Sunny Side Up

The sun is always shining in Gordon Johnson’s world. As an analyst at New York-based Hapoalim Securities, he spends his days seeking out investment-worthy companies in the solar technology industry. It’s a hot field (pun intended) that’s generating plenty of buzz as the Obama administration promotes green energy as a pillar of its efforts to reduce greenhouse gas emissions while creating jobs in the recovering economy.

The solar energy industry is made up of hundreds of public and private companies that produce the equipment used to convert sunlight into electricity. The main component in that conversion is a polysilicon wafer that contains photovoltaic cells. These wafers are pieced together to form the mirror-like solar modules that are appearing increasingly on the rooftops of homes and businesses around the world. Photovoltaic solar cell production has doubled every two years since 2002, making it the world’s fastest growing energy technology, according to business research firm GlobalData.

Johnson’s job is to synthesize the science and economics of the solar market and make that information useful to investors. He talked to Black Enterprise about the industry and its future.

We keep hearing about green technologies. Does that mean investors can simply pick a good solar energy company and ride the stock into the stratosphere?
No, but that’s been the general thought process. In the U.S., that kind of thinking is what’s driving solar stocks higher. Many governments around the world are talking up solar

energy, outlining plans to make investments in solar energy projects. Some countries claim they want their energy to be 20% solar by, say, 2020. In anticipation of that spending, some producers began growing supply. As a result, prices for solar modules have fallen by more than 50% in less than two quarters because of oversupply. So some caution is warranted. This year, and next, will be defined by industry oversupply, which will weigh on margins for many players in this industry due to pricing pressures. I do, however, see a couple of companies that are positioned to benefit.

Before investors jump in, what are some important factors to understand about the solar market right now?
In 2006, more than 30 opportunistic Chinese chemical companies began building polysilicon plants to take advantage of an explosion of solar demand in the world’s No.1 market, Spain. Consequently, the price of polysilicon was expected to soar from $40 per kilogram in mid-2006 to a projected $450 per kilogram by mid-2008. Today, numbers have fallen back to $60 to $70 per kilogram. On the other hand, it costs about $30 per kilogram to produce your own polysilicon. Companies that had the capital and ability to build polysilicon plants saw this market as a sure thing. [Margins were close to 95%.]

The price of a solar module is determined by: (1) the cost of polysilicon and (2) labor- electricity costs to run your plant. The Chinese solar

forwp-incontent-ad2"> module vendors have the lowest labor-electricity costs in the world. However, in 2006, 2007, and 2008, most of the Chinese module vendors were at a significant disadvantage to their U.S. and European peers, because they had to buy more expensive polysilicon while many of the U.S. and European solar module vendors had previously signed long-term contracts for much lower prices. But now polysilicon prices have come down. So, the Chinese module guys have seen a massive increase in demand for their modules, and taken share.

Is your first pick one of these Chinese companies?
Yes, GT Solar (SOLR). The market dynamic I described created a significant benefit to GT Solar. Its primary line of business is installing equipment to produce polysilicon. It is a leader in this segment of the market. However, given the onset of the financial crisis, and a massive spending pullback in Spain, demand virtually collapsed. At the same time, many of the polysilicon companies that purchased equipment from GT Solar didn’t have the scientific and manufacturing expertise to do well. We believe many of these companies now need GT Solar to help them correct manufacturing issues. It’s a very costly, contract based endeavor that will require GT Solar’s help for at least six to 12 months. While many solar companies are suffering right now due to oversupply, we believe the recent weakness in GT Solar’s shares creates an opportunity as our analysis suggests a material revenue opportunity for the company providing polysilicon production engineering expertise and equipment. Any small pickup in demand for its products will have a significant impact. We do not believe this dynamic is fully understood by Wall Street. So GT Solar offers an attractive opportunity to play solar volume, because you need equipment to get output–as prices go lower, volumes will likely grow. GT Solar is best positioned to benefit here.

Are there other Chinese solar companies that are positioned to do well?
Well, many Chinese solar manufacturers haven’t yet worked through the higher-cost inventory they built in 2007 and 2008. This means it will take longer for them to fully realize and show the benefit to gross margins as a result of lower raw material costs. However, while other solar cell/module vendors such as Suntech, Trina Solar, Yingli, and Canadian Solar have all experienced tremendous share price appreciation year-to-date, the value of China Sunergy’s (CSUN) shares are actually down year-to-date. Considering that China Sunergy’s production costs are in line with all of the Chinese solar module companies that have outperformed this year, this dynamic is somewhat interesting. China Sunergy’s inventory levels actually fell by 50.8% between fall 2008 and spring 2009. So we believe it is clearly positioned to reap the benefit margins of lower input costs much sooner than any of its peers. Given the stock’s significant underperformance versus its peer group, it is our opinion that there is a 40% to 50% upside potential for the shares over the next three to six months. We see this as a great near-term growth play for investors with a high risk-high reward investment profile.

Does anyone have a chance against these Chinese manufacturers?
Despite its 39.22% share price increase year-to-date, I think German manufacturer SMA Solar Technology (S92) represents a great buying opportunity. Unlike other companies in the sector, it doesn’t carry significant technology or execution risk. The company develops and sells solar inverters, the central components used in every solar photovoltaic system. SMA benefits when sales, or volumes, increase. Thus, unlike solar PV companies, who rely on technology and low prices for outperformance, SMA is as close a pure play on value as you can get in this sector. Furthermore, there are barriers to entry in the inverter market–such as elaborate certification procedures to become a distributor–and we believe the risk of new entrants into this market is low. We believe SMA is among the best positioned in the solar industry to benefit as demand improves. SMA is a pure play on the overall growth of the solar market while avoiding the issue of module price declines due to the current oversupply facing the industry. I’m forecasting photovoltaic installations to increase by 36% in 2010. It’s my opinion that SMA is well positioned to maintain its market share–currently 39.6%–and grow margins.

This article originally appeared in the October 2009 issue of Black Enteprise magazine.