Solar's in Trouble

 | Oct 19, 2011 | 6:45 AM EDT
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I am in Dallas attending the annual solar industry trade show known as Solar Power International, and am getting some interesting and actionable intelligence on this leading "clean tech" industry. The mood here could not be more sour, as the industry is flat on its back. Maybe a dozen companies announced preliminary earnings in front of the show, reinforcing investor suspicions that the industry is not yet at a trough in this downcycle that started early in the summer.

The industry was always cyclical -- a growth cyclical to be sure. But, this time around, the entrance of Chinese module vendors is creating massive overcapacity at the same time that financing difficulties in Europe are creating a painful demand contraction. Excess inventories of panels are being purged at surprisingly low prices. In fact, we've seen some reports of panels being offered at less than $1 per watt. The solar industry has now "broken the buck."

 Those prices won't last. They are due to an inventory purge, and that price level is not sustainable given current production costs. But, in the near term, the industry is waiting for demand elasticity to kick in, as it typically does. Still, the elasticity is slow to arrive, probably because installation costs are now looming as a larger percentage of project cost, and those are not falling in lockstep. Installation is estimated at $6 per watt, depending on the situation. Project developers are looking for innovation in installation, whether it is via kits or systems like SolarDock that do not require hole-through in roofs.

 The massive overcapacity means an eventual shake-out among module manufacturers, and all of them are putting expansion on hold as they slow production. Trade floor scuttlebutt has some manufacturing equipment vendors with zero orders on their books for the next two to three quarters. Equipment vendors such as Amtech (ASYS) are good short candidates, even with the stocks already down significantly this year.

 With Chinese overcapacity, the open question is whether China will create domestic demand to absorb the production that is now going to the export market. Some analysts see domestic China doing five gigawatts in 2012, far higher than 2011. No one knows whether any of the Chinese module makers can be profitable, however, since the Chinese government is more likely to see this as a full employment plan than a profitable endeavor.

Chinese module makers already run at very low margins (Canadian Solar (CSIQ) reported 5% gross margin this quarter), so the profit-and-loss statements of this group are very shaky. India is developing as a new market for solar, but will only do one gigawatt next year. So, unless Europe rebounds quickly, the upcycle next year may be slower than hoped.

The long-term growth prospects for solar are still attractive, as the equipment approaches grid parity. Lower prices will drive demand, just as it did in the semiconductor industry. The only question is timing, and investors are watching closely, and waiting, for evidence of the turn. It's not there yet.

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