Tuesday, December 21, 2010

Churning Out Chips

According to Solarbuzz, an online resource on the photovoltaic (PV) sector, there has been a continuous decline in solar module prices. In early December 2010, the lowest retail price for a multicrystalline silicon solar module was $1.82 per watt from a U.S. retailer. The lowest thin film module price was $1.37 per watt, also from a U.S.-based retailer. The price declines were impacted by some seasonal factors, but the downward trend in retail prices for PV modules is unmistakable.

Solarbuzz has also gone out on the limb with a forecast of 46% growth in PV shipment growth in 2011. Increased demand is expected in the U.S., China and India. Additional price declines near 15% year-over-year are expected, led primarily by low-cost Asian producers such as Trina Solar (TSL: NYSE) and JA Solar (JASO: Nasdaq).

Despite the growth, margin compression appears to be in the future for the module manufacturers. Thus we believe investors should look a bit further down the supply chain. GT Solar International, Inc. (SOLR: Nasdaq) is a provider of polysilicon production technology, crystalline growth systems and other materials for solar, LED and specialty electronics markets.

GT Solar sales stalled in 2009 as the economic disaster filtered through every industry. Since the beginning of 2010, orders have skyrocketed from its principal customers, Trina Solar and Ja Solar among others. Total revenue increased 120% year-over-year in the October 2010 quarter. I am also impressed by GT Solar’s success in building margins to 40.6% in the October quarter compared to 32.9% in the prior-year period. Economy of scale was a prime contributor to the improved profit margin, but firm pricing was also a factor.

GT Solar’s products help drive efficiencies in module manufacturing facilities, making the Company an indispensible partner for chip manufacturers. Its chemical vapor deposition reactors are used to produce the polysilicon that is the favorite raw material for solar wafers and cells. Directional solidification systems furnaces are used to cast multicrystalline ingots for wafer production. Using GT Solar’s equipment, PV manufacturers can reduce production costs and protect their own margins against falling finished PV prices.

GT Solar reported $732.7 million in total revenue in the twelve months ending October 2010, on which the Company earned $129.3 million in net income or $0.88 per share. The consensus earnings estimate is for the fiscal year ending March 2012 is $1.24 per share on $842.7 million in sales. The estimates suggest an average annual growth rate near 12%.

SOLR is priced near 6.7 times the consensus estimate for the next fiscal year, a compelling value. The forward multiple implies a PEG ratio 55.8 (price/earnings to growth rate). If that is not impressive, consider the prevailing price/earnings ratio of 18.0 times trailing earnings for the solar PV industry.

SOLR share have a beta of 2.10, suggesting some wide swings in the stock as the greater market moves. Nonetheless, investors can take some comfort from a solid balance sheet with $259.6 million in cash and low debt. Company operations generated $81.0 million in cash in the twelve months ending October 2010.

GT Solar recently announced a $47.3 million order for polysilicon reactors from OCI Company in Korea. We expect more announces from GT Solar that could lift valuation of SOLR. The stock had taken a bit of breather in November 2010. The strong upward move that followed in early December 2010, appears to have affirmed a price support level at $7.50, providing investors with a downside protection.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. SOLR, TSL and JASO are included in Crystal Equity Research’s The Atomics Index.

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