Each week, a professional investor tells MoneyWeek where they’d put their money now. This week: Joseph Wat, Atlantis Investment Management.
Clean, renewable energy sources are big news and the hottest of these is solar power. Photovoltaic (PV) panels contain semiconductor wafers, usually made of silicon, which absorb the photons from the sun’s rays and react by producing a flow of electricity. Globally, the capacity of grid-connected solar PV panels has grown by an average of 60% per annum for the last ten years, increasing one-hundredfold since 2000. And it’s not just eco-friendly individuals who are responsible for the increase. One quarter of this capacity is in utility-scale power plants (200 kilowatts or higher).
Recent fears for the sector, and its resulting underperformance, arose from concerns about oversupply. While supply has been growing rapidly, some analysts fear that global demand growth will weaken, in particular due to cuts in subsidies in Germany and other key European markets. Germany consumes more than half the global supply of solar panels and a reduction in feed-in tariffs is undoubtedly bad news for the market. However, we believe investors underestimate the sector for two main reasons.
Firstly, the production cost of silicon wafers is constantly declining. Since the third quarter of 2009, the average selling price of wafers has stabilised, but cost reductions have led to higher margins. Secondly, we believe analysts have underestimated demand from the rest of the world and focused too heavily on Europe. New demand will kick in from the US, China, India and Japan. China’s government in particular has identified the solar sector as a key strategic area that will be grown during the 12th Five Year Plan (2011-2015). The result is that the sector is trading on an undemanding forward p/e of nine times earnings, which we believe has created a buying opportunity. Prices in the sector have stayed firm and costs are decreasing. So we expect margins to increase in 2011. But which companies are the sun shining on?
We prefer the upstream firms; the suppliers that produce polysilicon and wafers for the panel manufacturers. This is because the barriers to entry are high – a large investment outlay is required and there are stringent product quality requirements. There are two names to watch in this field. The first is GCL Poly Energy (Hong Kong: 3800), China’s largest polysilicon producer. From 2008 to 2011 it increased its production capacity from 3,000 to 25,000 mega-tonnes. GCL has also recently started operating a new wafer-processing facility and aims to reduce its processing cost from US$0.28-0.30 per watt to US$0.25 per watt by the end of 2011. Production is expected to be 4.2 giga-watts of wafer shipments in 2011. We expect margins to increase from 28% to 33% in this side of the business. Despite a run-up, the stock is still trading on a p/e of nine. As the largest China solar play, this quality company should be trading at a premium to the sector and the market.
The second key player is Comtec Solar Systems (Hong Kong: 712). Founded in 1999 in Shanghai, the firm is focused on solar wafer production and has recently seen a massive surge in demand. In September it reported that more than 600 mega-watts had already been received in orders for 2011. This is expected almost to double to one giga-watt by the end of 2010. The company is ramping up its production capabilities in order to meet this level of demand. The stock is only trading on six-times current year earnings.