very well enhance FSLRís already robust profit margins down the road.

Risks

In any young and dynamic sector there are considerable risks. Solar power, as an alternative source of energy competes against wind power, hydroelectricity and natural gas amongst other options. Additionally, there is aggressive competition within the solar sector for business. In a growing industry, there is plenty of room for multiple competing companies and ideas to increase in market share. So long as the solar industry continues to expand, there will be room for many of the companies to exploit the new profit opportunities. With First Solarís impressive profit margins, they enjoy considerable pricing power relative to their peers.

Cadmium telluride is actually a toxic substance, and in the European Union, it is designated as a toxic carcinogen. However, in a study at the U.S. Department of Energyís Brookhaven National Laboratory, results demonstrated that there is no risk to either human health or the environment, so long as solar modules are recycled correctly following their usage. Despite the EUís designated of cadmium telluride as a carcinogen, First Solarís modules remain a popular choice in the Eurozone for producing solar power.

The bigger concern out of Europe stems from the uncertainty over sovereign budgets and the impact that will have on the regionís generous subsidies for solar power. Much of the uncertainty has eased over the past year, as countries have reorganized their budgets and made public their revised subsidy rates. While this has impact on the growth rate of these companies, the US market will be the key driver of growth moving forward.

This begs the question, can the competition compete with FSLR over the long run?

In a growing industry, there is room for multiple competing companies to increase their revenues without hurting each other. So long as the solar industry continues to expand, there will be room for many of the companies to exploit the new profit opportunities.†An efficiency advantage in terms of price or technology can set one firm apart from another and to date, FSLR enjoys an advantage in both spheres.

There is a significant amount of overlap between the competing technologies and competition for the solar industry occurs on multiple levels. Not only do solar companies compete with other solar companies, the industry on the whole must distinguish itself from other forms of alternative energy including wind power, fuel cells and hydroelectric power. As the most abundant form of energy in the universe, the Sun provides the solar option with a significant catalyst for further technological advancement and success.


Fundamentals


First Solar has demonstrated a consistent trend of quarter-over-quarter revenue increases since its birth as a public company. First quarter 2010 revenues of $568 million represent a 188% increase over Q1 2008 revenues. It was only 2005 that FSLR brought in just $48 million in revenues. FSLR continues to be an astounding growth story.


Despite FSLR’s rapid revenue and earnings growth over the past couple of years, the valuation on shares has been dragged lower by collapsing crude oil prices after the 2008 bubble. FSLR was trading at nearly 100 times earnings in Q2 2008 reflecting not only the rapid ascent in oil prices that made alternatives much more attractive, but also that EPS was growing 49% quarter-over-quarter at that time. Net income and revenue growth has remained strong and steady yet Mr. Market has re-valued shares dramatically. Shares now trade at a mild 25 times trailing earnings. Considering the 22% quarter-over-quarter net income growth rate, FSLR may deserve a higher multiple.


The driver of any solar company’s gross earnings is the difference between the price they charge per watt of power versus their cost per watt. FSLR has shown an ability to maintain pricing power over time with little variance between 2005 and 2008. The price charged in 2005 was $2.43 while the year 2008 had an average price per watt of $2.49.


FSLR’s cost per watt has steadily fallen over time generating higher margins for the solar panel maker. The cost per watt in 2005 of $1.59 is 32% higher than 2008’s cost at $1.08 average per watt. Lowering costs while keeping stable pricing power has been a key driver of FSLR’s earnings.

Technicals


Over the last year FSLR’s shares have traded to a high of $176.05 and a low of $98.71. Based on 12-month trailing earnings per share of $7.60 and the July 20th closing price of $136.22, the current P/E is 17.9. If FSLR were to fall to a P/E of 15 it would trade at $114. If shares were to be re-valued up to 25 times trailing earnings, the price would rise to $197.50.



SunPower Corporation (SPWRA)

History as a Public Company

SunPower shares first started trading on November 17, 2005 to much fanfare: the stock closed 41% above its opening price on day one. Cypress Semiconductor had spun off a partial interest in the company and kept the rest in the form of privately held ìBî shares in order for SunPower to begin trading publicly.†SunPowerís shares rallied aggressively from its inception as a public company, and accelerated mightily as energy prices soared. However, the growth in the company’s income and revenues lagged the share price acceleration.

Once the energy bubble popped with the rest of the economy, SunPowerís shares took a mighty beating.†On September 30, 2008, Cypress Semiconductor (NYSE: CY) completed a spinoff of SunPower, dividing the stock into Class ìAî and ìBî shares, and adding to the publicly available supply of SunPower stock. This further exacerbated the selling of the companyís shares. SunPower’s valuation is compelling trading within a couple percent of book value in mid-2010.

It is important to view the fundamental development of this company separately and distinctly from its share price action. SunPower boasts the most efficient commercialized solar cells commercially marketed. The technology was originally conceived and developed at Stanford University, and reached market in conjunction with investments and research from Cypress Semiconductors.†Now, SunPower is an independent company with a solid balance sheet and exhibiting impressive growth in its revenues and earnings per share each year since coming public.†The growth has continued despite the beating SunPowerís shares have taken.

The SunPower Advantage

SunPowerís stock is cheap on a valuation basis. The stockís shareprices completely discount any prospect for growth beyond 2010. The price/earnings ratio presently sits at 25 despite a 40% pop from its 2010 lows.†SunPowerís primary consumers are large-scale utilities.†Half of their revenues come from such projects, with 25% from residential and another 25% from consumer sales. As a result, their exposure to a slumping American consumer is somewhat muted.

Buyers purchase full systems up front, through a dealer (some of whom finance the deals at no risk to SunPower themselves) and the Federal government provides a 30% tax credit on the cost of purchase.†Their modules cost between $6-9 per watt, depending on the size for the system (large-scale utility systems cost less for customers) and are guaranteed by SunPower to perform for 25 years.

As the most efficient commercially available solar energy source, SunPowerís modules require less input material per watt of energy produced than their competitors.†This is important in two key areas for SunPower: first, it gives them a pricing advantage when building largescale systems, as compared to their competitors, and second, it requires less input material and thus costs less to build SunPower modules than equivalent competitive systems.†Many utility companies prefer SunPower systems because their efficiency allows them to take up less physical space than competitorsí systems.

As a result of this competitive advantage, the company places a great focus on total systems costs, as this gives them an edge in the utility space: they can build larger systems at more competitive prices. And this is exactly where the most impressive growth for SunPower occurs. Some large utility projects include a 25 megawatt facility for FP&L, the largest solar PV plant in the US, a massive 250 megawatt facility for PG&E in California which expects permits this year, a 19 megawatt plant for Xcel Energy presently under construction in Colorado and a 14 megawatt plant at Nellis Air Force Base, operational since 2007.

The utility scale projects have made the US SunPowerís fastest growing region.†Although a US based company, historically only between 40-60% of the companyís revenues have been earned domestically. At present, the company can produce a total nameplate capacity of 574 megawatts of energy, and expects to produce 550 megawatts in 2010, along with an additional 50-100 megawatts purchased from third party manufacturers to meet exceptionally strong demand.†SunPower recently entered into an agreement to build a 1.4 gigawatt production facility in conjunction with AU Optrinics, which will help meet growing demand and improve margins on large-scale production.

Risks

In an effort to buildout the companyís manufacturing capacity, SunPower turned to debt markets to finance the investment. As the oil was flying and solar stocks were all the rage, SunPower took on $425 million in new debt. This leaves the company more vulnerable than the likes of First Solar to the potential for further trouble in debt markets. However, the companyís shares presently trade at a discount to book value and that, coupled with their expanding cash flow should help the company raise equity should debt markets play out unfavorably.

Since SunPower uses silicon in their solar modules, the companyís input costs are subject to fluctuations in the silicon market. SunPower is less vulnerable than their silicon-based peers as a result of their industry-leading efficiency, which necessitates less input material than the competition. The higher margins from thin-film alternatives like First Solar also increase the cost pressure on SunPower and could squeeze some margins in the future should demand slump.

As with First Solar, SunPower faces some short-term headwinds from the subsidy cuts out of Europe; however, once again further development of the US market will be instrumental in continuing their impressive growth.


Fundamentals

SPWRA has shown a strong trend of increasing revenues over time. A major hiccup occurred in early 2009 as the credit shock in late 2008 spilled over into the new year. Difficult economic and credit conditions resulted in many customers delaying purchases until credit markets unfroze. SPWRA looks to be back on track with a record 4th quarter of $546 million booked revenues.

SPWRA traded at an astounding valuation during the early 2008 oil bubble with a price-to-earnings ratio topping 300 amid frenzied enthusiasm for alternative energy companies. The current P/E of 24 is much more in line with the rest of the equity universe.

Technicals


SPWRA’s 52-week trading range is between $34 on the high end and $10.11 on the low end. The July 20th closing price of $13.42 puts shares near the lower end of the year’s range.


Chinese and Polysilicon Solar Companies

Name Symbol Market Cap Revenues EPS P/E
Trina Solar Limited TSL $3.4 B $1.58 B $3.42 10.45
Suntech Power STP $1.99 B $3.08 B $0.81 19.21
Yingli Green Energy YGE $1.86 B $1.89 B -$0.28 NA
LDK Solar LDK $880 M $1.16 -$1.82 NA
Canadian Solar CSIQ $575 M $663 M $1.41 9.82

China is unique when it comes to the solar sector. In July 2010 China passed the US as the worldís largest consumer of energy, bumping the US from the top spot for the first time since the early 1900s.[5] While the country is the fastest growing consumer of fossil fuels, China also recognizes the need to embrace alternative energies. As a result, they have invested heavily in alternative energyóincluding solar– and several of the worldís leading solar companies are based in China. A recent New York Times article summed up the trend:

Already, in the last three years, China has shut down more than a thousand older coal-fired power plants that used technology of the sort still common in the United States. China has also surpassed the rest of the world as thebiggest investor in wind turbines and other clean energy technology. And it has dictated tough new energy standards for lighting and gas mileage for cars.[6]

While China is its own rapidly growing market, many of the Chinese solar companies generate a significant portion of their revenues in Europe. At the moment, European demand is rather sluggish and suspect considering uncertainty over the nature of subsidies for the solar sector amidst sovereign debt concerns. While some of that uncertainty has recently subsided, the real growth for this sector over the next few years will come from the United States, as we believe the catalysts for growth are particularly US centric.

Suntech Power was the first of the Chinese solars to build a plant in the United States, and as such, it has the most solid footing in terms of generating revenues in the US.[7] Suntech pursued this plant because they recognized the important of the US economy as the future of growth in the solar sector, and now some of their Chinese peers are trying to catch up. While Trina Solar has been the strongest performer in equity markets, in June of 2010, after recognizing the growth prospects in the US, Trina took a major step towards expanding their presence. The company cited the changing policy landscape, but more importantly the ability to use their cell efficiency and capacity model to generate sales with a favorable cost structure. The policy is really just an added booster.[8]

With China being the worldís most populous nation and one of its fastest growing economic engines it deserves investor attention in the solar sector. Many of the leading polysilicon-based solar technologies are owned and developed by companies based in china, with Trina Solar and Canadian Solar enjoying the highest profit margins.

According to LDK Solarís (LDK) fourth quarter conference call, ìthe average cost of polysiliconÖconsumed was $69 per kilogram.î During the financial crisis, polysilicon did decline significantly in price (as evidenced by the collapse in share prices of memory drive makers, such as SanDisk (SNDK) and Seagate (STX). The industry suffered from an immense oversupply of memory which triggered a demand slump for silicon. As global reflation has continued, these prices are once again on the rise, albeit they are well off their pre-collapse elevated levels. Notably, despite the collapse in polysilicon pricing, the wafer producers did not substantially improve their margins nor did they increase in profitability. While LDK earns $1.2 billion in revenues compared to FSLRís $2 billion, LDK failed to generate a profit over the past year.

THE LAST CALL: Solar’s Bright Future

The technology in the field remains dynamic and itís worth pointing out that the highest efficiencies produced in a laboratory to date are owned by a Boeing subsidiary named Spectrolab. Spectrolab has achieved efficiencies of over 40%, in excess of the previously known upper threshold of 37% for single-junction solar cells. While this technology remains in the development phase and has essentially no chance of commercialization prior to 2015, the boundaries of what is possible with solar power are constantly expanding.

First Solar and SunPower both enjoy unique technological egdges over their peers. This provides both companies with an advantage in marketing their products, and affords a greater degree of pricing power, which ultimately translates into higher profit margins and stock market outperformance.

While Europe has been an aggressive early adopter on the solar front, the future frontier for solar power lies in the United States and, to a lesser extent China. The deserts in the American West are uniquely suited to maximize the Sunís energy output with large swaths of open land that enjoy strong sun exposure and existing access to the nationís power grid. As the catalysts align in favor of a shift away from fossil fuels, the transition to solar power as an important energy source will only accelerate.

Selected Bibliography:

1Understanding the Cost of Solar Energy“, Green Econometrics

2Solar Market Goes Global“, Solar Feeds

3,4Cadmium telluride photovoltaics“, Wikipedia

5China Tops U.S. in Energy Use“, Wall Street Journal

6China Fears Consumer Impact on Global Warming“, New York Times

7China Solar Panel Maker Sets First U.S. Plant“, BusinessWeek

8Trina Solar Makes Major US Entry“, Renewable Energy World

Disclaimer: © 2010 Wall St. Cheat Sheet. The information and opinions contained herein are not advice to buy or sell securities or any other investment instruments. Accuracy and completeness of data and opinions are not guaranteed. We may have an interest in companies and assets mentioned.

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