17 May 2011


SMA First Solar

'The days of all companies growing fast are over'

1. What is your vision on the development of the solar industry in 2010 and 2011 in terms of capacity ramp-up and actual production? What do you expect for 2012 and 2013?


We have arrived at a crossroads of sorts in solar whereby the winners and losers will be sorted out on the basis of their ability to produce and ship more volume through this turbulent period while not losing money. We can spot the winners in much the same way we did in the last cycle. The companies with the lowest cost structures, low operating leverages in financial terms, and the highest margin of safety will have the highest pricing flexibility that, if used, will steer volume to their company while not producing the same degree of pressure on profits seen at other companies without these attributes.

Module pricing is not as simple as supply and demand and supply chain acumen – for many reasons, including geographic mix, market reach, module accreditation and so on.  However, the module companies do have identifiable cost structures that have fixed and variable components. What we have found is that companies have varying degrees of "operating safety," or as we say, "margin of safety," that, looking towards the future, enables both the best and the worst positioned companies to continue to grow through the downturn like the one we are experiencing today. Put simply, at the end of last year, we calculated Trina's margin of safety as being the highest - significantly higher than that of First Solar, the company most widely thought of as being the best positioned solar company on the planet. Looking back on last year, Trina had nearly 285% more volume flowing through its facility than would have been required just to break even. What a feat! 

So, next comes operating leverage. If we think of this as dividing Contribution (Volume*(Price -Variable Cost)) by Operating Income (Module Sales - Cost of Sales), we can normalise the value for all companies in the group and compare this to see which companies’ profits are very sensitive to changes in sales and which are not so sensitive. If a high operating leverage really accelerates profitability, then we can say that this company will do comparatively better than another similar company which does not have such high leverage. Companies with a high operating leverage obviously like markets to be on the rise, and low operating leverage companies often outperform when volumes, prices or both are dropping, as we are seeing today. Aleo solar produced outstanding results last year for many reasons including great management, savvy supply chain tactics, and a very high operating leverage.

We are now in a position, therefore, to say something about the market development which we have observed over the past ten years and what lies ahead. The early phase, where companies’ immediate prospects were a function of technology choice, cost and module efficiency, is now over.  We are in the age of operations, marketing, sales and financial management. Companies with the lowest cost structures, the highest margin of safety and a low - not high - operating leverage, all combine into a growth strategy that will take steps through the cycle to continue to grow, will win the global market and set the competitive bar ever higher and higher. We expect to see leading companies grow in capacity at 35%-45% or more on average each year for the next several years, while we also see an oversupplied market on the margin this year and next. Thus, some companies will grow hyper-fast, but the days of all companies growing fast – or indeed at all - are over. So, while all companies will be less profitable throughout this cycle, 2012 will not be the end of the market as we know it for all companies. Consider the quote -- "Recession is when your neighbour loses his job. Depression is when you lose yours," and apply it to the PV market. Investors, suppliers and equipment companies can narrow their bets to those companies in recession and sort out those destined for inexorable competitive disadvantage. This is how we foresee market development.  


2. What is your view on global market development in 2011 in terms of MW of new installed power? Do you think that this year’s market growth is comparable to the record year 2010?


With the most recent changes in subsidies, we are seeing what most understand already is a difficult market. Our present global volume demand forecast was already down marginally (-8%) at the beginning of the year, and this has fallen by 15% year over year. We see between 12GW-to-14GW of global demand which essentially can be met by the top 10 module companies in China and Taiwan alone. What that means is that the market is in a recession – which is good for end-user system prices, but bad if you’re at a module company with a cost structure that cannot compete against these companies. You are in a depression!  


3. Are we facing a more serious oversupply and what is your expert vision on how these dynamics will impact the listed solar stocks? Who will benefit in the short term?


The oversupply is serious, as we have said. There will be some really rather nasty politics ahead, and a risk of more local content provisions throughout the world. The oversupply is significant enough to push itself back throughout the whole supply chain and foster efforts to reduce costs through contract renegotiations, facility rationalization and mergers and acquisitions that can facilitate large and lean production bases and thereby eliminate redundancy.


4. If the industry is in an oversupply situation and module and system prices are in decline, the market could reach grid parity sooner, with interesting growth perspectives. Would it thus make sense to buy solar stocks now although profit margins are currently under pressure?


Absolutely, but there are only a few companies worthy of making an investment in our opinion. Trina and Yingli are the only module companies that possess the management acumen and cost structure, with sufficient margins of safety and lower operating leverage that matter to us during this downturn. From the first quarter of 2008 through the fourth quarter of 2010, these companies have lowered their costs by between 61% and 70% respectfully. But that is where they have been. Where are they going? Back to the notion that they have the highest margin of safety, the lowest cost structures and lower operating leverage to combine with a drive to continue to grow. If we model these companies’ current year profits and stress-test their profitability based on lower sales resulting from falling prices, we see that these companies could remain profitable while others will be facing losses. This could mean that the two fastest-growing companies, based on the 2011 guided volume growth of 68% and 71% respectively, could eclipse competitors. Trina and Yingli appear to us to be in a position to capitalise in many ways as the markets recover (lower costs, better deployment of leading-edge processes, and customer service).


5. Stock-listed Evergreen Solar is in danger. Do you see more stock-listed companies facing difficulties to survive the current market situation?


We have unfortunately placed a number of public solar companies on the endangered list. These are module companies we feel could potentially lose 100% of their equity value. Evergreen Solar, Energy Conversion Devices, DayStar, Conergy and even Q-Cells fall into this category, alongside a number of others. The issues of cost and positioning are acute for these companies, as are other factors that may include debt in the form of notes and term loans that seem to us likely to result in equity losses.


6. What stocks would you favour in this situation: the upstream manufacturers or downstream players?


Over the past years, the profit pools have moved around quite a bit, which has that meant picking stocks as a function of upstream or downstream supply has paid off well for investors. This time round, however, this is less the case, because the stocks have already lost substantial value and trade at very low valuations. The short interest in most of the solar stocks is also extremely high, and so, arguably, professional investors have already positioned themselves for this downturn. Therefore, in terms of investing in companies with long-term potential we think Trina and Yingli now represent two of the best bets in the market. These companies, for the reasons we have outlined above, have what appears to us to be the very best long-term prospects. While Yingli is integrated all the way in the upstream, Trina is not. The question of what to buy, and in which step in the supply chain, is much more of a short-term play. While the upstream has maintained very good profitability, it is likely to come under more pressure as the cycle turns before it improves again. Downstream, the systems business is a regional one, and repositioning ahead of the changing markets is where most of our consulting efforts are made. It can take a year or more to reposition regionally (i.e., Europe to North America, etc). Therefore, the downstream, while feeling optimistic in comparison to the first quarter, now that the situation is clearer in Italy, is more than likely to experience heavy costs in rebuilding or establishing capabilities in other regional markets.  


7. You are a solar expert and analyst of crystalline solar PV companies. Do you see potential for further cost reductions by crystalline solar module manufacturers?


Yes, I am privileged to have colleagues who are premier PV materials consultants. Linx-AEI is number one in solar materials consulting today. We work on module cost fabrication and other technology- related projects that keep us up to speed with the costs of solar. We take these device-level workings into systems-level analysis for arrays of particular sizes and configurations in simulations in regionals the world over. What we are seeing are the right industry associations also getting involved, such as, led by the same leaders of the top semiconductor industry consortia and technology standards, as well as industry technology roadmaps. Companies in PV today that are not members of these associations are, in our opinion, likely to find that following cost reduction trends in isolation will become increasingly difficult. Furthermore, it also seems that there is a battle going on between the materials companies that are in many ways the true drivers of solar technology innovation and the solar equipment companies working to understand who are the companies and module makers that are likely to win. Cost leadership is perhaps the single most important factor in whether or not a company is considered for development work and investment of time by materials and equipment companies that understand the winnowing of the competition that lies ahead.


8. Recently, oil giant Total bought a large stake in SunPower. Some experts expect that multinational energy companies will someday buy leading solar pioneers from the stock market. But, why did Total do this - having stakes in solar already? And what do you see as their reason for having done this at this point in time? What do you think of the price they paid - is it reasonable?


I cannot speak to Total's investments in SunPower or AE Silicon, etc., but I am reminded of Chevron's investment in Energy Conversion Devices battery business, Norsk Hydro's investment in Ascent Solar, as well as many other investments by larger balance sheets, such as the well-heeled OCI buying into Evergreen Solar. Who got what and who benefited are just a few good questions to ask. The answers we must leave up to the dealmakers and executives in charge of these businesses at the time, and a value review, given today’s stock prices. Will Total open a conduit to their sub and provide large sums of development capital through which SunPower will be able to internally purchase panels from itself? What will Total's investment into SunPower A/B shares mean for existing shareholders? Given the fact that SunPower embraced Total's offer, we are left simply asking ourselves why they are selling stock at all when it does not bring new capital into the company of over $200MM per year, with a five-year verbal commitment to make a credit line available. For approximately 15x earnings, SunPower is agreeing to support a new majority shareholder. The deal looks even worse from a forward earnings multiple point of view, when trying to make any sense of this deal. A lower cost of capital and Total's majority stake does not seem to benefit the long-term equity investor in our view, unless the company is acquiescing to a cost structure that could result in an achievement of $23.25. The Total deal smacks of an admission and a sellout rather than the strategic deal that Total and SunPower's executive management are calling it. On the other hand, if SunPower's cost structure cannot come down appreciably and soon, the Total deal may look smart for all those that took the opportunity to get out.    


9. Do you expect that other giant (energy) companies will take over the other listed solar leaders on the stock exchange? To put it simply: should we buy shares in First Solar, Suntech Power, Trina, Yingli, SMA and SolarWorld because they are likely to face the same takeover?


At this juncture, we think valuations are very low and companies in technology and/or materials companies could acquire. We do not see a wave of acquisitions by oil companies sweeping through the solar stocks.


10. Let's think more long term instead of short term. Where will the solar industry and market be in 5 years? Thinking long term, doesn't it make sense to go into solar stocks right now?


This is absolutely the right way to invest in solar stocks, given the transitions we are witnessing in the current stage of market development. As the leading companies in solar are becoming identifiable, we think it is a wiser time than ever before to place educated bets. Tell me, who should buy the shares of ESLR? Only a pure speculator with a time horizon measured in days, minutes, or possibly even seconds? Or, on the other hand, at single-digit valuations for price to earnings, does it make more sense to invest in shares in the leading solar companies for the long term using your own level of risk appetite to guide you? This is for the individual to decide. There is no free lunch! However, solar PV is experiencing great growth and lower and lower cost levels as time goes on. These trends are likely to continue in the long term, strengthening the case for investing in solar stocks. 

Joseph Berwind will be a panel member during The Solar Future: Module Technologies Conference on 7 June 2011 in Munich, Germany. More information:

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