Solar Industry - Our Take on Legislative Outlook, First Solar (Nasdaq:FSLR) and LDK (NYSE:LDK)

Nov 18, 2008
Author: SCP Editor

November 19, 2008 - Solar stocks to a hit on Tuesday on comments from J.P. Morgan’s Christopher Blansett about the potential for reduced subsidies for solar in Europe. Blansett said that 2008 may he thinks 2008 was a peak for solar energy subsidization and recommended First Solar (Nasdaq:FSLR) as a “safe haven.” We disagree with Blansett’s assessment and timing. We think his assessment is doesn’t account for the legislative realities in place in the U.S., Japan and Europe. And we think his timing to call for instability in solar stocks is extremely late. Here is our take:

Blansett clearly isn’t impressed by Governor Schwarzenegger’s mandate for 33% renewable energy contribution in California, the potential impact and long-term stability in the U.S. market provided by the eight-year solar tax credit extension, and the expectation that Obama’s administration will likely accelerate the passage in Congress of a federal RPS. We think these dynamics alone, in the U.S. can more than offset any instability in European subsidies.

Moreover, new government incentives in Japan will also have an impact next year. Japan has seen strong legislative support for solar and its government is re-implementing incentives, targeting 70% of newly built houses to have solar panels by 2020.  Japan has earmarked 9 billion yen ($92 million) for solar panels for households in this year to March 2009. Japan's Ministry of Economy, Trade and Industry is seeking 24 billion yen ($246 million) for subsidies in the year starting April 2009, and estimates that about 100,000 homes would install solar panels next year, with the subsidy. We mentioned above that Japanese solar manufacturer, PV Crystalox is ramping guidance, not cutting it. And Kyocera (NYSE:KYO) last week announced it is building its second solar plant to double its output in three years to meet growing demand.

While France is proposing a plan to double the amount of energy provided by solar power and other renewables by 2020. The French government said it would seek tender offers by the end of this year to build at least one solar power plant for each of its regions by 2011 with aggregate capacity of 300MW. The current incentive program in France includes € 30c/kWh feed-in-tarrif for residential rooftop applications and € 55c/kWh for BIPV applications. The government is now planning to provide € 45c/kWh for large commercial installations, and intends to raise solar power output to 5,400MW by 2020 from less than 50MW in 2007. Its previous targets were for 3000MW of solar power by 2020. France’s target for renewable energy consumption by 2020 is 20%. And the EU has increased its target to 23% by 2020.

So we have to ask what Blansett is thinking when he makes such dour comments in the midst of what appears to us to be pretty remarkable legislative support in the U.S., Japan, France and the EU.

Add to this the dynamic in the industry which is expected in the midstream (module oversupply) and upstream (more polysilicon production coming online) in the next year and it seem to us that prices are going to come down, making solar a more attractive solution to the end customer. Meanwhile, efficiencies will only get better.  

Regardless, the mood in solar on the Street remains remarkably negative and, adding to the negative mood - MEMC (NYSE:WFR) lowered its guidance. The lowered guidance from MEMC exacerbated concerns that the solar industry will face stronger headwinds amidst a weak economic environment, with tighter financing conditions slowing down projects, or halting them altogether.

But again, there is plenty of good news out there, which, unfortunately just keeps getting overlooked. Pace PV Crystalox increasing its guidance;  LDK (NYSE:LDK) affirming its guidance and announcing another impressive supply deal this past week; and Suzlon considering entering the solar business because the India opportunity looks so attractive.

We do agree that the industry will feel the pressure of the global financial meltdown on some level. Companies with weaker balance sheets and higher cap ex requirements will be challenged to maintain their plans for expansion, and perhaps even operationally. But there are plenty of companies operating in the solar sector with strong balance sheets, strong cash flow and high visibility through long-term contracts.

We agree that First Solar (Nasdaq:FSLR) is a juggernaut, but can’t agree that it is a “safe haven” for solar stocks inasmuch as, on a peer basis, it still strikes us as being pretty expensive at a P/E of 32x (ttm). We are forecasting First Solar’s revenue for 2008 at 1.22 billion with net income of $317.2 million, and revenue for FY2009 at $2.1 billion with net income of $588 million.

In the current markets valuations in the solar sector have declined substantially with many leaders such as LDK Solar holding P/E ratios against current year forecasts well below 10x and against FY09 earnings less than 7. We don’t think that First Solar’s business is so much more insulated than the rest of its peers so as to justify multiple valuations of four to five times the group.

In which case, we would assign target P/E multiples to First Solar of 20x and 15x fiscal years 2008 and 2009 respectively, which are still twice the premium as its peers, and this would bring us to a target price against FY2008 projected earnings of $78 and a target price against FY2009 projected earnings of $108. So at yesterday’s closing price of about $110, we think the stock is still expensive.

To be sure, there is much to like about the company. It is the leader in thin-film. It continues to find ways to reduce cost per watt and its margins are impressive. All of these factors suggest a premium to its peers. We just think the premium needs to be reasonable.

On the other hand, a stock that we think is way oversold, which represents relatively less risk than its peers and substantially greater upside, is LDK Solar. Our forecast for its FY2008 revenue is $1.8 billion, and net income of $324 million, and for FY2009 our forecast for revenue is $2.9 billion with net income of $580 million.

At yesterday’s closing price of $14.89, the stock is trading at a PE (ttm) of 5.4 and a P/S (ttm) of 1.54; against forecasted FY08 results it is trading at a P/E of 4.89 and P/S of 0.88; and against forecasted FY09 results it is trading at a P/E of 2.73 and P/S of 0.55. We think the company’s growth rate, its strong balance sheet (about $490 million in cash) and access to credit (another $500 million or so available on credit line), and its leadership position warrant more compelling multiples.

At a reasonable 10x current year earnings (still half the premium we suggest First Solar warrants, and a third of the premium First Solar is currently getting), our implied stock target would be $30. Ultimately the markets will stabilize and valuations across the board will appreciate back to historical ranges (the S&P historical P/E estimates are about 14 to 15x) and we think this should start to happen at some point around mid-2009. At a 15x our projected FY2009 earnings for LDK, the stock would be trading at $81. So we think there is distinct upside in the stock at current levels, and that the risk has more than been factored in.

Important Disclosure: SCPEditor does not hold any position in First Solar, MEMC, PV Crystalox or Kyocera, and it is LONG LDK. The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance.  


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