Photo:urbangarden, Creative Commons, Flickr
It's been almost two months since Yingling Energy (YGE – Last trade $17.07) had its IPO, and the stock has rallied nicely from an opening price of $10.80 to a high of $20.40 on July 12. The company is a vertically integrated photovoltaic product manufacturer based in China. It produces silicon, builds solar cells and manufactures modules based on those cells. I continue to believe that the market hasn't separated the winners from the losers in the Chinese solar crowd, and it's probably too early to call YGE a winner.
As we have discussed before, the emerging consensus seems to be that solar is a commodity and that the only thing that matters is cost per watt. Many feel that solar will ultimately be based in China for all the same reasons that cellphones and computers are made there. Barriers to entry have dropped as a result of increased polysilicon supply, the emergence of thin film photo cells and the rise of Chinese solar cell production. Margin pressure, resulting from these reduced barriers to entry into the solar market, is expected to lead to many casualties.
I feel that YGE deserves a valuation premium because its vertically integrated business model offers a long-term advantage of lower production costs relative to its peers. Due to its lower costs, YGE should be able to maintain market share in the event of margin compression. However, it wouldn't surprise me if most of this premium is already priced in.
The positive long-term outlook for the stock was further reinforced with an announcement on July 10 that YGE has entered into an agreement with Wacker Chemie AG of Germany to supply polysilicon in the period from 2010 through 2018. The company is also expanding its manufacturing capacity, and recently announced a contract to supply 9.55 megawatts of PV modules to a Spanish integrator (about 10% of its current annual production).
It might look like smooth sailing over the long run, but the stock could be in for a shock over the next year. The company might have some problems on the polysilicon procurement front. They are relying on Xinguang, an unproven Chinese polysilicon manufacturer, which only started production last August. YGE's management recently indicated that they have polysilicon supply contracts in place for more than 90% of their expected 2007 production and approximately 50% of expected 2008 production. All of their 2008 polysilicon will come from Xinguang, and I believe this presents a major risk to YGE.
A recent note from CIBC noted that MEMC Electronic (WFR – Last trade $59.66), which have been producing polysilicon for over 50 years, have experienced delays in ramping production. Xinguang is in the process of ramping capacity from approximately 260 tons of annual output to over 1,200 tons. If an experienced company like MEMC is having a hard time ramping production, inexperienced companies like Xinguang are more likely to experience delays. YGE's earnings will be hammered if they don't have sufficient access to polysilicon during 2008, not to mention the market share they will lose if their expansion plans are derailed.
In summary, YGE 's long term outlook is solid, but its over-reliance on an unproven polysilicon supplier could hurt results in the near term. If we had to see this stock rally sharply over the coming months, I'd like to short it on the chance of a supply disruption.
Disclaimer: I don't own any of the stocks mentioned above. I don't own a solar panel.