Profit Taking Could Dim Solar Plays

I knew solar stock popularity had reached an extreme when I saw the crew of CNBC’s Fast Money jesting about the name of a Chinese solar company, Solarfun Power Holdings (Nasdaq: SOLF). The stock’s performance on that day, Thursday, November 29, was, however, a very serious plus 31%. That said, here’s why I think the fun in the solar sector is due for a momentary eclipse. As a matter of fact, this is one of my favorite short themes for early ’08, but keep in mind that it’s a trade idea for the near-term, not a long-term investment strategy.

I expect a combination of two factors should drive a value adjustment in solar stocks soon. The first factor seems to be taking hold now, while the second should arrive with the turn of the year. First, the price of energy, specifically crude oil, looks poised to move lower to me. I expect that short-term demand factors are finally pushing the price of the black gold lower. As this occurs, I expect to see a simultaneous and exaggerated impact to solar stocks. Secondly, there are huge profits in these shares that have been secure until recently, due to the turn of the tax year. As we trade in ’08, these stocks could lose a lot of ground fast given the right catalyst.

The Fundamentals of Solar Fun

More than anything, what makes exotic energy sources viable alternatives on an economic basis is their competitive price-play with traditional sources. Obviously, as crude approached $100 and natural gas $8, the cost competitiveness of wind and solar energy improved. I think it’s clear that this is the fundamental reason solar stocks performed so well in 2007. Yes, believe it or not, that capitalistic sin of ours, profit seeking, is likely driving the run in these stocks and not environmental concerns.

Yet, consider what could happen to solar stocks if oil were to succumb to the pressure being applied by fundamental near-term catalysts? Slowing domestic economic growth, and possibly global health as well, could put a damper on near-term energy demand. Also, despite the messy start to winter in America, winters have run warmer and warmer as the years have progressed, and it was 60 degrees Fahrenheit in New York on Tuesday; this has a way of limiting heating oil and natural gas usage. Meanwhile, confronting Iran seems much less likely after the recent NIE report; I stress the word “seems,” because no matter what your expectation regarding Iran, it is current impression that matters more than reality in impacting price. Given these considerations, yet with a watchful eye on the geopolitical scene, I believe oil prices could contract sharply from here.

The cost of producing energy from the sun is on the highest end of the scale, and so related stocks should exhibit significant correlation to traditional energy prices. Furthermore, I expect the correlation of solar stock prices to the price of oil and natural gas, is likely on the very high side. This is because, as oil and nat gas prices rise, the costly solar dream gains dramatic ground toward becoming reality. R&D expenditures required to bring the cost of energy production down from the 20-40 cent per kWh rate make more sense when oil is at $100. As a result, capital becomes easier to raise and interested investors abundant. Thus, you have the wild rocket ride of solar stocks this year.

Jim Hansel, CIO of Eight Winds Capital Management, LLC, an advisor focused on energy and energy technology stocks, says that the rise in solar shares is greatly due to the fundamental driver of global solar panel demand that far exceeds manufacturing capacity. Jim, whose performance was +90.11% in 2007 through November, also feels solar stock prices have benefited from increased investor interest in the shares, while a shortage of U.S. based solar companies exists to choose from.

Uh Oh, it’s the Taxman

But, I think it’s time to pay the piper now. Oil is clearly on the near-term downtrend, in my view. If sustained for a little while, then it should not be long before solar stocks start to exaggerate that decline. I’ve got just the right catalyst to get that cataclysmic dive started right here in my back pocket, tax calendar year turnover.

Just look at the profits that are waiting to be had in these high flying solar stocks.

Solar proponents will tell you that despite the chart, the stocks might not be overvalued. Even so, the end of the tax year can throw a monkey wrench into the fundamental reasoning you expect to normally drive stock performance. Sometimes even valuation can’t get in of the way of capital flow.

Thus, I would look for the perfect solar storm at the start of 2008, with oil easing and tax-delayed gains finally taken. However, based on the valuation you see presented above, and my view that long-term fundamentals still favor expensive oil, I would look to reenter the space not too long after the sun sets.

Comments

[cleanenergy4me]

Disclosure?

[MicahelLofrano]

On a short-term valuation basis, I agree the solars have about as much substance as sunshine. I would, however, be hesitant, to short them. There is something just short of a mania at work here, but remembering how ridiculous the dot coms got before people came to their senses, it makes me queasy to think what could happen to holders of short positions. I don't think investors have recognized how insane some of this is. When a solar company rises 10% on the news that it has secured a supply of silicon, it tells me that investors are dabbling in something akin to a tulip mania. It is equivalent to GM soaring because it has announced that it bought some steel.

[kkin365]

According to his bio, the poster is a "sell-side analyst" for S&P. This is the first time I have heard a position description of this kind.

[iphonecanada]

Solar power is here to stay. Dangerous short
Solar-power-blog.blogs...

[ErnieMontague]

Oil is on the downslide? It is within a few dollars of the highest it has been in decades.

[RIA]

Yahoo finance shows SOLF earnings per share have just been boosted from $6.+ to $8.+ for '08 in the wake of the $230mm contract last week. At $27./share today and just 3.3 times '08 earnings that's overpriced? If you put even a 30 multiple on that you get a stock price well in excess of $200/ share. What's wrong with this picture? I've searched high and low and can't seem to find the caveat.

[Dreamrider]

Where the "blogger" may have a relative point, it must be noted that:

1) These solar operation's strength is in markets where oil-derived economic pressures are far greater than that in the US, i.e.: European Union Countries (remember their big contracts with Spain, France, etc), where a gallon of gas, regardless if oil was $55, or $99.99 per barrel, is the equivalent $5-$7/gallon, even back to 1998!

2) Because of the currency disparity of between the Euro and US dollar, couple to Chinese "hogging" the falling dollar to produce PV's sold to Europeans that pay in Euros...

3) What everyone has been talking about - supply not being able to keep with demand, i.e.: shortage of the primal epoxy required for the production of PV's. So... hmmm... Did Mao resurrect, and multiply his snot in a Christ-like-miraculous fashion, so there is a sudden oversupply of "organic" epoxy? Or is it that the plant being built by HOKU is going to be soooo big that the Pacific Ocean is going from salt water to salty epoxy... Supply demand still applies; low supply of epoxy = higher prices, higher prices for epoxy = higher prices for PV's, higher prices for PV's = greater revenues, unless, of course, all Europeans decide to not use their light bulbs at all in unison, in which case, we should buy stock in Chinese wax candles factories

[alpha24seven]

And I'll add.

1) Overcapacity and slacking demand. The overall ouput in MW's far exceeds all global subsidies by at least 50% going forward. Solar never sells without a subsidy. Who will pay for it? And YES demand is slacking. For example, Germany is soft and the California program is struggling. Subsidies are slipping as in Germany where they are starting to favor wind and witness the latest lack of support for solar in the US energy bill.

2) The housing debacle. The residential solar market is terrible. Who puts a +$20k (after subsidy) solar array on a home losing value? This is putting pressure on the commercial side to absorb the excess and it isn't happening -- yet. And this just isn't the US. Spain is in a tailspin and England is knocking on the door.

3) Recession. If we have one it will definitely impact solar sales. No question. It is not immune by any stretch of means. Many say we are already in recession.

Forget all the multi year projections from the solar industry. Recognize what is happening at the street level today.

[HaroldKramer]

Two points:
1) Listen to what is being said by world leaders. European support for alternatives was very strong at the Bali conference. All Democratic and most Republican candidates have positive positions on creating a sustainable energy economy in the U.S. for whatever reasons, be they security related and/or environmental. We don't know who will win the election but one thing is certain - it won't be George Bush.
2) In reply to RIA - In regard to Solarfun having a forward P/E of 3. Don't believe everything you read on Yahoo. I've seen these mistatements before on the Web. $6-$8 earnings for next year are probably stated in some other (Chinese) currency. Too good to be true.

[HaroldKramer]

Reply to M Lofrano
Point taken, but it really is a big deal when a solar panel maker gets a long term silcon supply contract. The difference between paying contract price and spot price for polysilicon can be huge and have a huge impact on margin and earnings. Witness the recent history of Solarfun (last two quarters).

[MicahelLofrano]

To HK
I realize that there may be a huge disparity in spot vs contract, but presumably the disparity works both ways, i.e., spot prices could dip, especially if demand slackens or production increases(as it most surely will). What then happens to the competitiveness of those locked in at higher prices?


The larger point remains:investors are euphoric over every bit of perceived good news, and, too, they seem to ignore every warning, no matter how cogent. This is beginning to smell like greed run rampant. Maybe, maybe not. God knows, even if that is true, it could drive prices higher for a very long time before anyone gets the point.

[taslen]

as these companies become more efficient in reducing the cost of producing energy from a natural source, the consumer will be saving, this in effect will not only improve the environment but allows the gains to be used for something else. This form of energy production also has good prospects for the developing world as the carbon offsets should encourage and enable them to access to forms of very useful improvements in living standards. The complexities in maintaining a new aspect will need carefull support but its a sure investment for the future

[oil4solar?]

The biggest problem with this article is the underlying assumption that oil prices affect solar stocks. There is almost zero correlation.

Why would the price of oil affect solar stocks? Oil powers cars; on-grid electricity powers homes.

[User 158398]

oil4solar: the reason that oil WILL affect the price of solar(and most alternative, for the matter) is that oil is used to produce them. There was an article not too long ago on the cover of the WSJ questioning why, now that oil was expensive, why the alternatives are not cheaper?
A sad commentary IMO. The answer, of course, is that oil is used to mine, refine, produce, and distribute the oil alternatives. I have solar on my own roof, which I bought long ago, they have now paid back the energy(from oil) it took to produce them. Sooner or later, the price of oil will affect solar, which is not the same as solar stocks, BTW.