September 18, 2007
Adding To My Position In Suntech Power Before the Polysilicon Shortage Ends

by Trader Mark

Despite general misgivings about the market as a whole, I have been looking at some individual names over the past few days. One that I like for the long term, whose chart has improved significantly last week, is Suntech Power Holdings (STP). This company is the Google (GOOG) of Chinese solar producers... best research, best management, biggest scale. However, due to a large relatively large share count, it does not 'fly' upwards like some of the smaller solar players in the space. It is, however, the most conservative way to play this angle in China.

I am unclear why solar stocks are not reacting to $80 crude; I assume it's a result of the major concern over the ability for these companies to acquire enough polysilicon to fund their expansion plans in 2008 (right not there is a worldwide shortage of this commodity, driving up prices). This is an overhang on all companies in the sector who use this raw input. [Note: a company such as First Solar (FSLR) uses a different technology, called thin film, which shields it from these current issues with polysilicon.]

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Suntech had spiked to mid $40s in early August before a free fall to $33 range in late August, which put the stock below both its 200-day ($35ish) and 50-day (mid-$36 range) averages. In the past 5 sessions through Friday's, the stock has made higher highs and higher lows in each consecutive session. With a break above the 50-day moving average, I am now going to add to my 2.0% position in STP with 300 more shares - this will bring up my position to 2.9% of my fund.

Suntech Power is not a cheap stock by any means, but keep in mind that this is a company growing at a greater than 50% year-over-year pace. Earnings estimates call for $1.01 in 2007 and $1.60 in 2008, giving a forward PE ratio of 37x (2007) and 23x (2008).

Now the key driver in most of the solar stocks is the availability and cost of polysilicon. When the inevitable overproduction of polysilicion does happen (China is ramping up production), gross margins in this sector should improve dramatically. This material makes up 65-75% of the cost of goods for many of these companies!

On a related note, an American competitor, SunPower (SPWR), terminated a solar cell contract with a Chinese supplier JA Solar (JASO) due to quality issues. As I have opined before, these quality issues are now catching up to Chinese manufactures across all industries - when new quality standards are increased, it leads to higher prices (for customers) and/or lower profit margins (for Chinese companies). I don't think this is 'priced' into the Shanghai market - yet another reason Big Ben must be careful as the Chinese start exporting 'inflation'.

Disclosure: author is long Suntech Power in his fund and personal account.



(Source: SeekingAlpha)