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Solar Headwinds, Part II

Tom Konrad, CFA

Prospective investors in solar manufacturers should consider the competitive forces that constrain the industry's long-term profitability.

In the first part of this series, I showed how a competitive analysis of the corn ethanol industry in early 2007 illuminated the forces that soon caused ethanol company stock prices to collapse in late 2007.  I also implied that the solar cell manufacturers, including industry leaders such as Sunpower (SPWRA) and First Solar (FSLR) are vulnerable to these forces and may not be able to maintain high returns on capital over the long term.

I'm not predicting that solar stocks will collapse later this year, as happened with ethanol stocks in 2007.  The dramatic timing of my article on ethanol companies with the quick collapse of ethanol stocks was coincidental.  Competitive analysis of an industry can illuminate long term trends, but short term stock prices often have very little to do with long term trends or underlying economics.  Given that solar stocks have fallen considerably over the last two years (see chart), a further drastic decline seems unlikely.
Solar ETFs vs. S&P and Nasdaq
Solar ETFs KWT and TAN compared to market indexes Mar 2008 to Feb 2010.
Yet a recovery in solar stock prices that might bring solar indexes back into line with general market indexes is also unlikely, because the intense competition in the sector restrains the underlying profitability relative to companies in sectors with average levels of competition.

Returning to Micheal Porter's classic competitive forces model, each of the five forces are each composed of a number of factors.  The more of these factors are above average, the greater the overall competitive contribution of that force.  In the table below, I list above-average factors which contribute to competitiveness, and below average factors, which reduce competitiveness, and the resulting overall competition for each force.

Factors increasing competition
Factors decreasing competition
Overall Competition
Industry rivalry
Large number of firms, High fixed costs, low switching costs, low product differentiation, specialized equipment, diverse companies
High market growth, nonperishable product
Threat of Substitutes
Electricity can be produced in may ways, and is usually more conveniently and cheaply available through the grid
Government requirements or subsidies for solar power
Buyer Power
Product is standardized
Many diverse buyers
Supplier Power
Suppliers are concentrated (but becoming less so)
Commodity inputs, customers weak
Average to Low
Threat of new entrants
Constant innovation in solar technology, ability to purchase standardized manufacturing equipment, globally traded product, low minimum economy of scale, little brand franchise
Asset specificity
Very high

The key factors keeping competition high are the strong threat of substitutes and rapid innovation bringing new entrants into the industry.  Electricity from other sources such as fossil fuels or other renewable generation is functionally indistinguishable from solar electricity, and may be available at night or on cloudy days.  Hence there are not only readily available substitutes to solar panels, they are often more convenient to use.

I brought up the specter of innovation in solar technology as a risk factor for solar stocks in my recent article on risks for alternative energy investors.  The great hope for the solar industry is that constant innovation will quickly bring down costs to the point where solar power is cost-competitive with electricity from the grid, or grid parity.  But that same innovation, if it comes from outside the current industry, will undermine the economics of manufacturers using current technology.  The advent of First Solar (FSLR) is a case in point.  Because First Solar can produce its CdTe technology at much lower cost per peak watt than conventional silicon manufacturers are able to match, First Solar is able to expand its market share at the expense of other manufacturers while maintaining strong profitability. 

But First Solar may only be in its current privileged position for a few years: other thin-film technologies such as Copper-Indium-Galium-diSelenide (Ascent (ASTI), DayStar (DSTI), and many private companies) or amorphous Silicon (Applied Materials (AMAT), Sharp (SHCAY.PK) and many others.)  Beyond these up and coming thin-film technologies, there is a constant stream of new innovations such as organic PV and PV from abundant materials (IBM) that could potentially be manufactured at much lower cost than current thin film technologies.

There are also non-photovoltaic competitors.  Bloom Energy is trying to present itself as an alternative to solar, but not very credibly.  Concentrating Solar Thermal Power (CSP) has long had a cost advantage for large scale farms, and has the additional advantage of producing on-demand power because it is simple to integrate with inexpensive thermal storage.  PV is not safe from encroaching thermal technologies even at the residential level.  One potential challenger is startup Cool Energy.  Cool Energy's combined heat and power system uses an array of evacuated solar thermal collectors to provide space heating in cold months, and then uses a Stirling engine to convert excess heat in warmer months into baseload or on-demand electricity. 


Because of rapidly falling costs and a vast solar resource, solar PV is likely to produce a significant and growing portion of our electricity in years to come.  But this growth trend is an industry trend, and the growth could easily come from new competitors at the expense of current solar stocks. 


DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

was posted on AltEnergyStocks.com.

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During the next decade all incumbent solar PV manufacturers will be under margin pressure. Many will also experience revenue pressure. In the short term, there is substantial production overcapacity. Medium to longer term, innovation will likely be dramatic, as you indicate.

Tossing a few more logs on this fire:
1) Developments based on germanium arsenide PV cells seems to be ramping up. In particular, note the work done by Sharp Solar in the UK and by RFMD in North Carolina. These could result in cost effective concentrating PV, possibly before 2015.
2) Thermal solar for residential hot water, never broadly cost effective in the USA, could take another hit from heat pump water heaters such as those from GE & Rheem. These units can be installed for roughly $1600. For a house using electricity to heat water (much of the US sun belt)and with high hot water usage (say 4 people), this may be a very cost effective choice. Cost savings appear to be comparable to solar at roughly half the installed cost. Although not solar PV, this highlights another source of competition for PV installation, energy efficiency. In most cases, ee is more cost effective than PV. And, the number of ee products and their effectiveness is increasing. Noteworthy in this regard are the lighting technologies now and about to be commercially available.

This brings me back to a company I mentioned above, RFMD. They are a very strong player in the mobile phone market, among others, with nice cash flow. Simultaneously, they are positioning themselves for possible entry in the high performance concentrating PV market. And, "very far below the radar" they are involved in research toward improved LED technology. Seems like an interesting long term play.

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