Manufacturing Overcapacity Continues to Plague Solar Stocks: Expert Research Reveals Economics Supporting an Inflection Point

Wall Street Transcript

67 WALL STREET, New York - September 6, 2012 - The Wall Street Transcript has just published its Utilities, Alternative Energy and Water Services Report offering a timely review of the sector to serious investors and industry executives. This special feature contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Outlook for Biofuels and Biochemicals - Asia Pacific Demand for Solar Energy - Grid Parity Timelines for Alternative Energy - Water Infrastructure Development - Irrigation and Metering Technology - Water Industry Consolidation

Companies include: Dow Chemical Co. (DOW), Chevron Corp. (CVX), Sasol Ltd. (SSL), First Solar, Inc. (FSLR), Total SA (TOT), Canadian Solar Inc. (CSIQ), Maxwell Technologies Inc. (MXWL), Johnson Controls Inc. (JCI), Albemarle Corp. (ALB), EnerNOC, Inc. (ENOC), ABB Ltd. (ABB), Toyota Motor Corp. (TM), Covanta Holding Corporation (CVA), Johnson Controls Inc. (JCI) and many others.

In the following excerpt from the Utilities, Alternative Energy and Water Services Report, an expert alternative energy research analyst discusses his outlook for the sector:

TWST: The last time we spoke, the segment you were least excited about was solar. Have there been any developments for the solar industry that have shifted your view either positively or negatively?

Mr. Kallo: One of the things that's plagued the solar industry is the solar module manufacturers in 2011 continued to build out capacity really ahead of demand. And demand has been at least slowed because of subsidy resets in Europe and some subsidies going away in the United States and other places. But really it's building out capacity, and mostly this is Chinese manufacturers that built out capacity, which has outstripped demand. What I've continuously looked for to become more positive is a slowdown, and then even a curtailment of capacity.

Now, we've seen the two most rational companies - I would say, First Solar (FSLR) and SunPower (SPWR) - come out and curtail their capacity, and even shutter capacity. And then, both have undergone restructuring to reduce their capacity and both companies are more focused on the balance sheet side of their business in moving the markets that aren't subsidy related. This could be in South America, this could be in Middle East, North Africa. And so this is an evolution of a business model where I'm purely a module manufacturer to where I'm actually making energy products. I'm acting more like an engineering procurement construction firm. And First Solar and SunPower, both, I would say, have been the best at that.

I think SunPower really has the better entree into some of these developing markets, because of their relationship with Total (TOT), the big French oil and gas company. Total operates in many of these developing countries where solar makes sense from a cost perspective today. And so I think that will help in addition to Total's helping backstop any financial needs that SunPower has. So I think that will help them there.

Now, as far as the overall market goes, we continue to see consolidation, not enough, really consolidation is occurring in non-Chinese companies, European companies or North American companies, but we continue to see a buildout of capacity in Chinese companies. I was recently at Intersolar in Germany, in Munich a couple weeks ago, and Intersolar in San Francisco this week. These are the two big solar conferences, and you see the second- and third-tier Chinese manufacturers continuing to expand capacity.

And then, even yesterday, there were reports that Canadian Solar (CSIQ) is going to increase their capacity by 700 megawatts. Now, that's exactly the opposite of what I want to see in a market, where supply drastically outstrips demand. So I want to see the opposite of that one. I want to see some of these smaller second and third players go away.

On top of that, because there is this oversupply, there is also now a drastic decline in average selling prices. And we've seen in some of my checks when I was in Germany, hearing about second- and third-tier manufacturers selling products as low as $0.65 a watt, which is below even the most efficient manufacturer's production cost, and they're really just producing below cost. And a lot of these companies are being effectively subsidized by real cheap Chinese debt, and I think that they're even viewed as a jobs programs for now. I don't think it will always stay like that, but for now that's where we are as we're in a period of products flooding the market at levels below a lot of the companies' production cost, and we're continuing to build capacity also. I don't see anything that gives me a lot of hope for the next couple of quarters.

I think at some point, the Chinese government steps in and some of those smaller companies go away. We've seen some of that occur. We're to make the analogy to the Chinese wind industry, which is, I'd say, one to two years ahead of the Chinese solar industry as far as capacity buildout goes.

Now, on the flip side, the positives are new markets are opening up. China has definitely accelerated their internal demand for solar projects. So this year, we estimate between five and six gigawatts will be installed there, rising maybe up to seven gigawatts next year, but what that's going to do is benefit the overall market. It's going to suck up some of those Chinese products. Pricing there is going to be under pressure. So margins are going to continue to be compressed, I think.

Japan is definitely a very bright spot. Again, that's a captive market where most of that business is going to go to Japanese companies or if companies are able to partner - non-Japanese companies are able to partner with Japanese companies. And the prime example there is SunPower's relationship with Toshiba (TYO:6502). I think that's the best way to get exposure. And if I pull it all down to where we are right now, if I was going to own one of these stocks where I do think there is still some more risk, it would be SunPower. That's the one I'm most constructive on.

And then we see things like markets in India opening up as well, although I think that will take until 2014 before it's a very sizable market - in the size of Japan. And then, the Middle East, there are definitely some interesting things happening, especially in Saudi Arabia, where they're definitely making a push for installing solar, which seems that's counterintuitive at first glance with all their energy there, but the opportunity cost of burning oil is actually more now than producing electricity using solar. So it's better to ship a barrel of oil than burn a barrel of oil to produce electricity. So that's another market in the 2014 time frame. And then, there are markets, like South Africa and South America, but we still have a stretch to get there. So I don't think as far as the stocks go, we really get there until likely 2013, and then, or maybe even mid-2013.

TWST: For the stocks you have "neutral" rated, what are some of the changes, either in the macro environment or within the companies, you'll need to see to consider upgrades on some of these stocks?

For more from this interview and many others visit the Wall Street Transcript - a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs, portfolio managers, and research analysts. This special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

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