Competitiveness: Analyst-Middle East instability brings solar to “Grid Parity”

 

BABE ENJOYING SOME SOLAR ON A PANEL

Blog Note: The masses in the Middle East, long suppressed by autocratic rules-now have democratic aspirations-that could serve as the foundation to better lives. In that transition period-instability has replaced predictability.

In the oil rich Middle East-that transition-may have resulted in a new national security paradigm for oil dependent countries-as static gives was to new dynamics and paradigms.

One paradigm that is changing is that of global energy-particularly with alternative energy.

For global investors, the attached  Seeking Alpha report listed a few interesting solar investment opportunities.

For investors in Thailand, there are also listed solar firms. In fact, if Thai Intel is not mistaken, a Thai solar firm announced a major “Grid” play not very long ago.

The risk in the solar business-is technological advancement-with many cutting edge discovery being made. While the economics of energy makes solar an interesting play-keep in mind that in the high-tech area-technology is critical.

The Following is from Seeking Alpha:

by Mike McDermott

EXECUTIVE SUMMARY:

Rising global demand for energy is driving investment in both traditional and alternative energy sources.

• Fear of cutbacks in European subsidies have pressured solar stocks – offering attractive valuations.

China’s energy demand should pick up European slack as the country sets aggressive renewable energy goals.

• Three key solar stocks are well-positioned trading opportunities as the solar market rebounds:

The world is at a major crossroads when it comes to energy needs…

In a market traditionally dominated by coal and oil, energy demand has broadened to include natural gas, nuclear power, wind, geothermal and of course solar. But despite viable alternatives entering the marketplace, an advancing global population continues to face supply challenges and the potential for energy shortages.

The story of an expanding Emerging Market population is well known to the investing public. Not only are the number of EM citizens expanding, but a major lifestyle transformation is taking place. Entire countries are beginning to experience a higher standard of living, which in turn drives demand for commodities like food, housing, and of course energy.

Recent unrest in the Middle East has added uncertainty to the mix as energy traders scramble to put together scenarios for different regime possibilities. Egypt’s revolution caught the limelight as the country has been a relatively strong US ally, and a stabilizing factor for the entire region. If Mubarak’s stranglehold on the country is replaced by a less peaceful regime, it could dramatically change the political and economic landscape.

But in addition to Egypt, unrest is popping up in other countries like Iran, Tunisia, and Algeria. Rising inflation (specifically food costs) is lighting the kindling of revolution that has sat dormant for generations. The political and economic landscape of the Middle East may experience vast change in the next 12 to 36 months.

The Effect on Alternative Energy

Significant disruptions (or even the possibility of disruptions) in traditional energy markets spurs demand for alternatives. Over the past few months we’ve taken a close look at opportunities in a number of non-oil energy companies.

  • Uranium miners have benefited from strong demand for nuclear energy. Emerging nations in Asia as well as South America are building so many nuclear reactors that the demand for uranium fuel could far outstrip supply over the next few years.
  • A number of natural gas producers have benefited from strong US demand significantly higher production volumes. Chinese investment companies have begun stepping into this market, buying natural gas assets in an attempt to meet their growing needs.
  • And with demand for energy supplies increasing in both domestic and international markets, Master Limited Partnerships focused on transportation of coal, oil, and natural gas have offered both traders and investors attractive opportunities.

Today, we’re going to take a look at the solar energy market – which is experiencing its own rebound both in terms of improving business dynamics, as well as a better trading environment for solar stocks.

The solar energy market is loosely correlated to traditional oil prices. As oil prices increase, solar energy becomes more competitive and catches the attention of investment managers. Of course there are other factors such as competition against natural gas electricity plants, as well as traditional coal economics.

But today’s solar market operates with a tailwind of higher traditional energy prices – bringing solar powered electricy closer to “grid parity” or the equivalent cost of producing energy from traditional sources.

In addition to the pure economic factors, there are also environmental concerns. Large Chinese cities are especially well known for their pollution problems – an issue that has caused a significant amount of embarrassment for the world’s economic growth leader. As China attempts to deal with this problem, the government has set an aggressive goal: China intends to generate at least 20% of their energy demand from renewable sources by 2020.

This aggressive goal will require an extensive investment in solar energy. And plans are already underway for massive solar power plants – including the world’s largest solar installation in the Mongolian desert. When completed, this plant will have an impressive capacity of 2,000 megawatt-hours – enough to power roughly 2 million individual homes.

As China embarks on these solar projects (and is joined by developing and economically mature countries around the world) demand for solar manufacturing will be robust. This is great news for existing solar companies who have the technology and the manufacturing capabilities to meet the growing demand.

European Concerns Create Valuation Opportunity

Despite the big-picture optimism for the solar market, there have been some recent challenges which have pressured prices of solar companies. In 2009, there was significant overcapacity in the industry, and a lower oil price made for a very difficult market. Many solar companies were forced to discontinue operations or sell out to competitors.

As is often the case with manias and bubbles, the solar industry became excessively leveraged and overbuilt. It was only natural that a major shift would knock out all but the strongest players – leaving the industry to rebound once many of the excesses had been wrung out of the system.

Today, the biggest argument against solar stocks is the issue of declining European subsidies. Over the past few years, countries like Germany and Spain have been generous in their support of solar energy – offering incentives for businesses and individuals who install solar systems and therefore require less grid power.

While it’s certainly true that European governments can no longer afford to offer the same solar stimulus programs that the market has become accustomed to, emerging nations like China are helping to pick up the slack. And since solar technology is helping push solar power closer to grid parity, the stimulus measures may no longer be needed to drive the market.

Finally, most solar stocks already appear to be pricing in lower European subsidies. A number of strong solar companies have stock prices which carry a single digit or low double digit PE. That’s notably cheap for an industry that is experiencing growth and likely to see that growth continue.

Of course there are challenges and will continue to be volatility along the way. But today, several key solar stocks are breaking out of consolidation patterns and offering very attractive trade opportunities. With the sector showing relative strength and individual stocks clearing bullish inflection points, we have been building exposure to this area and will be tightening risk points as our gains accumulate.

Below are three solar opportunities that look especially attractive this week:

JA Solar Holdings (JASO)

Strong product shipments indicate current demand for solar products.

New supply contracts are being signed – evidence of strong demand and creating better visibility for future profitability.

Strong financial position with low debt and healthy cash flow.

Attractive multiple gives the stock plenty of runway for bullish price action.

JA Solar is in the sweet spot when it comes to the recovery in solar energy. The Chinese company has the enviable position of being a domestic solar producer in mainland China. So as the world’s growth economy builds out its 20% commitment to renewable energy, JASO is one of the first companies to be bidding on supply contracts for these projects.

But while China may represent one of the largest opportunities for JASO to pursue, that doesn’t mean the company isn’t pursuing international opportunities as well. So far this year, JASO has already announced multiple supply agreements including a 400 MW contract with a key (unnamed for competitive reasons) European solar energy supplier.

The contract will span three years with JA solar delivering 100 MW of modules in 2011, 125 MW in 2012 and 175 in 2013. Long-term supply contracts like this are especially helpful because it creates a better environment for forecasting future earnings – an important metric for sell side analysts and mutual fund investors.

JA solar will be announcing fourth quarter earnings on February 22 before the market opens. Analysts expect earnings to come in at 48 cents per share for the quarter on revenue of $569 million. Of course, the fourth quarter numbers will not be nearly as important as any guidance management gives for 2011.

In the third quarter announcement, management noted that JASO signed supply agreements covering 1.2 gigawatts. As far as shipments are concerned, the company delivered 418 MW of product – a 34% increase over the second quarter.

As long as management can continue to show growth in both shipments (actual production and delivery) as well as supply agreements (representing future revenue), investors should be happy. At this point, the stock is priced at less than 6 times expected earnings for this year, so the hurdle is being set very low.

A less-than-stellar announcement from the company would certainly be met with some selling. But considering the low price of the stock – and the strengthening financial position (the debt to equity ratio is now below 40%), the risks appear relatively limited.

On the positive side, if management has encouraging statements about demand from Europe, China, or even the US, investor confidence could shift dramatically and the earnings report could turn out to be a significant catalyst for the bulls. Even if analyst expectations remain stable, better visibility could lead to a double-digit PE – equating to a stock price 75% higher than today’s level.

Over the last two months, the stock has found support near the 200 EMA (just above $7.00) and over the last week, JASO has begun to trade higher out of an attractive basing pattern. This week’s breakout looks especially attractive with the backdrop of a rising solar group – and even if the stock only tests the October high, it would still represent a 25% increase from the current price. Click on chart to enlarge:

JinkoSolar Holdings (JKS)

Aggressive revenue and earnings growth continues to attract buyers – even though the stock is up 160% from the IPO price.

Attractive price with a forward PE below 6.0 – giving the stock plenty of room to run before valuation becomes a challenge.

A recent financing transaction gives the company plenty of capital to fund growth.

• Constructive pattern with weak holders shaken out and inflection points in play.

It took a lot of guts to buy Jinko Solar (JKS) when the stock made its debut last May. In fact, initial investors didn’t see a profit for the first six weeks of holding time. For IPO transactions, a negative start can represent a very large challenge. Institutional investors (myself included) expect to receive a discounted price for taking the risk associated with a newly issued security.

If a stock immediately falls below the offering price, it indicates that the underwriter mis-judged the demand for that issue – leaving the initial IPO investors trapped in a losing position. It can take months or possibly years for even the healthiest of companies to overcome such a rough start.

But within two months of its challenging start, JKS surged above the $11.00 initial price on its way to a nearly 300% run.

Since hitting a high of $41.75 in November, JKS has backed off in a major consolidation. A decline of 50% was more than enough to knock out the weak holders and at this point JKS appears to have shaken off the IPO jitters and is now ready to begin trading on the merits of the company – not based on the hype of the IPO transaction.

Fundamentally, the company has been on an aggressive growth tear over the last several quarters. Revenue increased by 111% in the March quarter, 310% in the June quarter, and 267% in the September quarter (year-over-year comparisons). JKS now has the bar set fairly high so it isn’t reasonable to expect growth to continue at such a torrid pace.

But the company has been using the proceeds from the IPO along with capital from new financing deals to increase capacity. On December 10th, JKS announced that capacity had increased to 600 MW and the backlog of supply contracts had reached 546 MW. It’s encouraging to see a young growth company not only increasing its manufacturing capability – but also booking contracts to utilize the growing capacity.

In January, JKS rebounded from support at the 200 EMA and jumped as much as 50%. By the end of the month, the stock ran into resistance just above $32 and has been forming a consolidation for several weeks now.

A new breakout from this wedge would attract momentum traders, and given the turbo-charged movements of this stock I wouldn’t be surprised to see it tack on another strong run.

Management reports fourth quarter earnings on February 28th and that could turn out to be another bullish catalyst. Remember, the stock is currently trading at six times earnings – so any positive news could propel the stock much higher as traders try to catch up to the intrinsic value of this growth machine. Click to enlarge:

ReneSola Ltd. (SOL)

• Majority of revenue comes from China (the solar growth engine) with light exposure to Europe.

• Increasing capacity allows ReneSola to take advantage of growing demand for solar products.

All-Star list of customers provides stability and diversification of revenue.

Attractive valuation leaves plenty of room for stock price appreciation.

ReneSola is an upstream manufacturer – creating many of the raw materials and basic wafers which go into solar end products. The company has 6 existing patents and 11 pending patents in its manufacturing process – giving SOL a competitive edge in creating efficient and attractively priced products. Click to enlarge:

From an analyst perspective, one of the most impressive qualities of this company is its leverage to China solar demand.

While many solar manufacturers are bemoaning the decline in European subsidies, ReneSola only receives 13% of its revenue from Europe – and the vast majority of revenue is from China – the growth engine of solar demand.

Over the past several quarters, ReneSola has seen triple digit revenue growth and an earnings rebound after posting a loss in 2009.

When the company reports fourth quarter earnings on March 1, analysts expect that the company will have earned $1.95 per share for the year. In 2011, earnings are expected to continue to grow by 13% – however, analysts have recently been increasing their estimates as China demand picks up and higher oil prices make solar power more competitive.

Over the past month, traders have been warming up to the solar industry, and this past week SOL has broken yet another consolidation pattern in keeping with its overall bullish trend.

Considering the fact that the stock is priced at around 6 times earnings (are you noticing a trend here?) there is plenty of skepticism priced into the stock – and a lot of room for positive movement.

A test of the October highs would represent a 25% increase from the current level – and if the solar industry continues its fundamental improvement, gains could be much more significant. Click to enlarge:

Disclosure: As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here.

(solar has many attractions)

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