Three Trades for the Solar Rebound

January 7, 2011
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If the first few days of trading are any indication, solar stocks are poised to rebound sharply in 2011.  During the first week in January, a number of key industry names have already broken higher out of various basing patterns, and the strong fundamentals are likely to attract attention from both growth and value investors.

From our perspective as traders, there are a number of reasons to like this industry:

  • Broad energy prices are on the rise – giving solar energy a more competitive landscape
  • Valuations have dropped to a level where the worst-case scenario should be priced in.
  • Historically, the solar energy market is very “trendy” with extended bullish or bearish periods
  • Traders are likely to be over-committed to the short side of this market – offering fuel for a sharp rebound

Of course, there are significant concerns for this market that cannot be papered over.  Europe’s debt crisis and future austerity plans will most definitely affect the demand side of the equation.  In the past few years, European government subsidies have generated a large portion of demand for solar products – subsidies that are not likely to continue in 2011.

But despite these setbacks, emerging market demand along with higher prices for traditional energy has created an improving competitive landscape – and a number of solar names look like great trades at this point.

China Picks up the Slack

While solar energy expansion is likely to moderate in Europe, China is set to pick up the slack with significant solar investments.

The emerging market superpower has set a goal of generating 20% of its power from renewable energy by the end of the decade.  This means a huge ramp in solar installations.  Keep in mind that China’s power consumption is will experience robust growth with a broad portion of the population moving from an agrarian to an urban standard of living.

Solar companies are winning huge contracts – helping the country move toward this challenging goal.  For instance, First Solar Inc. (FSLR) is currently working with a national power company to build what will be the worlds largest solar energy plant near Mongolia.

U.S. solar panel maker First Solar Inc. said it is working with China Guangdong Nuclear Solar Energy Development Co. to revive a project to build what it expects to be the world’s largest solar-energy plant in China’s Inner Mongolia region.

The two companies will cooperate on the first phase of a two-gigawatt solar field, First Solar President Bruce Sohn said on Wednesday. Work on the 30-megawatt demonstration project in Ordos will likely begin by the end of this year, and the whole project is expected to be completed by 2020.

First Solar Plans Inner Mongolia Project – WSJ

China’s economic growth has not occurred without significant challenges along the way.  Food and housing inflation currently represent the most difficult hurdles to tackle, but higher energy prices give policy-makers even more incentive to increase investment in renewable energy.

Widespread solar projects can help to alleviate future energy risks, while simultaneously helping with the country’s employment picture.  With most of the R&D and manufacturing taking place in China as well – the incentive is even stronger.

So despite worries over European demand (which has sent solar prices spiraling in late 2010), total industry demand isn’t as troubled as many investors believe.


Heightened Oil Prices Boost Alternatives

It’s no secret that oil prices have been on the rise, other traditional energy sources like coal and natural gas have shown support as well.  Higher traditional energy prices create a lower hurdle for solar energy to reach grid parity.  At the same time, technology continues to advance, giving solar energy a better shot at economically competing with fossil fuels.

In 2007, solar stocks spiked as “peak oil” theories created an alternative energy panic.  Governments, corporations, and individuals rushed to find alternatives to oil and natural gas energy consumption.  Investors got on the band wagon as well, pushing stock multiples through the roof.  The situation had “bubble” written all over it!

But of course as most bubbles go, the industry became excessively leveraged, and investors got crushed.  A number of key companies went out of business and oversupply issues had solar manufacturers selling products below cost just to try to get some revenue in the door.

Today, we’ve seen many of the excesses wrung out of the system, and leading solar stocks are trading at very reasonable multiples that imply very little growth.

If stronger traditional energy prices have any effect on demand for alternatives (and from what we see in China demand looks set to ramp), solar equities will see strong demand.

  • Value investors will be attracted to the low earnings multiples and improved financial metrics.
  • Growth investors will buy based on upwardly revised revenue and earnings estimates.
  • Trend followers will see the positive price action and should quickly build (and pyramid) long positions.

Three Trading Opportunities

As we build out our radar screen for this industry, three stocks stand out in particular as excellent trading opportunities.

Trina Solar (TSL) is a Chinese development and manufacturing company with a robust product line.  The company has seen sales increase by triple digits for the last three quarters, and analysts have recently begun increasing their forward projections for the company.

In 2011, TSL is expected to generate $3.60 in EPS, but the stock is currently trading near $25.00.  This is the type of earnings multiple you would expect for a mature cash cow like Home Depot (HD) or General Electric (GE) – not a solar energy company with strong growth potential.

On Thursday, the stock broke above the 50 EMA on strong volume, good news for the Mercenary Portfolios which picked up exposure to the name earlier in the week.

It’s difficult to handicap how high this name could run, but if history is any guide, a 20 or 30 PE multiple could be in the cards once managers become comfortable with industry growth potential.

ReneSola Ltd. (SOL) saw earnings go negative in 2009 due to overcapacity and excessive leverage.  But management has turned the situation around and analysts expect the final EPS number for 2010 to be $1.91, and SOL is expected to hit $2.05 in 2011.

Once again, these numbers are being revised higher, so as the industry picks up traction this year, expect both the estimates along with the price multiple to push the stock price geometrically higher.

Using just the $2.05 earnings estimate for this year, with a conservative PE of 15, one could easily make an argument for the stock to climb above 30, a full 200% above the current price.

First Solar Inc. (FSLR) has been one of the more robust solar companies, continuing to grow earnings even throughout the financial crisis.  The stock has spent the last two years in a very broad range, finding support near $100 and meeting resistance near $160 (save a brief move to $200 in mid 2009).

Analysts have revised their targets higher to $9.06 for this year, and FSLR has a higher PE than it’s rivals given the relative strength of the company.

But given FSLR’s ability to win large contracts in China and it’s exposure to the US as well, the company should continue to exceed expectations – driving the stock price back to historical highs.

This week, FSLR broke above the 50 EMA (albeit on light volume) and should quickly challenge recent highs near $153.  If this hurdle can be cleared, momentum traders will likely give the name a shot – and true swing traders can adjust stops along the way – riding the trend as long as the bullish action continues.

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