Solar's Inconvenient Truth

Many solar companies aren't remotely as profitable as their accounting numbers let on.

I've been thinking this dangerous little thought for a while now. Cash flow concerns have cropped up in my writing on Yingli Green Energy's (NYSE: YGE  ) year-ago IPO, stunted China Sunergy (Nasdaq: CSUN  ) , and capital-craving ReneSola (NYSE: SOL  ) , but I haven't really addressed what is a sectorwide issue.

Some trusted investor friends of mine have publicly tackled this matter in recent weeks, pointing to not only the chasm between various firms' net income and operating cash flow, but also things like the fragility of Solarfun Power's (Nasdaq: SOLF  ) framework agreements and SunPower's (Nasdaq: SPWR  ) exposure to third-party financing.

To help me visualize the cash strain in the space, I put together a spreadsheet of every solar company's key financials, alongside capital expenditures. Companies reporting positive net income and negative cash flow get red-flagged. Companies with expenditures far in excess of cash flows get flagged as well. There's a lot of red on my screen.

These companies are highly dependent on the continued ability to raise outside capital. This is an increasingly risky proposition given the current strain on the world's financial institutions, combined with potentially rising risk aversion among investors as we border on bear market territory.

The idea that solar investors should have serious cash flow concerns finally went mainstream today with a research note by Goldman Sachs (NYSE: GS  ) . Here, an analyst singled out Trina Solar (NYSE: TSL  ) for "weak working capital management," but the same could be said for many competitors.

I urge Fools to give their solar stocks a good hard look. The upside is easy enough to envision, but also think about what would happen if the capital markets closed up shop for a while. Would your company be able to meet its take-or-pay agreements with suppliers? Could it pay the contractors executing its multi- or centi-million dollar expansion? In some cases, I believe the answer will be "no."

Related Foolishness:

Fool contributor Toby Shute doesn't have a position in any company mentioned. The Motley Fool has a disclosure policy.


Read/Post Comments (23) | Recommend This Article (11)

Comments from our Foolish Readers

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  • Report this Comment On July 01, 2008, at 3:46 PM, lbentiger wrote:

    Really appreciate your insight, especially after GS call. Could you validate your statements by posting the Spreadsheet in the article?

    Thanks.

  • Report this Comment On July 01, 2008, at 3:48 PM, ubermouse wrote:

    I'd also like to see the spreadsheet, sounds interesting.

  • Report this Comment On July 01, 2008, at 4:36 PM, scooperone wrote:

    Can you explain what you mean by Solarfun's fragile framework agreements? How did you determine they are cause for concern? Also, please post the spreadsheet - thanks.

  • Report this Comment On July 01, 2008, at 5:46 PM, CSIHawaii wrote:

    This article is supposedly based on numbers yet there is not one quoted. Some companies are red flagged because their earnings are greater than cash flow but in many cases in depth analysis may show this to be for good healthy reasons. Other companies are red flagged because they have capital expansion with a strong inference that managements have committed to projects without the means of financing the projects. This is highly improbable and to suggest it broadly is preposterous if not scurrilous. Since solar is a new industry in a stage of rapid development most companies have capital expansion projects and the whole industry is effectively red flagged - as if it had done something wrong! Capital expansion is key to the exponential sales growth that analysts are projecting for the solar industry, yet it is presented as a red flag.

    Most people (investors) are moved more by words than numbers, as a smart author would know. The title is taken from a reputable book "An Inconvenient Truth" which is filled with facts. The title "Solar's Inconvenient Truth" conveys the same pedigree, yet the article contains no quoted facts and has no truth to tell. The Motley Fool makes considerable effort to demonstrate the poor performance of analysts, yet this author finds one with something negative so say and uses that to substantiate this otherwise barren article. A spreadsheet full of waving red flags sounds good enough to manipulate stock prices, especially in a fear filled stock market. Let's check a few at the following day's close: TSL -4.4%, LDK -7.6%, CSIQ -9.5%, YGE -6.8%, CSUN -7.6%, SOL -8.9%, SOLF -7.8%, SPWR -7.4%. Meanwhile NASDAQ +0.5%. Oh my! This author is no fool.

    There was a time when we could rely on the Motley Fool to provide good investment analysis. It is a pity how things have changed.

  • Report this Comment On July 01, 2008, at 6:31 PM, sajmal wrote:

    Growth sucks up cash flow. We know that, so why is it a problem. Business declines generate a ton of free cash flow. Are you suggesting we invest in shrinking businesses? For these companies, when equilibrium is reached, can cash flow equal net income? How quickly can solar companies get to that state? Sounds similar to the argument made about Google, Amazon, XYZ.(Pick any hyper growth company).

    Thoughts?

  • Report this Comment On July 01, 2008, at 7:23 PM, jsIRA wrote:

    It is often the case when so many bashed those stocks that is the time to start buying.

    So I will start buying YGE at $14 level, TSL at 27 level, etc and hold for 6 months to see how my money would grow.

  • Report this Comment On July 01, 2008, at 8:31 PM, 88778877 wrote:

    The irony is that the solar stocks are the ones to benefit from the high oil prices. Their estimated earnings numbers really look good going forward 12 months. It seems that their prices are really driven by a large number of speculators who look at momentum rather than value.

  • Report this Comment On July 01, 2008, at 9:50 PM, mafuren2000 wrote:

    I agree with 88778877.

  • Report this Comment On July 02, 2008, at 12:16 AM, 10qdetective wrote:

    Toby:

    In addition to our referenced comments on SunPower's third-party financing issues:

    http://industry.bnet.com/energy/2008/06/13/creative-financin...

    There is also the pressure on all solar company's gross margins, as illustrated by CSUN's recent REC procurement announcement

    My Best!

  • Report this Comment On July 02, 2008, at 12:39 AM, XMFSmashy wrote:

    In addition to David Phillips, aka the 10Q Detective, I owe a hat tip to Yehuda Fruchter, who has written on this subject over at Envoy Global Research. (http://www.envoyglobalresearch.com/)

    Thanks for all the comments, everyone. Stay tuned for a follow-up.

  • Report this Comment On July 02, 2008, at 12:40 AM, seariver wrote:

    When people wrote this kind of article... I know it is time to load up and ready for next run... bot TSL today at 27.80 and waiting for 50% gain in two months...

  • Report this Comment On July 02, 2008, at 9:47 AM, speakthetruth wrote:

    I read this article several times in order to try to find something in there that substantiates what TOBY was saying, but could find NONE, just a pile of accusations thrown out without any supporting information. the author of this article, although he is very clever using a play on a title that is very well known and filling the article with intelligent sounding analysis, says nothing that we haven't heard already, yes of course solar industry players are trying to raise capital in order to complete expansion projects, I would be much more surprised & dismayed to see no search for capital by companies in an industry which is growing hand over foot...

    I agree with CSIHawaii, this article is barren of any commentary which is paticularly insightful.

  • Report this Comment On July 02, 2008, at 12:35 PM, djdelphi wrote:

    I enjoy the comments - the last few especially! Why would you hype the stock for so long, then finally flip flop on all of your advice and throw feces at the companies. Naturally loans play a critical role in Solar companies - without the necessary government subsidies, companies are forced to seek lenders, both from banks and from financiers, in order to get access to the cash needed for continued development and innovation.

    Not only does the author fail to present his magical little spreadsheet (or ANY information from it) it seems to me that he fails to announce his own positions regarding the stock - a legal obligation. Perhaps a little independent research would should that he has closed out all long positions and initiated a short position. Whether this is true or not, it is necessary for all commentators to explicitly state their own personal conflicts of interest, which the author fails to do. Furthermore, I wouldn't be surprised to learn that the author is heavily invested in fossil fuel energy stocks.

    If I wanted to read articles that talk down not only one company but the entire solar industry, I could find many articles elsewhere (you probably know where I'm talking about), but I expect a lot more substantial, tangible information, and a lot less biased speculation from 'independent' sites like this one.

    I find this article to be very poorly written in so far as it presents completely unsupported claims without any actual information or numbers. Not that you (the author) don't have that right, but seriously, if you want to make claims like these, set forward your info and let the info speak for itself. Why do you (the author) choose to neglect ALL information? Are there subtleties that you are trying not to address in your over simplification?

  • Report this Comment On July 02, 2008, at 3:01 PM, 88778877 wrote:

    It seems that it doesn't matter how good the profits are for the solar companies. With good forward earnings estimates, they are still being sold off as if going out of business.

    Since solar is relatively new at the present demand/sales levels and NOT WELL UNDERSTOOD by many analysts and investors, we may be in the middle of a situation where speculators find solar stock prices easy to manipulate to make a lot of money on shorts. All they need to do is create doubt, whether true or not. For example, claim "shrinking margins" even though they will still be much better than margins of many other companies with much higher P/E. It is easy to create doubt. Later, they may change tactics and buy so solar will shoot up and they will make money. Outside of the SEC getting involved, there is not much anyone can do.

    You either buy, hold, or sell based upon your perception of the long term future. In the short term, you have no idea which way they will go.

  • Report this Comment On July 02, 2008, at 3:54 PM, youremyboyblue wrote:

    I just wanted to say that this is my first post on any investing issue, honestly first post on any issue. However, I felt I needed to commend many of the responses related to this article, CSIHawaii - very insightful. I recently opened an online account and conducted quite a bit of research on solar stocks right about the time they started heading back up, right around mid march. It seemed that with the price of other energy increasing it made sense to branch out and look at alternative energy, especially with China adapting to the solar source with its ever increasing need for energy.

    In discovering which companies to invest in I sort of took an undergraduate approach and looked at P/E and other ratio's, forward P/E in comparison with the industry, and where certain clientele is based, hoping to catch a few big jumps when quarterly numbers were posted. However, the biggest lesson I learned is that even though you are more informed here with a chance to gain an advantage with the amount of time you invest in attaining knowledge about the company, the individual investor has better odds playing blackjack.

    For example a little more than a month ago I started hearing things about solar stocks (it seemed like the very next day after I took on a few long positions) and how investment firms started thinking they were a great short, (due to what? I would like to know), however there was no information provided other than positive cues from the increase in oil futures (which may hurt in a way but positive for alternative energy) to the great news about the expansions within particular companies to the positive net income which has been rising at percentages unheard of.

    Confused! That's exactly what I am right now. I realize with the economy the way it is there will be days when selling takes place but with no negative news, only speculations I guess I can only wait until another upturn.

    And why would the stock not just go to the true price in one day, I have heard quite a bit about market efficiencies and how the prices should reflect the values of the company at any point in time. Well how is it that every morning people wake up and say "Man I must have been smoking something yesterday because I actually think that this particular solar stock is worth about 8% less today than it was yesterday." without any news.

    Comments, criticism welcome.

    Thanks,

    Nooby Investor

  • Report this Comment On July 02, 2008, at 4:21 PM, akapital9 wrote:

    In this case, as with many others, the greater fool is the author.

    This fool agrees with majority of user's comments.

    Most of the recent criticism leveled against solar stocks and alternative energies apply to any expanding growth business and are not specific to this industry.

    Also, there appears to be a confluence of short sellers fighting the new technology. Is their a conspiracy against alternative energy and are traditional brokerage houses and big oil working behind the scenes to (literally) discredit innovation in this technology?

    There is an epic battle going on right now between traditional energies and alternative energies and correspondingly the longs and shorts. There is speculation that the shorts aren't playing fair - e.g. naked shorting. Their may be some truth to manipulation here.

  • Report this Comment On July 02, 2008, at 8:40 PM, 88778877 wrote:

    I feel that maybe here is a opportunity developing. I am down a lot in my solar holdings but they are a small part of my overall wealth. To me, when these stocks bottom (which they will do), it will be a great buying opportunity. I will be committing shorter term investment money. When they recover, my original investment will be no worse off than if the stocks had just held steady -- but I will have made money with the shorter term investment. If you don't have additional money to invest, then you just need to hang in there.

  • Report this Comment On July 03, 2008, at 12:43 AM, XMFSmashy wrote:

    To address djdelphi's concern (one of them, anyway) -- it is clearly stated at the end of the article that I have no position in any company mentioned. That means long or short.

  • Report this Comment On July 03, 2008, at 2:49 AM, JackLampka wrote:

    Toby, I thought the Fool supports long-term investing, not short-term trading. Your comments and analysis (I'm assuming there is some analysis behind, though so far not seen anything) may be relevant to next quarter's earnings announcements. But it has NOTHING to do with the performance of the solar industry over the next 3-5 years. The solar industry is probably in the Tornado stage, using Geoffrey Moore's Technology Adoption Life Cycle. There will and should be shakeouts and not every company will survive. But making statements like you did about the entire solar industry is irresponsible as a Fool writer. So, please write your articles in the realm of the Fool or write them somewhere else.

  • Report this Comment On July 09, 2008, at 3:06 AM, urbanhelios wrote:

    solar sector is right now a penetration and share gain stage. 3rd generation photovoltaic will take share from silicon based and current technologies. We shall see if the technology will deliver the superior optimize mix of cost/performance/life-time trinity. Upon this advance (and looked promising) the penetration will gain from the total energy sector. I see the choice is to pick the right horse rather than discounting the industry as a whole. ...And fosil fuel price ain't gonna come down...and this is an inconvenient truth, unless we all go support the artic exploration and muck up the world even more.

  • Report this Comment On July 09, 2008, at 11:43 AM, extremesurvivor wrote:

    Investor's Business Daily gives Yingli an A+ rating for Fundamentals, 99 for EPS, and for combined Sales, Profit Margin and ROE an A rating.

    How do these ratings agree or conflict with this Motley article?

  • Report this Comment On July 13, 2008, at 1:57 AM, ltn2000 wrote:

    Toby, if you are true to your words and conviction, then short these solar stocks with every penny in your asset and hold your positions for a year or more. Fortunes are made by people like you...Why invest in anything else? Until then, you seem like a short seller trying very hard to create chaos and panic for self-serving interest. Your analysis are bogus, flawed and laughable.

  • Report this Comment On July 15, 2008, at 10:20 PM, relzsek wrote:

    I think TOBY intended to be provocative and, judging by the responses, he succeeded beyond his wildest dreams. I take his message to be an effort to bring out some sobering realities, which, like it or not may adversely affect some of the industry players. I don't believe the solar company stocks will just go straight up because of their potential. This is rapidly becoming a very competitive area and one where technological advances and extraneous factors will threaten obsolescence and oblivion to some of the current stars. Just recall the early stages of any new industry. There will be a few 10 and 20 baggers among solar stocks and a whole host of empty shells of worthless companies left in the dust. Picking the right horse is not going to be easy, but I do think the winners will gain more than the losers will win. But DO EXPECT A LOT OF VOLATILITY and DIVERSIFY!

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