Solar earnings show demand fears overblown

Solar stocks outlook brightens as PV modules demand in the U.S. and Italy offsets Germany subsidy cuts, easing oversupply fears; prices slip less than expected, margins hold, while polysilicon costs and policy risk remain watchpoints.

Solar power companies are likely to surprise investors this earnings season with bright outlooks for 2011 as Italy and the United States ratchet up demand for panels following a cut in government support in the world's largest solar market, Germany.

Fears of a deep regulatory overhaul in Europe have overshadowed U.S. solar stocks in recent months, pressuring valuations as investors fretted that subsidy cuts in Germany, France and other markets would cause an oversupply of solar panels that would send panel prices down dramatically and hurt manufacturers' profits.

But makers of solar cells, modules and equipment for the subsidy-dependent sector are expected to deliver strong 2010 results for the last three months of 2010, and analysts said demand has remained strong and prices have come down less than expected.

"The Q4 reports as well as the outlook will probably come in better than expected," said Needham & Co analyst Edwin Mok. "Expectations are relatively low for the year and that will drive the stock prices higher. Demand will be pretty strong this year."

Investors have been concerned about the industry's notorious future uncertainty, as governments in top markets — such as Germany, France, Italy and Spain — are either cutting sector support, including German subsidy cuts and similar measures, or planning to do so.

For its part, Wall Street will be looking for companies to address how they are absorbing that decline, particularly in the German market, and whether they are able to expand their share in growth markets, such as the United States.

"While it makes sense on paper that the second half of 2011 will be weaker, there is a good chance that something could surprise us: that could well be the U.S.," said Commerzbank analyst Ben Lynch.

The United States is expected to overtake Germany as the world's biggest market for photovoltaic PV modules in 2014, data from the European Photovoltaic Industry Association shows, up from a current fifth place.

Boosting optimism for this year, after a period when solar cooled off somewhat, U.S. President Barack Obama proposed to increase funding for clean energy research and deployment to $8 billion in the fiscal 2012 budget.

In addition, expectations that top U.S. solar market California will soon require utilities to source a third of their power generation from renewable sources have underpinned a rally in solar stocks.

Germany's SolarWorld earlier this month said the U.S. market was developing strongly, expecting it to account for about 75 percent of its sales within the next two years, a statement which lifted the whole sector.

Demand in the United States has also helped buttress pricing. For solar power to become competitive with electricity from fossil fuels, prices on solar panels must continue to fall. However, when prices fall more quickly than manufacturers can cut costs, their solar profits suffer significantly.

So far this quarter, price declines on solar products have been less than expected at around 8 percent, according to Auriga USA analyst Mark Bachman, who said Italy and the United States are sopping up supplies of solar products.

"Things look pretty good for the solar market as we enter the first half of the year," Bachman said. "Italy and the U.S. are starting to pick up all of that slack in Germany right now. That adds an air of bullishness."

Expected subsidy cuts may also be giving the industry a temporary shot in the arm, he added.

"Mini gold rushes," or spikes in demand, happen when the market anticipates subsidy cuts, Bachman said. "That's what is happening in the first half of the year."

One potential risk to profits later this year are rising prices on polysilicon, the industry's key raw material. Most companies have locked in polysilicon prices with long-term contracts, but those that need to buy it on the spot market could have their profit margins squeezed.

This quarter, rising polysilicon costs could hurt smaller Chinese player JinkoSolar, according to Bachman.

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