By Richard Asplund

Solar stocks have been in a recovery mode since June 2010 and posted a new 10-month high in mid October. Solar stocks took a heavy hit during the global financial crisis in 2008/09, but are finally starting to emerge from those dark days. Solar stocks saw some weakness in early 2010 due to a larger-than-expected cut in the German solar feed-in tariff and the European debt crisis. However, solar companies in the past several months have seen extremely strong demand and module pricing has remained relatively firm, thus supporting solar company profits.

One way to watch solar stocks is by following the MAC Global Solar Energy Index, which is the tracking index for the Guggenheim Solar Exchange-Traded Fund  (ETF)1). An exchange-traded fund trades just like a stock but it is actually a pool of stocks. Rather than buying one or two stocks in a sector, an investor can buy an entire sector with an ETF, thus gaining the benefits of diversification across companies, technologies, and the value chain. There are 33 stocks in the MAC Solar Energy Index, with the largest holdings including First Solar, Trina Solar, Renewable Energy Corp, MEMC Electronic Materials, Meyer Burger, JA Solar, and SolarWorld. Of the 33 companies in the index, 27% have their headquarters in China, 40% in Europe, and 33% in North America.

Figure 1 is a graph of the MAC Solar index versus the S&P 500 index on a percentage scale so that the two indexes can be compared directly. The graph illustrates how solar stocks took an even heavier hit during the 2008/09 financial crisis than the S&P 500 index due to concern about weaker demand for solar panels during the global recession and about the difficult financing situation for solar installations. However, the MAC Solar Index bottomed out in March 2009 and then traded higher through mid 2009 as the economic recovery began and as the fallout for the solar industry was not as bad as initially feared. The solar industry saw a buildup of inventories during the recession but by the end of 2009, inventories had been worked back down to manageable levels. All in all, the solar industry came through the worst recession in post-war history in remarkably good shape.

Solar stocks showed weakness in the first few months of 2010 because the German government reduced the feed-in tariff rates, creating worries about lower module pricing. In addition, the European debt crisis emerged in spring 2010, which caused worries about whether European subsidies would be cut further and which caused a temporary sell-off in the euro (which hurts revenue for non-European solar companies that sell panels in Europe). However, solar sales in Germany remained strong going into the second half of 2010 even with the lower feed-in tariff, thus allowing Germany to retain its position as the top solar country, accounting for about one-half of solar system sales worldwide.

Solar stocks since June have recovered because of very strong global demand for solar modules, an improved financing climate for solar installations, and positive earnings reports from most solar companies. For example, First Solar (FSLR), the stock with the largest weight in the MAC Solar Index, released a favorable Q3 earnings report on October 28. First Solar’s Q3 revenues of US$798 million were up 66% from the year-earlier period. Q3 earnings per share of US$2.04 beat the analyst consensus of US$1.96. First Solar’s Q3 manufacturing cost per watt of US$0.77 was down 10% from the previous year, illustrating First Solar’s progress on cutting its costs and maintaining its profit margins even in a climate of falling solar prices. First Solar has a huge pipeline of projects and recently announced plans for new factories in the U.S. and Vietnam, bringing its production capacity to 2.7 GW by 2012. First Solar is quickly taking advantage of the fast-growing segment of building power solar plants for U.S. utilities.

Meanwhile, Chinese solar stocks, which account for 27% of the MAC Solar Index, have also been doing very well, supported by low costs and strong sales growth. In addition, the Chinese government is strongly supporting the Chinese solar manufacturers with large-scale financing. The Chinese Development Bank, a government-backed banking institution, recently provided a combined US$30 billion in loans to Suntech Power Holdings (STP), Trina Solar (TSL), LDK Solar (LDK), Yingli Energy (YGE), and JA Solar (JASO), all stocks that are in the MAC Solar Index. The companies can use these loans to pay down more expensive debt, finance expansion of production capacity, or provide project financing. The Chinese government clearly views the solar sector as one of its strategic industries and plans to strongly support the sector.

The U.S. has always been considered the sleeping giant in the solar market and the giant is finally starting to awaken. Suntech executives recently said they expect U.S. solar systems sales to reach 1.2 GW in 2010, which is more than double the 500 MW of sales seen in 2009. Moreover, a forecast from GTM Research said that the U.S. solar market could reach 2.5-3.0 GW in 2011, which would be more than double the 2010 level. The U.S. government recently approved six solar plants on federal lands in the southwestern United States that will provide power for two million homes.

There are challenges at the U.S. federal policy level for the solar industry since a cap-and-trade carbon law appears to be dead and since the odds do not look good at present for a national renewable energy requirement for utilities. In addition, the option to take the 30% federal tax credit as an up-front cash payment expires at the end of 2010 and the federal loan guarantee program expires in September, 2011. The prospect for an extension of those provisions is uncertain. But while the solar policy picture is cloudy at the federal level, the policy picture for solar at the state level remains very supportive, mainly in the form of requirements that utilities generate a minimum amount of their power from renewable sources such as solar. The states were the vanguard of the alternative energy movement through the Bush years and that should continue into the future.

The solar industry received some good news on November 2nd when California voters reaffirmed California’s clean air and energy policy. By an impressive vote of 61% to 39%, California voters turned down Proposition 23, which would have suspended California’s climate legislation known as the Global Warming Solutions Act (AB 32). Proposition 23 was conceived and heavily promoted by fossil fuel companies. The solar and cleantech industries were encouraged that they were able to win a public referendum on clean air and energy in a head-to-head battle with the fossil fuel industry. The outcome of the referendum in California also provided encouragement to officials in other states that public opinion generally favors pursuing alternatives to fossil fuels such as solar energy.

Looking forward to 2011, the main issue is the large amount of new solar production capacity that is coming on line. This new production could pressure solar prices and shave profit margins if sufficient demand does not emerge to absorb the supply. However, the solar industry over the past several years has repeatedly shown that demand turns out to be much stronger than even the most optimistic forecasts. Even if demand evaporates in one country, such as in Spain, demand pops up in another country, particularly as solar pricing falls and makes solar projects more economical.

Moreover, in the big picture, the solar industry needs to reduce its prices commensurate with its cost reductions in order to reach grid parity and wean itself from a dependence on government subsidies. Solar power is already competitive with the grid without subsidies in areas of the world where daytime electricity is expensive. Solar power currently accounts for less than 1% of electricity generation worldwide, which means there is huge upside demand potential for solar power as solar pricing declines and becomes increasingly competitive with fossil fuel sources. 

One of the best things that solar stocks have going for them at present is a reasonable valuation level. As Figure 2 shows, the forward price/earnings ratio for the MAC Solar Index is currently only 10.9, which is well below the forward P/E for the S&P 500 index of 14.4. While stock investors are being conservative in valuing stocks due to the uncertain macroeconomic climate, there appears to be a substantial amount of room on the upside for solar stocks to rally as solar companies meet or beat earnings estimates in coming quarters.

Richard Asplund is Research Director of MAC Solar Index (www.macsolarindex.com), the tracking index for Guggenheim Solar ETF (NYSE: TAN) and author of the book, Profiting from Clean Energy (Wiley, 2008).

REFERENCE

1) http://www.guggenheimfunds.com/tan