It’s turning out to be survival of the fittest in the solar gold rush. The solar company stocks to watch will be those that can successfully weather the current storm of business failings and stock plunges, according to solar industry analysts.
Once the dust settles on a period of extreme volatility, solar companies will have to prove they can chip away at their high inventory, keep costs and pricing low, and compete effectively on a global scale, the analysts say.
At this point, the solar industry is bracing for a challenging second half of the year following the release of dismal second quarter results.
Last week’s industry shakeup offered a good indication of the rocky road ahead: Evergreen Solar (NASDAQ: ESLR) filed for bankruptcy; First Solar (NASDAQ: FSLR) announced that its CFO (who apparently set up many of the company’s big deals with public utilities) was leaving; several other solar manufacturers closed or prepared to close U.S. panel factories; and stock prices for most of the major solar companies dropped about 10 percent a day.
Still, solar analysts consulted for this story advised taking a broader view instead of focusing on the short term slide in share prices. A few declines don’t have to mean the industry as a whole is doomed, they say.
With the steep decline in the solar stocks since March, many are trading at bargain prices that could lead to a rebound in the shares later this year. However, be careful of a value trap in solar, predicts Aaron Chew, a research analyst at Maxim Group who covers solar stocks. When the solar industry emerges from the current downturn there is likely to be distinct bifurcation between the higher-quality names most likely to survive the shakeout and others that are poised for even further losses, he says.
As solar emerges from the recent downturn, solar manufacturers may see a big jump in shipment demand, but the pricing declines suggest these sales will come at much lower profit margins, Chew says, while a higher level of normalized margins may not become apparent for a couple years.
Maxim lists among the solar stocks to watch Trina Solar (NYSE: TSL) and STR Holdings (NYSE: STRI). Both are rated ‘buy’ and the latter is part of what Chew calls the “pick and shovel” equipment and material supply chain that doesn’t experience the same volatility as the manufacturers.
“We suggest viewing any continued declines in the sector as a possible window of opportunity to establish attractive entry points with some of the highest quality names in the sector, such as TSL and STRI,” he wrote to investors in a recent industry update.
Trina Solar earlier this week reported its second quarter FY2011 results with earnings of 17 cents per share, compared to 63 cents per share in the first quarter of 2011 and 52 cents in the second quarter of 2010.
In a news release announcing those results, the company chairman and CEO, Jifan Gao, said he expects the third quarter will bring a significant decrease in manufacturing costs and a substantial improvement in the order pipeline.
Citi Investment Research Analyst Timothy M. Arcuri rates Trina Solar as ‘buy/speculative’ with a price target of $25. The shares currently trade in the $14 range.
In a research report published earlier this week, Arcuri noted that Trina’s second quarter results were "largely inline" with expectations and that there is “evidence of a strong rebound in Germany,” a country that represented two-thirds of Trina’s second quarter shipments.
For his part, Chew said that while Trina Solar’s stock “is unlikely to revisit its 52-week highs through the end of the year, we see it as a long-term survivor. While the stock could remain under pressure with earnings likely declining in 2012, if investors can stomach the volatility….we see it [Trina] as offering tremendous value relative to its core long-term earnings power and thus represents an attractive long-term investment at current levels.”
Another company that Chew says is likely to remain viable through the current upheaval is Yingli Green Energy (NYSE:YGE). The company reported better-than-expected second quarter earnings last week with EPS of 34 cents per share. The shares have lost close to 40 percent of their value year to date and currently trade in the $6 range.
Chew has a ‘hold’ rating on Yingli and wrote that “[w]hile YGE’s margins are also likely to come under pressure and cash flow to remain out of reach, we see the low-cost producer as a survivor at $1 a watt, and believe current valuation is fair.”
Citi’s Arcuri has a ‘hold/speculative’ rating on Yingli and recently lowered earnings expectations for the stock. He does, however, have a price target of $8.50 on the stock, a number derived from the company’s current book value.
According to Barrons.com, analyst Sam Dubinsky at Wells Fargo reiterated an ‘outperform’ rating on Yingli after the company’s most recent earnings report. He did, however, lower his price target from the $8.50 to $9.50 range down to the $7 to $8 range.
What stocks to sell?
The stocks Maxim has been recommending investors sell are First Solar, previously seen as the thin-film solar leader, and Suntech Power Holdings, (NYSE: STP), expected to continue losing money.
First Solar, for example, may no longer have the cost advantage it once had with solar energy prices for the more popular silicon panels dropping to nearly $1 a watt. First Solar was the first to reach that level.
Also, it’s somewhat discouraging to see the company’s former CEO and current chairman sell more than $68.5 million worth of First Solar stock earlier this month, reducing his holdings by 90 percent. (The company put out a press release yesterday noting that five of its senior executives bought 5,500 shares this week to add to their current holdings.)
Those purchases came after analyst Mark Wienkes of Goldman Sachs cut the price target for the stock to $150 from $175 and gave it a “buy/neutral” rating. The shares, which were previously featured on Goldman’s ‘conviction buy’ list, have declined more than 25 percent this year and traded for as low as $95.58 on Thursday morning.
Wienkes still said he likes First Solar’s cost advantages and expected “sharply accelerating” results for the second half of the year as First Solar “executes on its systems pipeline, lowers costs and diversifies its end markets.”
Similarly, Chew is not discounting a possible short-term pop in First Solar’s stock price due to sales expected from a few major solar projects that received funding from the U.S. Department of Energy. But, such government subsidies are drying up around the world.
“Long-term economics point to further declines for FSLR and STP,” Chew tells investors.
J.P. Morgan alternative energy analyst Christopher Blansett rates First Solar as ‘underweight’ with a $105 price target. “We expect [gross margins] to decline meaningfully going forward as the company increasingly shifts its focus towards system development and as subsidies in Europe and the US are reduced,” he wrote in a research report published earlier this month.
Brighter future ahead?
In his advice to investors, Chew said that solar sector stocks have historically exhibited extreme volatility due to a variety of factors including the industry’s reliance on fickle government incentive policies, the cyclicality of subsidies, pricing and demand.
But he adds, “The overarching elasticity of solar demand acts as a self-supporting defense mechanism.”
While the industry is struggling to catch its breath right now, it’s coming off a year of monumental growth with runaway demand and rising prices, Chew told investors.
That led to an acute case of oversupply. Most of the big companies produced too much, while dealing with government subsidy cutbacks.
Now, many solar stocks are probably close to hitting bottom, Chew says. So far he’s seen a sluggish pick-up in third-quarter demand. But he still has faith in the second half of 2011 and beyond.
“What’s happening is cyclical,” Chew says of the current industry upheaval. “There’s a downturn in demand, a major collapse in pricing. When the cycle is on an upturn again in 2012…demand will rebound.”