Saturday, November 24, 2007

Interesting Survey from Chinese Solar Companies - Price Concerns Already an Issue

Thanks to reader AJ for highlighting an interesting survey from the Chinese solar makers [88% of Greater China Solar Panel Suppliers Set to Lower or Stabilize Prices]
  • Despite higher polysilicon prices, most Greater China solar panel manufacturers say they plan to lower or keep prices steady to win market share.
  • The Report shows 88 percent of suppliers plan to decrease or keep prices stable, while only 12 percent plan to increase prices.
  • "With the polysilicon shortage expected to continue until 2009, most manufacturers are implementing measures to streamline production," said Report publisher, Spenser Au. "These include expanding to gain economies of scale, backward integration and R&D to produce thinner solar cells that require less polysilicon."
  • Au said: "Manufacturers are generally optimistic, with 97 percent expecting exports to increase over the next 12 months. However, with excess capacity in the high double-digits, a larger number of suppliers are reducing prices to gain orders."
  • What are the major concerns over next 12 months? Investors would think polysilicon pricing but in fact that is #2 (25%), #1 is price competition (60%)
I outlined my longer term theory earlier this week [Motley Fool on China Sunergy]

While this will take a long time (years) to play out, my vision is eventually the leaders with scale will get their cost structure down to a point where they can lower average selling prices (ASPs) to a point where it will cripple the small fry in the pond. Some of these smaller companies are having major trouble building their product above cost (gross margins very low), and while the drop in polysilicon prices (65-75% of costs for many Chinese solar companies) will help these smaller companies, it will also be helping the larger companies. So right when these small fry get to the point where their margins reach levels the leaders are enjoying now (1-2 years from now), the leaders will already be onto the next step - expanding volume by dropping prices. And this will mean another crippling era for the smaller players. Even if the overall pie of solar is growing. Again, just a theory but this is how all commodity businesses work, and solar should be no different in the 'long run'.

The counter argument has been, well the pie is growing so quickly everyone can win. I find that amusing at best; dangerous at worst. While the pie will be growing, and should be growing for decades there can be periods of time (2-3-4 years) where manufacturing capacity far outweighs demand. What happens in those time frames? Basic economics suggest, prices will drop. In fact, I think this would already be happening if not for the shortages in polysilicon - what is perceived as a bad thing (due to the high costs solar panel makers have to pay for their main cost input) is in fact limiting the supply of product. Once these supply shortages are taken care of in the next 18-36 months, the world will be awash in panels. And yes, demand will be increasing for solar products as well, but all you need is an 18 month period where world demand is lagging supply to seriously impair business operations for those without size/scale/cash hordes. We could be entering (soon enough) an era where we have enough supply of panels (in say 2009/2010) to satisfy a level of demand that will be seen in 2013/2014. Don't think this is possible? I liken this to the global glut of fiber we had in the world in the late 90s/early 00's. In the rush to build out the internet, billions upon billions (financed by cheap money and over eager capitalists) of fiber cable was laid out across the world, by land and by sea. The idea was eventually all this cable would be needed as the internet exploded. They were right, it was needed - but they were about a half decade too early. And most companies building these networks either shrunk dramatically or went out of business completely. It is all about timing.

Again, I am a solar bull - but to read the simplistic analysis of "we need alternative energy, every solar company will be a winner" is frightening. There will be winners and losers. This happens in every industry. There will be times when every stock in the sector rises up, as people forget fundamentals and buy any company even loosely affiliated with the sector. That's fine for speculation but for an investing thesis, it will be dangerous to your portfolio. Over time winners will emerge and those jostling at the lower end will be fighting amongst each other for scraps. Think Intel vs AMD but think of 30-50 AMDs coming down the pike. Will all these capacity eventually be needed? Surely! Solar is only a fraction of a fraction of worldwide energy use. But will over eager capitalists (even in China) overbuild (too early) in the quest for riches? I am sure of that as well. And at some points over the coming decade, supply will outstrip demand for shorter periods of times (by shorter I mean quarters or 1-2 years) and in those times the smaller companies will be seeing serious pain. Some will probably weaken to a point they falter completely or get bought out at a serious discount by stronger players.

I wrote in last week's piece on Suntech Power (STP) [Suntech Power Reports Outstanding Results] that in fact, if I were a larger player I would inflict some of this pain myself - the more smaller players you drive out the larger market share you will eventually have to yourself for the "really long" term.

At this point, if I were one of the larger players, I'd be lowering Average Selling Prices (ASPs) in 2008/2009 to crush my smaller competitors over the next 2-3 year period, and then once they are weakened, grab as much market share as possible in this commodity business for the years ahead... sort of what a small company you might of heard of before did... Intel.

So how do you best increase your odds of finding the eventual winners? Look at size / scale / leadership / research & development / gross margins "today" - some of the companies I have written about in the blog are making their number by 'accounting' mechanisms - i.e. currency gains or by not spending much at all on R&D. While this appeases a very short sighted investor base who only cares about your next 90 days (the only thing that matters is the next quarter type of thinking), in the long run this is a commodity business and those not spending real money to continue to find efficiencies and improve their manufacturing process will end up being the long term losers. Even as giddy speculators are happy they "beat the numbers" this quarter and never read past the headline number.

Again, my theories on what will happen in this industry won't be proven correct or incorrect for a few years - but these are the realities that have occurred in every commodity business, regardless of the size of the overall pie. To think solar is somehow immune is simply putting your head in the sand. Remember... the hordes of Chinese/Taiwanese are coming... more competition = more pressure on prices.

This year alone, the number of solar companies in Taiwan has tripled, to more than 20. "It's incredible," says Tsai. "Even some companies, I cannot remember the names. It's really very hot."

Long Suntech Power in fund and in personal account

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