The shifting sands of solar trading

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We are abandoning our idea to selectively establish long-positions with certain names within the solar sector.  Investor sentiment is at an all-time low and looks to only sour more as we approach the third quarter earnings period.  We withdraw our previous idea to selectively buy a few names for a 2H11 trade into a solar “gold-rush” as our early signs of improving fundamentals appear to now be a mirage rather than an oasis. 

Specifically, we expected to find demand momentum would improve significantly, but is now only paltry, at best. Module pricing would become more rational, but instead is continuing a steep downward trajectory.

Polysilicon pricing is starting to crack

To cap the fundamentals, polysilicon pricing were expected to average ~US$50/kg through year-end, but we are now hearing of pricing quotes into the ~US$45/kg range.

We are finding polysilicon pricing now at ~US$47/kg for immediate delivery in the remaining weeks of Q3, and quotes of ~US$45/kg for early Q4 deliveries.  While falling polysilicon pricing helps the cost equation for module manufacturers (a US$10/kg price reduction saves US$0.06/W the solar sector is unsurprisingly out-of-favour, and although there may be individual positive achievements for a few companies, the overall trend for the group is likely to maintain a downward trend.

Demand momentum is lacking

Despite attractive IRRs in the most price competitive European markets of Germany and Italy, we are not yet seeing elastic demand.  While the lack of construction financing is slowing the momentum in Italy, we find that module companies are coping with this issue by essentially financing the construction period themselves through the extension of module payment terms up to 180 days. 

While this will produce some ugly balance sheets in Q3 in terms of expanding DSOs, and also creating cashflow concerns for several module manufacturers, this financing crutch has done little to spur additional module sales. 

In Germany, we continue to find a decent lending environment, but with the installation rates through both July and August being miserable, we are not finding a large enough incremental pick-up in the first two weeks of September to suggest that industry shipment expectations for Q3 or 2011 are safe. 

We find a significant disconnect between falling module prices and the lack of incremental demand.  One explanation suggests that developers are waiting for prices to stop falling before committing to volume orders; this generally explain 1H weakness when there is still plenty of time to install in 2H.  

However, a more telling argument might suggest that module pricing does not rationalize such that module price declines into 1H12 will be greater than the expected subsidy cuts on January 1, hence IRRs will remain above hurdle-rates in 1H12.  In short, there is little risk to delaying projects if module prices are expected to fall below US$1/W. 

Pricing has not rationalized

Even if shipment volumes approach the low-end of industry (and company specific) expectations, we believe pricing is going to be the driver of increased negativity toward solar stock investments. 

In general, we are finding Q3 ASPs of roughly ~US$1.25/W and Q4 pricing of ~US$1.05/W.  These prices may allow a positive gross margin at some module manufacturers in Q3, but gross margin is likely to be at break-even for even the most cost competitive manufacturers in Q4 while many less cost competitive companies could actually report negative quarterly gross margins by year-end 2011. 

Low factory absorption (utilization) rates will continue to thwart improvement to non-polysilicon processing costs if demand does not markedly improve, but most manufacturers pin their hopes on the price of polysilicon rapidly declining.

If module prices continue to decline during the remainder of Q3, investors should expect meaningful negative revisions to consensus estimates as we approach Q3 earnings.

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