The growth of alternative energy demand is one of the hottest trends within the market today. Investors have poured dollars into countless sub-sectors of solar, wind, biodiesel, geothermal, etc. The hope that a few of these trends will soon compete with our traditional sources of energy (fossil fuels) offers considerable rewards for long-term investors willing to bear the risk. AllStar sees the considerable promise in solar through photovoltaic cells (PV) and has reaped considerable returns from the trend through Suntech Power (STP), a Chinese company that is one of the major players within the industry.
The company designs, develops, manufactures, and markets various photovoltaic cells and modules to provide electric power for residential, commercial, industrial, and public utility applications worldwide. Though most of the solar industry operates on shaky fundamentals and continues to trade with the wild mood swings of the market, Suntech is company that generates substantial revenues, earnings and cash flows. The company has several major end markets in Europe, with the majority of revenue coming from Germany and Spain. China, despite its massive energy demand and worsening environmental conditions, is not yet one of the major end markets for the company, though CEO Zhengrong Shi optimistically visions that Suntech may supply 2% of China’s energy needs by 2020. While government subsidies and feed-in tariffs continue to support the entire industry, the initiative to make solar competitive with traditional grid electricity is real for the major players like Suntech. Suntech’s strategy is to “be the global market leader for the development and manufacture of PV products and spearhead the movement to deliver solar-based electricity at a cost equal to the cost or retail electricity.”
Suntech shares were unfairly hammered since the last earnings report where the company broke its streak of consistently exceeding production targets and forecasts due to skyrocketing solar module demand. Suntech’s 2008 target production of only 530MW despite 1GW of capacity shows how higher silicon costs have stalled the growth of the industry. Though the company has had a strong record of signing long-term silicon supply contracts at better fixed prices, even at this low target of production, Suntech will rely on the spot market to supply 40% of its silicon needs. With spot silicon prices continuing to soar upwards of $400/kg (up 30% vs. a year ago), Suntech’s decision to scale back its production to preserve margins was wise. Though the expected glut of silicon due to increasing capacity may be years away, even a slight ease expected in the latter half of 2008 or 2009 would be massively accretive to Suntech’s operating performance. In a recent note, an analyst at Raymond James & Co noted that with an ease of spot silicon prices from $400/kg to $300/kg, the gross margin on each produced solar module would jump from roughly 4% to 23%.
Though the near-term impact of high silicon prices is a point of concern for the expansion of the industry, for long-term investors, Suntech’s commitment to research and development is the strongest point of differentiation in the race to grid parity. Even as revenues surpassed $1.3 billion in FY07, the company continued to dedicate at least 1% of revenues to R&D. Improving conversion efficiency of solar modules is the most essential goal. The conversion efficiency is the percentage of sunlight that is converted to energy. Over the past five years, the conversion efficiency of Suntech’s multicrystalline cells has improved from 14.0% to 14.9%. In the more efficient monocrystalline cells, the conversion has improved from 14.5% to 16.4%. The promising innovation on the horizon is Suntech’s Pluto technology which, in pilot production, has reached industry-leading conversion efficiency of 18% to 19%. A commercial production line using Pluto technology is being rolled out this year.
The R&D spend has also shown promise in combating rising silicon costs. One of the other benefits of the Pluto technology is that it can be applied not only to monocrystalline wafers, but also polycrystalline wafers and lower grades of silicon. The further development of this technology will give the company the flexibility to use a wider range of silicon sources. Suntech has also been able to reduce silicon wafer thickness from 220 microns to 180 microns, allowing the company to use less silicon per wafer.
Thin-film cell development is the company’s other major R&D investment due to the growing demand for thin-film products. Though thin-film cell technology currently holds about half the conversion efficiency of typical cells, the technology near equally cost effective as thin-film cells are more flexible and can cover more area since they are not limited to the large panels. This includes BIPV (building-integrated photovoltaic) products, which are incorporated within the design of a building or rooftop. The company broke into the BIPV space by purchasing MSK, a competitor within the industry and is currently constructing a major thin-film R&D and manufacturing plant in Shanghai, with the plant is expected to reach 50MW of thin-film capacity by the end of 2008.
At $45 per share, Suntech shares seemingly command a hefty valuation at 44x 2007 EPS. However, the multiple is very reasonable given the growth figures. Capacity of 1GW in 2008 is expected to double to 2GW by 2010. Revenues are also expected to grow in the range of 40%-50% over the next two years, which with flat margins would place the PEG at around 1. Though at present the valuation is reasonable, the most tempting reason to buy shares is the massive upside potential if the race for grid parity is indeed successful. For example, shares of First Solar (FSLR) soared from $25 to over $250 in 2007 because the company’s PV technology is presently the closest in the race. As Suntech narrows the gap, long-term investors willing to ride the volatile shares will be rewarded.
Neal Sangani
Disclosures: I own shares of STP. My comments are for educational purposes only.
Monday, April 14, 2008
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