Solar Stocks: A Good Play?

In recent months, all solar stocks have come down to near bottom as a result of three factors: fast falling prices due to technology advance; reduced government subsidies in top markets like Germany and Italy; and overcapacity in production and supply. The industry is currently undergoing a shakeout where some weaklings have collapsed (e.g. Solyndra and Evergreen).

Which company is going to die next? Nobody knows for sure unless you are a top official or shareholder of the company. The shakeout is essentially a short-term problem that the industry must work through for the next several months. When the dust finally settles, the survivors will become stronger because they will have taken over the market shares of the fallen.

When you invest in stocks, short-term problems should be examined to see if they portend future opportunities. The problems facing the solar industry right now do not look that bad considering the near explosive demands and other long-term potentials.

First, falling prices due to technology advance should be a good thing because it invites the mass market. How many industries possess this extraordinary advantage? The electronics or high-tech industry is the champion in this respect. Solar technology is electronics in nature because it involves capturing sunlight to drive the electrons to generate electricity. Similar to computer chips, the raw materials in photovoltaic cells are predominantly silicon, only in some cases cadmium telluride and others are used.

The method of manufacturing is also similar to electronics. It involves packaging the photovoltaic cells as densely as possible onto the solar panel, thereby increasing its efficiency in absorbing sunlight. The current solar efficiency is around 25% only, hence a lot of room for improvement. Another significant component is labor cost. That is why Chinese firms have risen to dominate world solar production. Like electronic products, solar panels are characterized by continuously improving efficiency combined with plummeting prices. However, it also means short-term turmoil for solar companies as occasional shakeouts occur due to the nature of this business.

Since the sun only shines for half a day, the electricity generated must be stored in a large battery pack for use at night to avoid being wasted. So battery technology must deliver lower storage prices hand in hand with falling solar panel prices. To cite an example of the battery for electric cars, the magic number is $350 per kilowatt-hour to trigger adoption by the mass market. Many experts agree that this price threshold for electricity storage will be reached within the next few years from the current $900.

In view of falling prices for both electricity generation and storage, solar energy is fast approaching cost parity with fossil fuels. If the subtle pollution costs of fossil fuels were taken into account, solar energy had already outperformed its rivals. The current handicap is the initial out-of-pocket cost for solar panel and battery installation, where some companies in the US are already offering zero down payment. When parity is reached in the next few years as expected, there will be a mass switchover to solar energy from fossil fuels. The idea of one solar panel per rooftop is coming closer to reality, just like the realization of one personal computer per household, or one mobile phone per person.

Second, government subsidy in Europe has to end someday if prices have fallen so fast. The reason is that there is simply no need because the market will take care of itself. Despite its shocking announcement, the German subsidy has already contributed to the takeoff and fast growth of solar. Furthermore, it has assisted a number of Chinese firms in achieving global producer status by selling to the German market.

Third, the current overcapacity cannot last long. Why? It has already produced lower prices that have stimulated demands. The higher demands will eventually wipe out the overcapacity. The consumers actually welcome overcapacity for the low price. Only the companies have to worry because it hurts their bottom lines.

Therefore, the current turmoil in the solar industry will turn out to be good opportunities. This is confirmed by the dynamics of the demand. The solar market has become global within two decade starting from near zero to surpassing $40 billion in 2010, and is projected to reach $150 billion by 2020. The biggest markets are currently in Germany and Italy, but many countries with large populations are vying for first place such as USA, China and India. In addition, the rest of the developing world needs solar energy as the best substitute for expensive oil. They cannot wait for the construction of a modern electricity transmission infrastructure. Solar energy enables households and communities to become independent electricity producers and consumers, thus bypassing the transmission line lacking in remote areas.

The following shows the stock performance of the top five solar companies:

JA Solar, China: high (2009) $27, low (2011) $1.21, now (2/17/12) $2.02.
Suntech, China: high (2007) $90, low (2011) $1.70, now $3.65.
First Solar, USA: high (2008) $317, low (2011) $29.87, now $42.59.
Yingli, China: high (2007) $42, low (2008) $2.50, now $4.74.
Trina Solar, China: high (2007) $36, low (2008) $2.81, now $9.64.

From the above, it seems that they were all racing to the bottom, but are recovering since last winter. The lingering question is: Which company is going to die next? I have no idea except to point out the following facts:

The dynamic growth of the global market will keep the solar industry expanding by leaps and bounds. On the other hand, plummeting prices will cause some firms to fail.

The weaker companies will be eliminated, especially smaller ones. The strong companies are those that have achieved economies of scale and technological edge through advanced research. They will expand faster by grabbing the market shares of the fallen.

Government subsidies will become less important as the market expands. The German and Italian governments have succeeded in kick-starting the solar market with subsidies. On the other side of the globe, the Chinese government is determined to make solar a prime industry for the future. Chinese companies tend to receive easier funding from state banks in addition to direct subsidy from the government. The result is Chinese domination of world solar production in just a few years. Thus the failure of a major Chinese solar producer is less likely than a non-Chinese one.

The volatility of solar stocks is very scary indeed. The main reason is that it is an emerging industry of high growth and fast price drops, similar to the chip industry decades ago. Despite all the turmoil, I think solar is a good play with great rewards. As oil prices are surging to over $100 per barrel right now, almost the entire stock market will be negatively impacted someday except oil stocks. However, solar stocks will likely move up with oil, because higher oil prices will make solar more attractive. Therefore, solar is not only an emerging-industry play, but also an oil play at very low costs. How many other industries can you find where such niche exists?

(February 2012)