Solar Industry-Merill Lynch-2008-09

Further selling unwarranted as market rolling into ’09 growth

Uninspiring conference but further selling is unwarranted
Although investors have come away uninspired from the Spain Conference, we
believe that the lukewarm sentiment doesn’t warrant further short selling of solar
stocks. Given improved visibility in 09 demand and ASP, investors will soon slowly
roll into 09 growth multiples. Many Asian solar stocks still trade below 10x 09E
with 60%+ EPS growth and investors haven’t started to price in such growth, in
our view. We continue to favor Suntech, ReneSola and China Sunergy in Asia.

Multiple catalysts on the horizon
We see an attractive entry point emerging due to the absence of negative
catalysts in the near term and continued earnings momentum into 2H08. Germany
has largely settled its subsidy plan for 2009 and anything Spain announces
beyond its 300MW will be a positive surprise. We won’t revisit these two major
solar markets for another 6-9 months. Japan’s renewed interest in solar and the
upcoming US election bode well for the sector, and emerging markets such as
France, Greece, Korea, India and China will be new surprises in 2010.

Growth expectations in 2009 still intact, for now

Many solar cell/module vendors are fully sold out for 1H09; moreover, companies
also indicate healthy orders for the remainder of 2009. The market hasn’t formed
a consensus view on 2009 demand, but given the current signals we don’t see
any associated downward estimate revisions until early 2Q09.

It’s polysilicon, not subsidy

We will be entering a poly-price driven market dynamic soon. We believe that poly
price will start to drive down solar ASP in 2010, and slowly drive market dynamics
away from the subsidy dependence. With the poly shortage in the past 2-3 years,
limited cost reductions could be pulled from the supply side. As contract poly price
is set to decline 10-20% in 2009 and 10%+ thereafter, the margins of Asian
vendors should remain fairly stable as ASP should keep be tracking poly price
decline in the same magnitude or less.

What if demand is weak?

So if 2009 demand proves to be very weak, poly price will likely fall and margin
will expand – solar companies can still make up the top-line shortfall with
improving margin – hence EPS risk is somewhat reduced. Our view is that spot
poly price will remain firm in 2H08 due to robust demand and production hiccups,
but we remain bullish that spot will soften into 2009. However, since poly price is
highly correlated to solar demand, it’s unlikely that both solar demand will fall off
and poly prices remain high (hence, the risk of margin squeeze is minimal).