Sunset for Solar Stocks

While solar energy may have a bright future, The Greek sees some profit-taking ahead…

(Stocks in this article: Nasdaq: FSLR, Nasdaq: SOLF, Nasdaq: ESLR, NYSE: STP, NYSE: LDK, Nasdaq: JASO, NYSE: TSL)

I knew solar stock popularity had reached an extreme when I saw the crew of CNBC’s Fast Money jesting about the name of a Chinese solar company, Solarfun Power Holdings (Nasdaq: SOLF). The stock’s performance on that day, Thursday November 29, was however, a very serious plus 31%. That said, here’s why I think the fun in the solar sector is due for a momentary eclipse! As a matter of fact, this is one of my favorite short themes for early ’08, but keep in mind that it’s a trade idea for the near-term, not a long-term investment strategy.

I expect a combination of two factors should drive a valuation adjustment in solar stocks soon. The first factor seems to be taking hold now, while the second just arrived with the turn of the year. First, the price of energy, specifically crude oil, looks poised to move lower to me. I expect that short-term demand factors are finally pushing the price of the black gold lower. As this occurs, I expect to see a simultaneous and exaggerated impact to solar stocks. Secondly, there are huge profits in these shares that have been secure until recently, due to the turn of the tax year. As we trade in ’08, these stocks could lose a lot of ground fast given the right catalyst.

The Fundamentals of Solar Fun

More than anything, what makes exotic energy sources viable alternatives on an economic basis is their competitive price-play with traditional sources. Obviously, as crude approached $100 and natural gas $8, the cost competitiveness of wind and solar energy improved. I think it’s clear that this is the fundamental reason solar stocks performed so well in 2007. Yes, believe it or not, that capitalistic sin of ours, profit-seeking is likely driving the run in these stocks and not environmental concerns.

Yet, consider what could happen to solar stocks if oil were to succumb to the pressure being applied by fundamental near-term catalysts? Slowing domestic economic growth, and possibly global health as well, could put a damper on near-term energy demand. Also, despite the messy start to winter in America, winters have run warmer and warmer as the years have progressed, and it was 60 degrees Fahrenheit in New York on Tuesday; this has a way of limiting heating oil and natural gas usage. Meanwhile, confronting Iran seems much less likely after the recent NIE report; I stress the word “seems,” because no matter what your expectation regarding Iran, it is current impression that matters more than reality in impacting price. Given these considerations, yet with a watchful eye on the geopolitical scene, I believe oil prices could contract sharply from here temporarily.

The cost of producing energy from the sun is on the highest end of the scale, and so related stocks should exhibit significant correlation to traditional energy prices. Furthermore, I expect the correlation of solar stock prices to the price of oil and natural gas, is likely on the very high side above 1.0. This is because, as oil and nat gas prices rise, the costly solar dream gains dramatic ground toward becoming reality. R&D expenditures required to bring the cost of energy production down from the 20-40 cent per kWh rate make more sense when oil is at $100. As a result, capital becomes easier to raise and interested investors abundant. Thus, you have the wild rocket ride of solar stocks last year.

Jim Hansel, CIO of Eight Winds Capital Management, LLC, an advisor focused on energy and energy technology stocks, says that the rise in solar shares is greatly due to the fundamental driver of global solar panel demand that far exceeds manufacturing capacity. Jim, whose performance was +90.11% in 2007 through November, also feels solar stock prices have benefited from increased investor interest in the shares, while a shortage of U.S. based solar companies exist to choose from.

Uh Oh, it’s the Taxman

But, The Greek thinks it’s time to pay the piper now. Oil is clearly on the near-term downtrend, in my view. If sustained for a little while, then it should not be long before solar stocks start to exaggerate that decline. I’ve got just the right catalyst to get that cataclysmic dive started right here in my back pocket, tax calendar year turnover.

Just look at the profits that are waiting to be had in these high flying solar stocks.

Solar proponents will tell you that despite the chart, the stocks might not be overvalued. Even so, the end of the tax year can throw a monkey wrench into the fundamental reasoning you expect to normally drive stock performance. Sometimes even valuation can’t get in the way of capital flow.

Company	Tic	P/E ’08 EPS	P/E/G	2007 Appreciation
First Solar	FSLR	116	2.2	795%
Trina Solar	TSL	16	0.4	185%
Evergreen Solar	ESLR	NA	NA	128%
JA Solar	JASO	35	0.8	292%
Suntech Power	STP	37	0.8	142%
LDK Solar	LDK	25	0.3	73%

Based on December 31, 2007 data

Thus, I would look for the perfect solar storm early this year, with oil easing and tax-delayed gains finally taken. However, based on the valuation you see presented above, and my view that long-term fundamentals still favor expensive oil, I would look to reenter the space not too long after the sun sets.

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