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David Jackson The Green Investor

David Jackson, The Green Investor

Illuminating an Alt-Energy Subsector

by David Jackson

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Posted on Tuesday, January 22, 2008, 12:00AM

Within the alternative energy sector, solar stocks have become the new darling of investors. There's good reason for optimism: The global solar energy market has averaged a stunning 25 percent-plus annual growth over the last 10 years, with worldwide growth for the last 5 years well over 35 percent. Yet solar electric energy still accounts for only 0.1 percent of primary energy production globally.

If you're looking for exposure to the solar market, which stocks should you consider?

First Among Equals

Perhaps the most prominent solar stock is First Solar (FSLR). First Solar went public in November 2006 at $20 a share, raising $400 million in a 20 million share offering. By the end of 2007, its shares were trading at $267 -- a stunning return of over 700 percent that leaves the company with a market capitalization of $18 billion. (The value of this stock, along with others mentioned in this article, has fallen dramatically in recent weeks.)

First Solar manufactures solar energy modules with a patented process that lowers solar electricity costs. It became the first to achieve the highly sought-after energy conversion rate of more than 10 percent for its thin-film solar chips, via a technology that previously generated less power per square foot than the more conventional approach of crystallized-silicon photovoltaics (PV).

Let's take a closer look at First Solar's numbers. Revenues for the third quarter were $159 million, an increase of $81.8 million over the second quarter of 2007, and an increase of $118.2 million compared to the same period the previous year. Yet with the huge run-up in the stock, FSLR's trailing 12-month price to earnings ratio remains sky-high at 182.

What will it be in 2008? Before deciding to buy any stock, investors should read the company's latest conference call transcript to understand what the company is saying about its business and what issues concern Wall Street analysts. On First Solar's most recent earnings call, CFO Jens Meyerhoff said:

"Revenue in the first half of 2008 is expected to decline sequentially over the fourth quarter of 2007 levels, due to our contractual price decline, foreign exchange rate assumptions, and the anticipated timing of incremental capacity contributions from our Malaysia plants."

High-valuation growth stocks tend to depend heavily on growing revenue momentum, and FSLR has already run into trouble in the first weeks of 2008. But the long term outlook remains quite positive: First Solar has over $6 billion in contracts locked in over the next five years.

But not everyone is bullish on First Solar. Tom Konrad, an independent investment advisor and financial analyst specializing in renewable energy, recently shorted First Solar. Konrad explains his thesis:

"First Solar's valuation seems out of line because of an inherent limitation on their profitability. Their solar panels are based on cadmium-telluride (CdTe) thin film technology, and tellurium (Te) is one of the scarcest elements in the earth's crust. In 2006, First Solar's 60mW of production consumed 4 percent of the world's annual supply of the metal. In 2008, analysts expect revenues of approximately 4 times the 2006 number, meaning they will need approximately 16 percent of new annual tellurium supplies."

Other 'Pure Play' Solar Stocks

What other pure-play solar companies should investors consider?

• SunPower Corporation (SPWR) designs and manufactures high-efficiency silicon solar cells and solar panels. Its stock price was up over 230 percent in 2007, but its P/E ratio is a towering 661.

• Suntech Power Holdings Co. Ltd. (STP), headquartered in China, is another solar stock that's shown strong growth. Lehman analysts Vishal Shah and Tim Luke published a note claiming that demand trends are tracking "well ahead" of Street expectations and are likely to impact favorably on this stock and the sector as a whole.

• JA Solar (JASO) designs and manufactures solar cells, primarily in China. In November, JA Solar lifted its 2007 full-year revenue expectation to $320-$370 million, with gross margin expected to be approximately 20 percent. You can read what the company said on its latest conference call here.

• China Sunergy (CSUN) is another stock to watch, especially after China's government announcement in late December that it would commit the country to developing forms of renewable energy. The company sells solar cell products to Chinese and overseas module manufacturers and system integrators, who assemble solar cells into solar modules and solar power systems for use in various markets.

• LDK Solar (LDK), also based in China, manufacturers multicrystalline solar wafers. In 2007, the company's stock performance hardly mirrored First Solar's, beginning trading in June last year at $27 and ending 2007 at $47. But this solar player might be undervalued. The company just released its preliminary guidance for 2008 and indicated that 2008 revenue would be between $960 million and $1 billion. Q3 2007 revenue was $158.7M.

• Solarfun (SOLF) is a manufacturer of both PV cells and PV modules in China. Investors who bought this one in January 2007 saw their investment grow threefold by year's end, with a closing price of $37.64. The company recently raised its 2007 guidance and expects revenues in the range of $280 million to $300 million, up from the company's previously forecasted sales range of $250 million to $270 million. Here's more on Solarfuns' upside.

As you can tell from the descriptions above, China is a major player in this industry, and most of the companies mentioned here maintain a strong international presence that provides investors with some global diversification. Be sure to recognize, however, that solar stocks are highly volatile -- brace yourself for sharp daily fluctuations in price.

Solar Sector ETFs

Investing in an alternative energy ETF is another option to capture the solar sector's rapid growth. ETFs effectively invest in a basket of stocks and avoid some of the volatility and risk of individual names.

Today, there are over nine alternative energy ETFs for investors to choose from, and while none of them focuses exclusively on this subsector, some have more exposure to solar energy stocks than others.

First Trust NASDAQ Clean Edge U.S. Liquid Series Index Fund (QCLN), for example, has over 8.5 percent of its holdings in First Solar, and another 15 percent in other solar energy stocks.

Market Vectors Global Alternative Energy ETF (GEX) has a 5 percent stake in Solarworld AG, a 4.3 percent holding in First Solar, and a 4.25 percent position in Suntech Power Holding Co Ltd.

Risk vs. Reward

Solar is a fast-growing market, and could prove lucrative for investors over the next few years. But high P/E ratios indicate that to a great extent, the pure-play solar stocks already reflect those expectations. Any disappointment in the companies' growth could therefore hit the stocks hard.

Moreover, pending expiration of the alternative energy U.S. tax credits at the end of 2008 is a factor that could also hit this sector hard. This shift will squeeze margins and raise overall product costs for many solar companies. And although the long-term outlook for solar is exciting, that message hasn't been lost on venture capitalists, who are pouring money into solar startups. A few years from now, many of those emerging technologies will be competing with today's publicly traded companies, potentially taking market share and driving down prices in the sector.

So if you decide to own pure-play solar stocks, be prepared for volatility, and make sure these positions account for a limited percentage of your portfolio. In a future column, I'll look at other, perhaps less risky ways to play the solar market.

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23 Comments

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  • Yahoo! Finance User - Wednesday, January 23, 2008, 7:40PM ET  Report Abuse

    • Overall: 4/5

    Making Green from Green is important in todays financial marketplace. Green Money Journal been writing about it since 1992. Check it out at- www.greenmoney.com === ====== =========

  • wgaf - Wednesday, January 23, 2008, 3:34PM ET  Report Abuse

    • Overall: 3/5

    it is a nice idea: to invest in solar, but the fundammentals are so week that it is similar to investing in an internet startup in 1999. GE is a big player in solar and is much less risky, granted it is not putting all its eggs in greeen technology but most current companies that do put all eggs in a green basket will not be around in 10 years.

  • Dick Decent - Wednesday, January 23, 2008, 2:24PM ET  Report Abuse

    • Overall: 2/5

    I agree with Simon. Solar is not a fast growing market, the players have been in place for a long time. Of course china will rule mfg of pv panels which means lots of defects. Until there's a 2G or 3G technology breakthru, the sector is like the device - cumbersome and long-term.

  • El Viejo - Wednesday, January 23, 2008, 2:01PM ET  Report Abuse

    • Overall: 4/5

    A fine replacement for Penelope .... :)

  • Da Big Guy - Wednesday, January 23, 2008, 1:12PM ET  Report Abuse

    • Overall: 4/5

    Green Technologies will provide some long term safe havens with long term upsides. A well organized piece although the shortsters may rule the day on many of these for a while so be prudent!

  • Yahoo! Finance User - Wednesday, January 23, 2008, 12:21PM ET  Report Abuse

    • Overall: 5/5

    Over time these companies will be a good long term investment. Utility companies subsidize many solar applications to reduce peak load as they do with other alternative energy sources - this saves by not having to generate more expensive peak power. Solar will not solve the energy crisis but it will contribute significantly to future power needs. Costs will come down and efficiencies will go up. This with the increases in other energy source costs will make solar more attractive. Enough energy hits the surface of the U.S. every 20 minutes to power the entire country for a year. There are solar cells on the market with 20% conversion efficiency. Solar companies would not be investing in manufacturing and development if there was not a growing market.

  • Yahoo! Finance User - Wednesday, January 23, 2008, 12:09PM ET  Report Abuse

    • Overall: 3/5

    Solar will have its day eventually, but right now there are a LOT of companies with better profits and near-term growth prospects in which to invest. Most of these alternative energy companies he mentions have extremely high valuations right now, and as such are risky investments.

  • Yahoo! Finance User - Wednesday, January 23, 2008, 11:19AM ET  Report Abuse

    • Overall: 5/5

    Nice one David. I do not like the fact that people give an article one star because they disagree. This is a good overview of a major topic that does not get a lot of coverage on Yahoo! Finance or other big sites. By all means disagree--this is a controversial topic--but this is a good solid overview of issues that many (most) investors are unaware of. I have been a skeptic on these stocks for quite some time--they are like tech stocks in terms of high potential but also a high level of speculation. Let's encourage Yahoo! Finance to keep this kind of different perspective and topic.

  • Yahoo! Finance User - Wednesday, January 23, 2008, 11:17AM ET  Report Abuse

    • Overall: 2/5

    Solar energy is not competitive with other energy forms unless heavily subsidized by taxpayers. Since subsidies can and do change with changes of the political wind, it adds a level of risk above and beyond that of a normal business. A slowing world economy is likely to put downward pressure on traditional energy sources, making solar even less competitive. And slowing government tax revenue may make governments take a second look at expensive subsidies during a slowing economy. Add to this the fact that these solar stocks are selling at a high multiple to current earnings, and it seems to me the risk profile should cause the investor to have concerns. When/if solar technology reaches cost parity with other energy sources it could be a rapid growth industry for decades. As long as it has to depend on the whims of massive subsidies to artificially buy down its price, use caution.

  • Nick Name - Wednesday, January 23, 2008, 10:24AM ET  Report Abuse

    • Overall: 1/5

    FSLR was trading at $267 at the end of 2007 then neglected to mention its tanked to $167 since then. He is just pumping solar stocks because he likely owns them. SPWR has tanked 50%. The rest are probably similar. He gets around this by stating where the stock price WAS 4-6 weeks ago. Solar stocks went up on hype and they are crashing just like dot coms did in 2000. The overall market is down nowhere near 35-50% like these stocks are. Pump and dump. This guy needs to invest in Rogaine, not solar stocks. Now if he had told everyone to short solar stocks back then, that would have been something useful. Solar, without massive public subsidies, is just not cost effective. The rich are the only ones who can afford it without having taxpayers foot the bill - they have money to burn.

  • Yahoo! Finance User - Wednesday, January 23, 2008, 10:18AM ET  Report Abuse

    • Overall: 5/5

    Why can't RK write something as coherent, specific, and useful as this? This article is a breath of fresh air after reading that hucksters article yesterday.

  • Andy - Wednesday, January 23, 2008, 9:27AM ET  Report Abuse

    • Overall: 4/5

    Good stuff... hey YAHOO!, could you tweak your comment sections some. It'd be really nice if you could put "thumbs up" and "thumbs down" next to people's comments. There are many sites that do this. It'd be nice to see what other people think about stupid and/or good comments. Some people just type ridiculous stuff. I'd like the general public to be able to tell them they are stupid with a nice big "thumbs down"

  • Steven - Wednesday, January 23, 2008, 9:06AM ET  Report Abuse

    • Overall: 5/5

    Good article. Unlike other Yahoo authors, he is talking about specific stocks/sectors and giving both the pros and cons of the sector. He is giving ideas on what to buy now, not what he bought in the past. Other Yahoo authors like RK say stuff like "I was buying stocks in August 2007 when I wrote an article telling everyone to buy silver."

  • Yahoo! Finance User - Wednesday, January 23, 2008, 8:11AM ET  Report Abuse

    • Overall: 4/5

    Very good article. Lots of disclaimers concerning the volitility of the solar stocks. This is how alternative energies should be pursued-let private enterprise develop the market instead of the government (eg. Al Gore) forcing high cost, inefficient alternatives on people (although some alternative energy industries are currently subsidized by the government)...Best article here in a long time. David, it would be great if you could tell us about other alternative energies being developed and the stock of those companies, if applicable, for the speculators among us.

  • SandyLady - Wednesday, January 23, 2008, 7:46AM ET  Report Abuse

    • Overall: 3/5

    Solar energy is a great idea but its bogged down in equipment/assembly/installation costs and problems. (In the marketing research I've done so far). Right now the cost recapture rate is about 10 years for a typical residential homeowner in the USA, probably a little less in the western states. In many areas of the USA, there are few, if any repair facilities/or skilled repair personnel, so you better know how your system works and how to fix it yourself. Same issue with wind turbines...try putting one up in your backyard! (Incidentially wind turbines (even smaller models) have a longer useful life and practically never break down....largely used in many European communities and homeowners). Until the oil/coal monopoly dries up you will be using fossil fuels for electricity, maybe nuclear if funding is ever approved.

  • niels w - Wednesday, January 23, 2008, 6:35AM ET  Report Abuse

    • Overall: 5/5

    Here in Wisconsin our solar electric market has been growing at a rate of 220% for the last three years. With firms like NanoSolar, Miasole, First Solar bringing in new lower cost technologies, the Chinese firms (such as LDK and STP) ramping up production at astronomical rates, and climate change as a driver... I am an optimist. Soon nations may see supporting the solar industry as a way to put people to work and get a country out of a recession.

  • Yahoo! Finance User - Wednesday, January 23, 2008, 2:29AM ET  Report Abuse

    • Overall: 5/5

    Good article. There's major growth potential in solar stocks, no doubt. The solar industry is now getting heavy support from government entities across the world who are pushing for alternative energy solutions. Furthermore, most of these solar companies have long-term contracts in place which are already bringing in strong revenues. Solar is no longer just some dream of the future, it is happening right here and now. If you don't get on board now you'll surely miss the boat.

  • marks - Wednesday, January 23, 2008, 1:39AM ET  Report Abuse

    • Overall: 1/5

    I am here in HKG. Taiwan market just closed and for the last months Solar has been getting more press and less action than any sector in the Taiex. Taiwan is probably the key manufacturing hub/controlling chinese factories. So what happens here matters. get in the real world. Your hoping for something that won't happen for 10 years.

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