Solar Stocks are in Cyclical Down Cycle
The solar supply chain has been decimated and solar stocks are struggling due to over supply of Polysilicon and excess capacity. So what does this mean for the solar stocks and when is a good time to invest in them?
Like semiconductors and most other industries that require heavy capital investments, solar is a cyclical industry. When the times are good, companies are flush with cash and invest in new projects to meet the growing demand. Most of these capital projects take time to complete. For example, a new Polysilicon plant might take up to 2 years to come on line. In the meanwhile, if the demand levels out or decreases, it causes a few years of less demand and excess supply (as new commissioned plants are completed). This puts tremendous pressure on the prices and companies with high cost structures go out of business.
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We are in the 2nd year of the down cycle. There are some indications that the industry is bottoming out now, although it is not certain how long the recovery would be.
Is a 95% Decline in Polysilicon Prices Bad Enough?
Polysilicon is the key component for the solar panels. In 2011, the price of Polysilicon went from $475/kg to $33/kg, a 93% decline. The price of Polysilicon is currently around $20/kg – $25/kg, for an overall decline of 95% or so. Before the solar boom of the recent years, the price used to average around $30/kg.
The current production of Polysilicon is about 28% higher than the consumption, so the over supply persists.
The prices today are below the cost of production for most manufacturers, although a few top tier manufacturers such as Wacker Chemie AG and OCI are still able to generate positive margins. The result is a number of solar producers going out of business in this shakeup. A Bloomberg report published last year expects the number of Chinese silicon producers to fall to 4 from the currently known 35. A number of companies have delayed or cancelled plans for additional capacity expansion.
Bad European Economy and End of Subsidies
Spain cannot afford to subsidize solar energy anymore. Germany is the largest solar market in the world, and they have realized that doling out subsidies for solar has been a large money pit and they are in the process of ending it. Italy and Britain are following suit.
The subsidies have done a lot to help mass production of the solar systems, which has in turn reduced cost of the solar energy. However, as a perverse effect of the government "encouragement" of this sector, the over supply situation has put many of the producers out of business. Eventually as the subsidies are cut, the cost of solar energy to the end consumers will stay uncompetitive with the energy produced with fossil fuels. There are however innovations and new technologies being developed that can substantially reduce the cost of production and in time they will come on line.
The US government’s friendliness to the solar industry may be suspect as well going forward as the economics prove to be more costly for the tax payers dollar for dollar. If cheap natural gas continues to destroy the price for coal, coal fired generation plants will stay cheaper with any "green" alternatives (if coal producers can continue operating).
Solar Still Makes Sense in Some Areas
In India and other developing countries with inadequate generation capacity and antiquated grid, you need to compare cost of solar to the cost of operating diesel generators. Overall cost to the economy of installing a solar plant in these situations can work out better. Additional benefits include abundant sunshine, unlike most parts of Germany or rest of Europe.
The Shake Out and the Coming Up Cycle and How to Invest
The shake out has already started and is ongoing with bankruptcies piling up. The companies that survive will do so based on cheaper and more efficient production technologies. New sources of demand may come on line, and in fact the latest IHS-iSuppli research shows that the demand is firming up and price declines have started slowing. We just witnessed the first bubble-to-burst cycle in the industry and are very likely scraping the bottom. As Polysilicon prices are close to or below cost of production today, any further drop in Polysilicon, will just bankrupt more companies and reduce supply faster.
This may be a great time to selectively invest in the industry. There will surely be more losers that close shop in the coming years, so it is important to pay attention to the financial strength and the balance sheet of the company before you decide to invest. Companies like First Solar (FSLR) and Power One (PWER) have found ways to return to profitability while rest of the industry suffers and may be worth a look.
Cheap undervalued stocks in this sector are not hard to find but do make sure that the company is financially strong enough to survive another year or two of bad economics if needed. It’s going to be rough.