SOLF – Cheap Chinese Takeaway

As I pointed out in the note on Canadian Solar (CSIQ), U.S. listed photovoltaic (PV) companies based in China are experiencing a significant sell-off after the Shanghai Composite index tumbled 9% on February 27. I feel that the drop in China-based solar stocks has been exaggerated, creating some buying opportunities. The fate of China-based PV companies is not directly tied to the economic future of China, given that the bulk of their sales come from Europe and the U.S.

Even though there are some doubts about their internal financial controls, I like Solarfun (SOLF – Last trade $13.85). SOLF is an established manufacturer of both PV cells and PV modules in China. I wouldn't have bought the stock before the Chinese sell-off (SOLF shares have risen 41% since the company went public in December), but the shares are now looking cheap. After the Chinese sell-off on February 27, shares tumbled from $16.50 to $14.20, and on March 1 shares dropped from $14.30 to $13.10 amidst a nervous equity market.

SOLF is placed in a better position in the industry value chain (i.e. PV module production with 100% in-house PV cell supply), and this should allow SOLF to deal with tight raw material supply in the coming months. In addition, the company has their costs under control. According to Goldman Sachs research, raw materials make up 82% of SOLF's costs, and the company has 75% of their 2007 raw materials requirements covered by lower-price long-term contracts. The company also has above-industry-average conversion efficiency and low silicon requirements.

The company has said that it plans to expand into building integrated products, which carry significantly higher margins, and this raises the possibility that it could boost guidance when it reports earnings on March 7.

However, I would wait until the company reports earnings on March 7 to decide whether to buy the stock. The company's biggest market is Germany, and we have started seeing evidence of slowing solar demand in the country impact the earnings of other solar plays. (A full analysis is done in the CSIQ note). Given the weak earnings of other solar plays, any bad news related to the earnings should already be well priced into the stock.

There are two other reasons I'd wait before jumping on board with SOLF. Internal control deficiencies over financial reporting is still troubling the young public company, and this will be an overhang on shares until the auditors give the company a clean bill of financial health. Also, I'd wait for the nerves to settle in Chinese equity markets. The sell-off in Chinese equities is technical rather than fundamental. The Chinese government is unlikely to try and kill a one and a half year bull run ahead of the 2008 Beijing Olympics, and SOLF shares are likely to rebound with Chinese shares.

Disclaimer: I do not own any stocks mentioned above. I do not give investment advice.  Do your own research.  Do not rely on anything in this blog to make investment decisions. Consult an investment professional familiar with your specific financial situation before buying or selling any security.