Suntech Power (STP) Up 15% on 2 Pieces of News

I had been bemoaning by choice of selections in the solar sector a few weeks ago; when poorly run companies that had disappointed the street had risen by 1/3 since early August yet a company that is the true leader in China was left in the dust. It appears Suntech Power (STP) might be getting some respect this morning; the stock is up 15% on the back of 2 catalysts.

First, a massive polysilicon purchase of a whopping $1.5 Billion (over 7 years though)

• The contract provides for the delivery of a volume range of polysilicon each year at fixed prices, using a take-or-pay approach, with delivery beginning in the second half of 2008. A predetermined annual price reduction curve will provide Suntech with high purity polysilicon at prices lower than any of Suntech's other contracts.
• ''This contract with Asia Silicon will form a critical element of Suntech's polysilicon supply portfolio as the average price paid under the contract is so low that we believe that it reflects what is essentially grid parity pricing for Suntech, when combined with our high efficiency solar cells and world class low cost of production,'' said Dr. Zhengrong Shi, Suntech's Chairman and CEO.
• ''We believe that this is truly transformational, with the price decreasing to substantially below $40 per kilogram, as it enables Suntech to be at the forefront of leading the solar industry towards an environment without government subsidies or incentives.''
• Asia Silicon is deep in the process of building a state-of-the-art polysilicon plant in Qinghai, China with polysilicon production capacity targets of 2,000 metric tons by July of 2008 and over 6,000 metric tons by the end of 2010.

So it appears the term "essentially grid parity pricing" has gotten the market hot and heavy over Suntech Power. One of the main issues facing solar is the need for government incentives to make the pricing competitive with conventional energy supplies. If truly we are entering a phase where the solar power companies can achieve pricing that is on par with conventional energy, this is a whole new ballgame. With that said this $40 per kilogram pricing for polysilicon is eye opening. Due to worldwide shortages this 'commodity' has been driven up to the stratosphere, which has really hurt gross margins in the industry. But the Chinese advantage is labor costs are so low that material costs are approximately 75% of their cost of goods, so if you can slash the material costs to such a degree, gross margins will explode up. When this would happen was an open question, but the thesis has been the Chinese will oversupply any commodity so eventually the world will be flooded with polysilicon - it just takes time to bring it online - 18 months to 2 years to bring a new plant is the consensus. This type of announcement seems to bring the time line closer than we thought.

Interestingly an announcement like this should be a shot over the bow at First Solar (FLSR) but with that stock run by momentum players it also is up today. The thesis behind First Solar is that their less efficient solar products have an advantage because they do not use polysilicon - thus they are shielded from worldwide shortages in the product. But an announcement like this brings the day of reckoning closer, when polysilicon is abundant and the costs for solar companies who use silicon drop precipitously. But again, this is logic and in the short run investors don't appear to respect logic. So somehow this appears to be good news for First Solar (FSLR)?

Second a nice write up in Investors Business Daily:

• The U.S. was the third-largest market for solar panels last year, and some analyst think it will slip to No.4 when this year is tallied. But the Wuxi, China-based Suntech says abundant sunshine and leadership from states such as California will propel the U.S. to the top of the market within five years.
• "The main thing that has to change, which will happen, is the price of the product has to come down, which means the price of silicon has to come down," said Steve Chan, Suntech's chief strategy officer.
  
• Suntech's U.S. sales still are tiny. The U.S. market accounted for just 3% of its $599 million in revenue last year. Germany was tops with 42%. Suntech also sold more of its systems in China and Spain than in the U.S.
• Chan said U.S. sales could account for 10% of Suntech's 2007 sales. Globally, the U.S. lags in solar installation. Germany accounted for 55% of the 1.7 gigawatts of new photovoltaic capacity last year, according to industry research firm Solarbuzz. Japan was second with 17%. The U.S. market absorbed 8%.
• Some analysts predict heavy subsidies in Spain will vault that nation ahead of the U.S. for 2007. But spiking oil prices are keeping U.S. and European governments interested in solar power. That means subsidies.
• California leads the U.S., with an 11-year, $3.4 billion initiative to subsidize solar panels on up to a million roofs. Other states have weaker incentives. Analysts say it will take a large national incentive program to drive more U.S. demand.
  
• Suntech has ramped up production, too, outstripping the deals its signed to supply silicon, the raw material of solar cells. That's forced the company to buy silicon on the much more expensive spot market. "They've taken the tact to worry less abut gross margins and worry more about ramping their top line," John Hardy, an analyst with American Tech, said. That's pinched margins and spooked many investors.
• The shortage of silicon has created a bottleneck for the industry. That drove up prices, which in turn, spurred more development of silicon sources. ThinkEquity Partners analyst Budong "Peter" Peng says capacity could double by 2009, and then double again in a few more years. "Silicon could become a commodity in next three or four years," he said.
• The company ended 2005 with an annual capacity of 150 megawatts. By the end of 2006, capacity increased to 270 megawatts. It says it is on track to reach 480 megawatts by the end of this year. Suntech has exceeded its projected capacity growth in the past. A megawatt is about what it takes to power about 1,000 U.S homes.
• The main push now is to make standard ground- and roof-mounted solar panels more efficient. Suntech says next year it will deliver panels with 20% efficiency -- meaning they convert 20% of the available sunlight that hits them into electricity. The industry standard is about 16%. But San Jose-based competitor Sunpower (SPWR) already sells panels above the 20% efficiency mark. It says 22% is coming soon.
• Still, analysts say Suntech's cells are pretty good, if not the best. But its low-cost Chinese manufacturing base gives it a leg up. "They're definitely becoming known, I would say, as the best modules for the money," said Paul Clegg, analyst with Jefferies & Co.
• Peng says even Suntech's competitors thinks the company is on the right track. ThinkEquity surveyed Chinese solar companies about who they thought would be the eventual solar winner in China. "Each and every company answered 'us and Suntech,'" Peng said.

So I will save the lecture on how pathetic is that the biggest economy in the world subsidizes farmer when world crop prices are at record highs, subsidizes oil companies when crude oil prices are at record highs yet takes no nationalized steps to subsidize alternative energy such as solar. While sad it is reality. My position has been as the growing gulf between the value of Sunpower and Suntech has grown into a chasm in recent weeks - why Suntech Power (STP) which is the leader in China was not getting any attention. Yes, Sunpower has an efficiency advantage but it is valued at 55x 2008 estimates whereas Suntech Power, as of yesterday, was valued at 29x 2008 estimates. So almost a 50% discount? Made no sense. But this is the power of momentum investing and Sunpower had it; regardless of valuation and regardless of its Chinese peer (both leaders in their respective countries), being valued at almost half.

I did an analysis of Sunpower vs Suntech valuation back in September which you can find here. Since then Sunpower has exploded higher and gotten even more expensive relative to its Chinese peer.

In terms of the fund; unfortunately my impatience with this stock not moving while the US solar stocks made new highs daily, and even the poorly managed Chinese stocks made massive moves had me reduce this position to only 1% of fund, which certainly is not a positive on a day like today. That said, I've always contended that despite its sleepy stock, Suntech Power (STP) is the one solar stock you could tuck under a pillow and come back to in a few years and not worry about, unlike some of the others in the sector.

My last post on Suntech Power read:
Suntech Power (STP) is a mystery - all this stock does is perform quarter after quarter, it is the leader in China, with highly regarded management and while (relatively) expensive in valuation, it trades at a massive discount to its US peer Sunpower (SPWR). I didn't expect fireworks from this name but I expected better than 10% when the speculative names (which are busy firing and hiring new CEOs, CFOs) are returning 34% on average.

Long Suntech Power in fund; no personal position