Thursday, August 29, 2013

Tesla Motors (Nasdaq - TSLA) Still Cruising Despite Concerns

It seems nothing can go wrong for Tesla Motors (TSLA $166.00). The stock price has quadrupled since the beginning of the year, even in the face of concerns about the company's ability to manufacture and deliver its Model S, potentially damaging reviews, and several states have banned Tesla from selling the electric cars within their borders. In California, the Model S has outsold other luxury car manufacturers such as Porsche, Jaguar, and Land Rover. The U.S. National Highway Safety Traffic Administration recently gave the car the highest-ever crash safety rating.

There are questions that remain, such as how the car's battery will perform a year or two down the road, and if the battery charging infrastructure that Tesla is installing across the country will be adequate for the car to function as a primary vehicle. CEO Elon Musk is planning to take his sons on a cross-country road trip in the Model S, and charging it only at the company's network of Supercharger stations. The network is growing, but even in the areas with the most charging stations (California and New York/New Jersey), the Superchargers are too few and far between to make using the Model S for everyday activities realistic, much less convenient. The closest Supercharger station is 11.5 miles from my residence. The next closest is 83.5 miles away. I'm not sure exactly how many gas stations are within 11.5 miles from me, but I'd guess it's a few more, at least.

The Superchargers are free to use and solar-powered so the car is operating on zero emissions post-manufacture (mining the lithium used for the battery is not environmentally friendly). Tesla is going to need to drastically expand the Supercharger network to make the upcoming Model X work. It's being marketed to the middle-class, so it most likely will be used by people to commute, bring their kids to activities, etc. Tesla is claiming that by the end of 2014, the network will cover "80% of the U.S. population and parts of Canada," whatever that means.

The Superchargers are only practical for traveling between cities, something the average motorist isn't doing regularly. So an owner would have to plug the car in at home, pay for the electricity to charge the car, and say goodbye to the zero emission claim, since most of the electricity in the U.S. is still produced by fossil fuels. The car itself may not emit greenhouse gases, but the power plant charging it up still does. Also, while the Supercharger can give the battery a 50% charge in 20 minutes, it takes considerably longer to juice up at home or other charging stations. The battery also drains when the car isn't in use, so it has to stay plugged in.

Resale value is another factor that could have an effect on sales moving forward. The Model S hasn't been out long enough for anyone to be sure how well they age. Some studies have estimated that the battery packs in the Roadster, the precursor the Model S, will keep 70-85% of its initial capacity after being charged 300-500 times. Tesla says it should retain about 70% after 50,000 miles. Others have speculated the battery could last 20 years. But there are myriad factors that contribute to battery health, and there isn't enough data available for anyone to know for sure.

What we do know is that the battery packs are expensive, and the secondary market would be impacted if buyers were forced to install a new battery in an old car. But the cost for a new battery has been declining, so it may turn out to not be of great concern.

Potential Model X customers are probably willing to overlook these concerns. Tesla is cool right now. Musk is trending into Steve Jobs territory. The Model S has received rave reviews from publications and owners, and was named the 2013 Motor Trend car of the year. The Model X could be a hit if it can do a good enough job of replicating the experience of driving the Model S while slashing the price tag.

Customers can reserve a Model X for a refundable $5,000 ($40,000 for the "Signature" edition) right now, even though the car isn't expected until late in 2014. And that's just when the first shipment is expected. Someone could leave $5,000 in limbo for a car that takes at least a year and a half to arrive, or, according to Tesla's terms of service, might never arrive. Five-thousand dollars probably isn't a big deal to someone who can afford the more expensive Model S; middle-class families surely would be less inclined. And since the reservation price is fully refundable, those who decide to place an order have a lot of time to decide whether or not they really want to go through with it.

Tesla has been running more smoothly this year than many thought they would. The Model S pushed the company into profitability. It's critical that the Model X succeeds for Tesla to take the next step. A good deal of that success hinges on the company's ability to grow its Supercharger network. Time is working both for and against Musk & co. We'll see if they can pull it off.

Tuesday, May 14, 2013

Solar City ( Nasdaq - SCTY ) -- Losing Money Despite Massive Subsidies

Solar City's stock (SCTY $32.00) has quadrupled in price since it became publicly traded last fall.  The company has done a masterful of job of influencing Wall Street expectations.  In the March quarter a loss of $.36 a share was reported (adding back stock option expense).  Sales improved 21% to $30.0 million.  The shares surged in advance of the report and maintained most of those gains despite the relatively dismal showing.  Gross margins narrowed by 7% on the solar systems the company sold in the quarter.  The gross margins on leased installations, which are depreciated over 30 years, also fell by 5%.  (For income tax purposes, depreciation is taken on an accelerated basis over 6 years.)  Solar City reported it cut production costs significantly.  The only explanation for the reduced manufacturing margin is sharply lower selling prices.  Selling and administrative expenses climbed 40% in the March quarter.

Solar City's explanation is that most of the "profit" it generated was deferred into future years.  The company's leased systems require homeowners to pay monthly fees for electricity that escalate at a 2.9% annual rate over 20 years.  Solar cell efficiency, using today's technology, generally deteriorates 2%-3% a year as a result of use.  Solar City uses financing partners that take advantage of the 30% tax credits issued by the U.S. Treasury for solar installations.  The company still pays interest on the balance, which it projects to decline from current levels.  The company is installing systems at a rapid pace, to be sure.  If the payment stream holds up, and the re-sale value of the systems is as good as the company expects after the initial 20 years, (recall, depreciation is taken over 30 years), and market interest rates don't rise, earnings could develop at some future time.

U.S. Treasury subsidies are scheduled to end in 2016.  That will force costs to decline by 30% just to break even on current pricing, which still is inadequate to produce a profit.  More worrisome, Solar City is betting against the likely trend in solar technology advances.  Modest improvements won't upset existing buyers.  But if nanotechnology based cells or other advances make it into mass production huge gains in efficiency could be achieved.  Those units could make today's systems look like horse and buggies.  Solar City no doubt would hire swarms of lawyers to force its existing customers to stick with their old fashioned systems.  But enormous write offs could occur if that effort fails.

Solar City's antagonistic approach toward the utility industry is likely to breed further trouble.  Electric utilities to date have put up with the inefficiencies and poor economics associated with solar power.  But as more homes go off the grid that accommodative policy is unlikely to continue.  Over the long haul the utilities themselves are almost certain to become solar installers to keep control of their networks.  Independents like Solar City may wind up resigned to serving niche markets.

The Enron style of accounting used by Solar City presents additional concerns.  For years Enron was the apple of Wall Street's eye, even though few if any of the analysts following the company were aware of its off balance sheet activities.  Every analyst we've talked to about Solar City can't explain the company's financing partnerships, either.  Perhaps they're structured to generate a huge windfall in the future.  More likely, they entail a complex structure with a variety of danger points.  These shares probably will fare well as long as the music keeps up.  Enron was a high flier for nearly a decade.  We think investors are playing with fire when it comes to these shares, though.  Better speculations are available.

Sevcon ( Nasdaq - SEV ) -- Makes the Adjustment

Sevcon (SEV $4.25) reported unexceptional Q1 results.  The company is a leading independent supplier of controls for electric and hybrid vehicles.  The systems take directions from the driver and make the engine respond, maximizing efficiency and power.  Sevcon has a long history in the work machine market.  That segment fell on hard times last year when demand for mining and construction equipment declined.  Electric forklift truck demand slipped in the March period, as well.  Part of that is believed to the result of a shift towards natural gas powered trucks.  Sevcon entered the on road electric vehicle segment a few years ago via a relationship with Renault.  The company provided the controls for the 2-seat Twizy city car that Renault introduced, initially to relatively strong demand.  Weak economic conditions in Europe subsequently caused volume to slide, though, and that trend continued in Q1.  Off-road electric motorcycles and ATVs remained solid.

Sevcon responded to the slowdown last year by moving into the hybrid controls segment.  That effort hasn't resulted in large production runs yet.  But several programs are believed to be in the pipeline.  Sevcon's new Gen-4 system is geared primarily for the hybrid market.  The company also has beefed up marketing efforts in northern Europe, where the economy remains sound.  And pick-ups appear to be underway with the Renault and forklift truck lines.  Results probably will improve modestly over the next 1-2 quarters as the new opportunities reach fruition.  Significant gains are possible beyond.  Electric vehicle demand could advance in the wake of Tesla Motors' recent success.  The move into hybrid applications offers even greater potential.  Our 2014 estimates may prove ambitious.  But it won't take much to get earnings moving since only 3.35 million shares are outstanding.

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Friday, May 10, 2013

Tesla Motors ( Nasdaq - TSLA ) -- Turns the Corner

Tesla Motors (TSLA $77.00) reported excellent better than expected Q1 results.  The electric car manufacturer sold 4,900 luxury Model S sedans in the period, driving revenues up 18.6x to $561.8 million.  All of those were delivered to U.S. customers.  About 100 cars ended the quarter in inventory.  Fully taxed earnings came in at $.08 a share.  Production costs were elevated in the period as Tesla scrambled to meet demand.  More efficient operations are expected in upcoming periods, which should help margins.  Federal tax benefits bolstered performance.  Those subsidies are expected to decline in the next two periods and disappear altogether in the December quarter.  In spite of that manufacturing margins are predicted to rise materially and plateau at around 25% in the final quarter.  Overall margins will depend on how much Tesla spends on product development, marketing, and service.  Those investments probably will stay high to lay the groundwork for additional growth beyond.  A solid profit performance appears attainable, nonetheless.  We estimate fully taxed earnings will finish the year around $.50 a share.

Unit volume growth will exceed revenue gains in 2014.  Tesla plans to introduce a leasing program to broaden its potential market.  The company will collect 100% of the sales price from its financing partners.  But from an accounting standpoint revenue will reflect the underlying lease payments, spreading results out over a three year period.  Tesla is guaranteeing the re-sale value of its cars after three years.  That conditional adjustment requires to use of the lease accounting treatment.  Volume should benefit as well from the beginning of international sales.  Most of that will occur initially in Europe where gasoline prices are unusually high, making electric power even more attractive than in the U.S.  Sales to Asia may begin, too.

Sales of power trains and battery packs to Toyota and Mercedes offer additional leverage.  Toyota is building an all electric RAV; Mercedes, a B-Class sedan.  Both rely on Tesla's underlying technology.  Tesla's own next generation vehicle, the crossover Model X, remains in an early stage of development.  Final  design is slated for mid 2013.  Deliveries could start in late 2014.  The Model X is expected to sell for approximately two thirds of the $90,000 charged for the Model S sedan now in production.  That will be a high risk, high return product line.  Today's luxury model is being purchased mainly by extremely affluent customers who typically have other cars they can use in case they need to travel significant distances, or just need to travel period if the power goes out.  The next group will consist more of everyday users.

Electric car technology remains a question mark.  E-vehicles are likely to carve out a variety of niche markets where range isn't a limiting factor.  Tesla is trying to expand its cars' driving potential.  But the upside to that is limited by the company's use of lithium batteries.  Mechanical and software engineering tricks may boost performance somewhat.  But it is unlikely lithium ever will re-charge quickly or materially extend driving range.  New battery technologies aren't showing much potential these days.  So a competitive leapfrog is unlikely.  Without major improvements, though, electric cars will have a hard time overtaking gasoline, diesel, and natural gas to become mainstream vehicles.  Tesla is a great company and is well positioned to thrive in the electric car segment.  Whether it break out from there remains to be seen.

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Friday, March 15, 2013

MIT Scientists Develop Nuclear Waste Reactor

The biggest complaints about nuclear power are its safety and its waste.Two MIT Ph.D. students are developing a nuclear reactor that combats both of those concerns. Their Waste Annihilating Molten Salt Reactor (WAMSR) runs on nuclear waste from other plants. Current nuclear waste takes hundreds of thousands of years to lose its radioactivity. The pair's new reactor would expend about 98% of the waste's remaining energy, which would reduce the decay time to only a few hundred years. Leslie Dewan and Mark Massie founded Transatomic in 2011, and are working on a prototype. They hope to have the working model ready by 2015, and have the new reactors operational by 2030. 
The technology actually dates to the 1950s. Oak Ridge National Laboratory developed the molten salt reactor, but light-water reactors became the preferred choice in the United States. Dewan and Massie have retooled the reactor so that it is "fuel agnostic," and can run on uranium or thorium. The nuclear waste is dissolved into a liquid, which can stay in a reactor longer and generate more energy. And there is plenty of nuclear waste laying around, waiting to be utilized. The world produces about 9,000 metric tons of nuclear waste per year. The U.S. accounts for 2,000 of those metric tons, which it stores in depositories like Yucca Mountain. Transatomic says it can take the roughly 270,000 metric tons of nuclear waste worldwide, and turn it into enough energy to power the entire world for 72 years, even accounting for increased demand. 

The WAMSR is also safer than conventional light-water reactors. There are two "loops" to the design. The primary loop contains the molten salt and nuclear waste. The molten salt mixture's high boiling point provides a fail-safe. If the mixture becomes too hot, it expands and keeps the fuel atoms too far away from each other to continue the reaction. And unlike light-water reactors, the mixture is under low pressure so there is less wear and tear on the machinery. A second loop filled with steam adjoins the primary loop. The steam is heated and spins a turbine, just like a conventional reactor. A WAMSR plant would also be safe if it lost power, which is what happened in Fukushima. The WAMSR has an electrical "freeze valve" at the bottom of the primary loop. The valve is a block of electronically frozen salt mixture. If the power goes out, the block melts and the molten salt pools into a container below, where it will cool into a solid in a few days.

The technology's still far off, but solutions like the WAMSR could help nuclear power make a resurgence. Transatomic and similar companies, like Flibe Energy, are just starting out, but they could have a big impact on world energy. We'll keep an eye out.

Tesla Motors: Ramping Up Production

It’s a make or break year for Tesla Motors (TSLA $35.30). The high-end electric car manufacturer is ramping up production on its Model S almost tenfold from 2012, to an expected 20,000 vehicles. The demand is there; the question is whether or not Tesla can keep up with production without hurting margins. We’re estimating that Tesla will post positive pretax margins this year (2%), a first. The company’s guidance suggests that gross margins will approach 25% by the end of the year, not counting the zero-emissions credits it receives from the government.

Right now, about three-quarters of sales are made in North America. Model S sales have been almost exclusively made in the U.S. so far. Elon Musk, the CEO, mentioned in the Q4 earnings release that only two Model S sedans were on the road in Europe at that point. Sales in Asia were almost non-existent. But Tesla plans to market more aggressively in those places this year. 

Tesla will be in a good position if it gets close to its 20,000 vehicle goal. We’re estimating $1.7 billion in revenue for the year, right around 17,000 cars sold. Musk also claimed that the negative review in the New York Times would cost Tesla $100 million this year. The effect remains to be seen, but it seems an exaggeration. The company could withstand a hiccup in production here or there since there isn’t much in the way of direct competition. Fisker, its chief rival, just had its founder step away, the latest in a series of mishaps. Electric cars from major manufacturers like the Nissan Leaf don’t offer comparable performance or luxury to the Model S. There is some competition with gas-powered luxury sedans, but for the most part sales are made to people who are already interested in driving an electric car. Since Tesla is relying on word-of-mouth, it’s got to keep its customers happy. Significant delays would lead to cancelled orders, and some potential buyers would put off buying a Tesla or lose interest altogether.

Shares are likely to post earnings this year. We estimate a $.17 EPS, but that’s achieved by adding back the stock-based compensation expense. Our calculations suggest income of about $30 million. Tesla’s official accounting will be closer to break-even. The stock price is high compared with earnings, and Fisker’s troubles show that there is plenty of risk in electric cars. Tesla will be in a much better spot if it can get through 2013 without any major trouble. The company’s crossover style Model X is due to start shipping early in 2014, and the car is already receiving reservations. Musk thinks the market for Model X will be about 70% that of the Model S.

Tesla doesn’t advertise its cars like traditional manufacturers. The company does have ads, but has gotten the word out principally through its Tesla Stores and word-of-mouth. Most of the Stores in North America are located in malls. This helps to lure in curious shoppers, and the centralized locations are convenient for people who live in the area. There are currently 25 Stores open in North America (24 in the U.S.), with four more opening in the coming months. There are more service centers opening up for customers that don’t live near a gallery. At the moment though, the network is sparse if you live in, say, Cleveland. The closest Store is in Toronto, the closest in the U.S. in Chicago. And the nearest service center would be two and a half hours away in Columbus. For now, the convenience really only applies to people in Southern California and New York/New Jersey. 

The company needs to develop a strategy to deal with bad press. John Broder’s New York Times piece is the most well-known example. He claimed the Model S’s battery struggled during cold temperatures. Musk responded with data logged during Broder’s test drive, and claimed the Times report was dishonest. At its core, it’s a he-said, he-said feud, and all it will do is invite others to investigate the battery’s performance. This post shows cold weather has a significant impact on battery life.

The battery itself has also come under attack recently, from Wall Street Journal opinionist Bjørn Lomborg. We’ll take what he says with a grain of salt, because he is a known green energy nemesis. He argues that electric cars, despite claiming zero emissions, actually leave a greater carbon footprint than gas vehicles. Research shows that it takes twice the amount of energy to manufacture an electric car than a gas-powered one. Most of this energy is spent mining lithium for the battery. Charging the car also uses electricity, which is still predominantly generated using fossil fuels. Tesla’s Supercharger stations are solar powered, but there are only nine of them in the United States. The company plans to install 100 by 2015. The company suggests keeping a Model S plugged in when not in use, because the battery depletes even if the car isn’t running. Unless owners can find a renewable energy source to keep their cars plugged into, the Model S becomes less environmentally-friendly than advertised. Lomborg says government incentives to electric car manufacturers and buyers don’t match the actual environmental savings. This technology is still fairly new though. Lomborg should realize that a true zero-emissions car won’t just appear out of the blue. It’s going to take some work. 

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Thursday, February 7, 2013

Under Construction: The State of Solar

By Eric Ramsley  

The Los Angeles freeway system is in disarray. There is a lot of work that needs to be done. But there is so much traffic that there isn’t a whole lot of time to get anything fixed. Even when roads are temporarily shut down, like the 405 was earlier this year, no discernible progress is made. And by the time any construction is finished it will be time to start all over again. The roadways resemble the handful of Frankenstein cars driving along them: Pieced together with spare parts and clinging to dear life, unrecognizable from what they once were.

Swap out a few words and you’ve got the United States’ power grid. A jerry-built electrical network owned and operated by competing companies that is being stretched to its limit. Improvements have been proposed, but much like the highways in Los Angeles, by the time they are complete it will be time for the next round of emergency surgeries. Some have suggested that the grid’s poor state leaves it vulnerable to a terrorist attack; others argue that it is so shoddy and unpredictable that such an attack might ultimately fail.

Los Angeles is so developed that replacing the highways is highly improbable, if not impossible. But it’s at least conceivable that a new power grid could be built around the existing one, with the old system providing power up until the new system is complete. The benefits should outweigh the costs. The U.S. could have a state-of-the-art grid in place, securely and efficiently meeting increasing demand. This would also keep power companies in control of distribution. As much as some of them seem to want to believe it, the current setup will not be around forever. 

Thursday, January 31, 2013

Sevcon ( Nasdaq - SEV ) -- Better Days Ahead

Sevcon (SEV $3.75) reported lower than expected Q1 (Dec.) results.  Sales dropped 22% to $6.64 million.  Earnings slid to a loss of $.39 a share.  Sevcon is a leading provider of controls for electric vehicle engines.  In general, half the business is directed towards off-road work machines.  The rest is used in small city cars, motorcycles, and all terrain recreational vehicles.  Both segments were hit hard in the latest quarter, continuing a slowdown that began earlier in 2012.  European volume nosedived 44% due both to the poor economy and a break in production by Renault of its promising city car line.  U.S. volume declined 18%, mainly due to the election.  The Obama Administration implemented stringent E.P.A. rules that will force a large increase in electric work machines.  Producers of those fork lift trucks and other vehicles delayed implementation, hoping Mitt Romney would be elected and moderate the impact.  Asian demand picked up by 17%, but that represents a small part of the business currently.

Work machine volume is poised to accelerate over the next 3-5 years.  E.P.A. regulations that go into effect in 2015 and 2017 will require less pollution and greater fuel efficiency.  Sevcon is working on a number of programs, mainly in the hybrid engine area.  The electric car segment promises to recover, as well.  Renault built a limited number of city cars to begin with in 2012.  Demand was strong.  Bigger production volumes are slated to begin in March.  Motorcycle and ATV demand has been consistent.

The long term outlook remains positive.  Electric vehicles will remain a niche segment until improved battery technology expands their range.  That's not on the horizon.  But there are millions of short range commercial, industrial, and consumer vehicles that are candidates for hybrid and electric engines.  The share count is low. So any meaningful improvement could support substantial stock price appreciation.

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Tuesday, January 22, 2013

Power One ( Nasdaq - PWER ) -- Malaise de Europe

Power One (PWER $4.00) appears on track to report lower than expected Q4 results.  The company is the second largest producer of string converters that turn DC power generated by solar panels into AC electricity.  Demand declined dramatically in Q4 following the elimination of key subsidies in Italy and Germany.  Other European nations have imposed reductions, as well.  U.S. business remains good.  Accelerated depreciation rules, federal tax credits, and a range of state and local programs have kept the residential and light commercial segments expanding at a fast pace.  But large installations, which account for half the American market, have slowed due to the recession and more efficient energy use.  Financial performance is likely to fall short of previous targets in the December quarter.  Sluggish results could persist well into 2013 as European declines erase whatever upturn Power One benefits from in the U.S.  Asian solar installations are on the rise.  But those projects are tough to crack due to protectionist schemes.

The long term outlook is uncertain.  U.S. subsidies are scheduled to end in 2016.  Tariff wars are cropping up, making it difficult to serve the entire world solar market.  Europe remains depressed, making it unlikely new government subsidies will emerge any time soon.  On the plus side inverter production costs keep coming down.  New products are in the pipeline.  And the cost of solar systems in general remains on a favorable slope, laying the groundwork for broad based adoption over the long haul.

2013 is likely to be a transition year for Power One.  The company is well financed, though.  And its new product pipeline promises to reinforce Power One's competitive position.  Earnings could rebound in 2014, perhaps bolstered by new U.S. government support.  Natural gas remains a huge challenge to the industry.  That lower cost and less polluting fossil fuel has displaced home heating oil and coal over the past five years, lowering co-2 emissions in the United States by 10% over that time.  The lack of electricity demand growth presents another obstacle.  More efficient appliances and lighting have helped keep electricity demand flat in the U.S. despite fast growth in the number of electrical devices.  If total electricity output doesn't improve solar probably will expand less rapidly than predicted.

Long term appreciation is possible in spite of the headwinds.  If the world economy returns to normal and trade obstacles are not created, Power One could rebuild earnings to the $.50-$1.00 a share range within 2-3 years.

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GT Advanced Technology ( Nasdaq - GTAT ) -- Backlog Vanishes

GT Advanced Technology appears on track to report poor Q4 results.  The company is the leading provider of capital equipment for the solar industry.  One set of machines produces polysilicon.  Another converts that into solar cells.  Assembly operations performed by other companies, primarily in the Far East, combine those cells into panels.  GT Advanced entered 2012 with a billion dollar backlog.  Oversupply conditions in the solar industry, brought about by sharply reduced government subsidies in Europe, caused incoming orders to dry up.  The company continued to recognize decent revenues earlier in the year from equipment that already had been delivered and was awaiting final customer acceptance.  New shipments took a nosedive.  And that trend is unlikely to reverse before late 2013.  Low revenues are likely to yield an operating loss in the December period.  A large inventory writedown is anticipated, as well.

A next generation technology is slated for introduction in mid-2013.  That will be a modular add-on unit with a selling price far below that of a complete system.  The new "mono-silicon" approach promises a significant improvement in solar cell performance at a comparable cost to "poly-silicon."  The Far East solar industry is in the midst of a consolidation, however, so few orders are expected right away.  Financing remains hard to obtain and profit margins still are under pressure.  Chinese government subsidies may cause the oversupply situation to persist by propping up weak participants as a vehicle to preserve jobs.  Orders for GT Advanced systems probably won't accelerate until the profit potential from its new machines improves.

The LED segment is under pressure, too.  GT Advanced encounters direct competition in that market.  LED lighting costs far more than conventional bulbs.  Consumer and commercial demand is rising, though.  The current lull in capital equipment orders is likely to end long before the solar industry rebounds.

Our estimates are below the company's official guidance.  GT Advanced predicts income of $.25-$.40 a share in 2013 on revenues of $500-$600 million.  Results could bounce back starting in 2014.  The company remains the only large volume producer of solar manufacturing systems.  Future results might be diluted 20% by a recent convertible bond issue ($7.71 a share).

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Monday, January 21, 2013

Real Goods Solar ( Nasdaq - RSOL ) -- Speculative Turnaround

Real Goods Solar (RSOL $0.85) appears on track to report unexceptional Q4 results.  New management was brought in during the third quarter.  The company's two largest shareholders each contributed $1.0 million in debt financing, as well, to tide things over while operations were straightened out.  Overdue receivables were collected, reinforcing cash flow.  Middle management was streamlined.  New marketing techniques have been developed.  And better supply arrangements were negotiated.  Still, the overhang from earlier mistakes almost certainly kept sales below potential.  Margins probably remained below normal, as well.  Another sizable loss is anticipated.

The solar installation industry is thriving, though.  If Real Goods Solar's new management team can restore operations to normal, profitability could reverse course in a meaningful way.  The company is a leading provider of solar systems for residential (50% of sales) and commercial (50%) customers.  The latter business was added early in 2012 via an acquisition.  The underlying business remains solid but too much bureaucracy was created by the merger.  Most residential contracts provide homeowners with electricity at prices below local utility costs with no upfront investment.  Real Goods Solar engineers and builds the systems, and then sells them to investors who benefit from a raft of tax benefits.  Homeowners either lease the systems and pay a fixed monthly amount.  Or they pay for the electricity they use, subject to a monthly minimum.  The format usually depends on what kind of buy-and-sell deals are available with the local utility.

U.S. tax credits offset 30% of a system's cost.  The law actually allows higher credits based on a "market value" formula, although that approach has been subject to abuse and now is being investigated by the government to identify possible fraud.  State and local governments provide additional payments.  And many utilities are forced to offer incentives of their own.  On top of that the I.R.S. permits 60% first year depreciation, and 100% after five years.  Low interest rates facilitate financing options further.  As a result installation companies like Real Goods Solar can sell systems at a hefty mark-up to the financing companies. The trick is to keep marketing, management, and regulatory costs to a minimum.

A large debt payment comes due next April.  Sales expansion is likely to be held back until that obligation is refinanced.  The bank is sure to require evidence that margins are returning to normal.  Despite that constraint on selling expense, sales promise to improve at an above average rate.  Panel costs continue to fall.  Installation methods have become increasingly efficient.  And the tax incentives will remain in place until 2016, if they aren't extended.  Climate change has been identified as a top priority by President Obama as he begins his second term.  Additional boosts could emerge.

We estimate Real Goods Solar will return to profitability this year.  In 2-3 years sales could reach $150-$200 million.  At 5% pretax margins fully taxed income could attain $.15-$.20 a share.  Higher margins appear possible, especially if the regulatory climate is simplified.  Obtaining permits and hook-ups now accounts for 25%-40% of a deal's total cost.  Aligning local utility interests with the solar industry could yield further benefits.  New solar technologies are in the pipeline which could double price performance of the panels themselves in 2-3 years.  That rate of improvement could be sustained for several iterations, making solar a mainstream technology.

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Sunday, January 20, 2013

Enphase Energy ( Nasdaq - ENPH ) -- Price Pressure Persists

Enphase Energy (ENPH $3.75) appears on track to report unexceptional Q4 results.  Enphase is the leading provider of microinverters that convert DC power generated by solar panels into AC electrical current.  Most of the solar industry uses string converters.  Those are large units that sit on the ground and convert an entire string of panels.  Microinverters are attached to each individual panel.  The string units are less expensive.  And their prices are declining quickly in response to engineering improvements and relentless competition.  Microinverters generate more electricity output, typically 10%-15% more.  String converters are limited by their worst performing panel.  If a single panel becomes impaired -- for instance by leaves, shadows, or debris --the entire system is affected.  Microinverteers enable each panel to produce at maximum output.  New financing arrangements in the U.S. residential solar market are encouraging system installers to emphasize price more than output.  Those schemes are cutting into Enphase's potential market, thwarting the company from growing as rapidly as it might.

A next generation product line could open up the commercial sector.  To date Enphase has serviced the residential market.  New systems slated for introduction early in 2013 promise to address the small commercial area.  Even larger units are planned for 2014.  Commercial building owners are likely to be more alert to the energy savings Enphase devices produce.  So even though lower initial prices for string converters will remain a competitive issue, acceptance could prove high.

Expansion outside the U.S. offers further potential.  Enphase concentrates on the U.S. market presently.  More than 90% of sales are to domestic customers.  Much of the rest is made in Canada.  New distribution channels are being developed to enter Europe and Asia.  The European market contracted markedly in 2012 due to the economic crisis, which caused subsidies to vanish.  Asian demand is picking up, although tariffs are on the rise to prevent imports.  Enphase is beginning from virtually a zero base, though, so at least some incremental benefit is likely.

We estimate 2012 earnings finished around minus $.80 a share.  Next year margins could improve as fixed costs are spread over a broader base, and direct costs are reduced consistent with selling price declines.  Our estimate is a loss of $.25 a share.  A move to profitability could occur in 2014.  The long term outlook remains uncertain.  U.S. tax subsidies equal to 30%-40% of a solar system's cost are scheduled to disappear in one fell swoop in 2016.  Further improvements in solar technology are likely to offset some of that.  But unless regulatory costs are brought down and electric utilities are given incentives to embrace solar, profitability might remain challenged well into the decade.

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