The hysterics around recent solar industry announcements that in general profit margins are narrowing are, as usual with all things solar recently, completely overblown. "Is This A Death Spiral for Solar Companies?" might be my favorite histrionic headline.
Yes, narrowing margins are making life difficult for smaller, higher cost producers. But this is and has always been a standard part of the evolution of any industry from niche to growth to mainstream. An undervalued name we own and that I’ve used as an industry representative example before, Canadian Solar (CSIQ), announced October 17 that, due to the rapid growth in the solar industry and emerging commoditization of some components, their overall profit margin is expected to shrink to 12% by year end 2011. Meanwhile, their industry is growing at 10 times the rate of the overall U.S. economy and will far more than make up in volume what it loses in margins. This is the normal progression with any new technology, and is usually considered a good thing. In fact, most mature industries operate -- profitably -- at or below 12%. Here's the Fortune/CNN 2009 list of profit margins by industry:
As you can see, solar, even with its newly revised, lower, 12% margins would still rank 6th of 53 on this list (if it were included). And the truth is, as solar grows and grows, and panels become cheaper and cheaper, margins will continue to drop to 10% and below. But, again, the industry is maturing into a high-volume business wherein scale will more than compensate for this narrowing just as occurred in most of the above industries. Yet when was the last time you heard a pundit claim that most of these industries was in a “death spiral?” I would argue that with its booming growth, solar is a better long term investment than any of these "stalwart" industries that currently operate between 1% and 10% margin rates.
Also bear in mind that as panels become ever cheaper and margins narrow, solar is fast becoming the cheapest source of electricity of any kind. Extrapolation of current trends shows that solar will be the cheapest electricity in the world by 2018, latest. What happens to industry growth as that day approaches?
After CSIQ's announcement, its shares dropped another 13% to $3.00, which is less than one-fifth of their $16.03 per share in cash. Ridiculous. CSIQ was already priced at one-quarter of cash, like a company hemorrhaging money, not making it. So the reduction in margin announcement should hardly have had the effect that it did, so what the further decline represents for me is a buying opportunity.
Bear in mind that China has made a $313 billion commitment to green energy, primarily solar, over just the next four years (the U.S. commitment is trivial by comparison, no doubt thanks in part to some dangerously misguided calls for America to give up on solar altogether). The favored Chinese manufacturers of solar PV will thus have no problem maintaining liquidity much less solvency as the industry, predictably, matures and consolidates. This kind of large, rapid investment in solar PV manufacturing has resulted in global supply outpacing demand at the moment, which is one of the factors causing shrinking industry margins. However, we believe this is a temporary imbalance because we’re observing aggressive solar scaling, utility-scale and rooftop, in nations worldwide. More on that in a later post.
As an aside, we disagree with current U.S. based efforts to sue China for solar panel price dumping. Dumping, which is defined as selling a product under production cost to capture market share, is not the same as out-competing, which has the same effect. If China has invested so much more in its solar capability that its cost of production is significantly lower than ours, so be it; the appropriate response is to invest in our domestic industry to make it more competitive. It will be interesting to see what the WTO concludes, but I don’t think the dumping case is necessarily clear. In any event, winning the case will allow the U.S. to apply tariffs to foreign solar panels, thus raising the cost for consumers, prolonging our dependence on fossil fuels (although that may be the point) and keeping energy prices higher overall.
Again, solar is a booming growth industry that is adding jobs, revenue and profits worldwide (including here in America), that is going to keep growing, and fast, for years if not decades: how many of us are aware that already, solar employs 100,237 people in the United States and is booming, compared to coal's 80,600 and shrinking jobs? [Note: the coal jobs figure is from the U.S. BLS. The BLS does not keep track of solar jobs, but refers interested parties to The Solar Foundation’s “National Solar Jobs Census,” cited above.]
The trick for investors is to find the low cost manufacturers with access to capital and with already profitable business models. Solar as an industry is here to stay; investors who own the best solar companies now will be very pleased in the long run.
Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, and is co-manager of the Green Alpha ® Next Economy Index, or GANEX and the Sierra Club Green Alpha Portfolio. He also authors the blog "Green Alpha's Next Economy."