Downstream German solar firms to shine through gloom

The sky is reflected in solar panels of the world's biggest roof based solar system in the southern German town of Buerstadt in this May 24, 2005 file photo. Downstream German solar companies with direct access to end customers are set to emerge top of the pile in a market that has proved more resilient than the rest of Europe to an industry downturn.

FRANKFURT (Reuters) - Downstream German solar companies with direct access to end customers are set to emerge top of the pile in a market that has proved more resilient than the rest of Europe to an industry downturn.

Relatively cheap valuations and government incentives should help shares of companies that install solar panels on customers' roofs outperform investments in producers of photovoltaic cells, analysts said.

The German solar market is estimated to become the world's biggest in 2009, with the European Photovoltaic Industry Association (EPIA) forecasting up to 2.5 gigawatts in new installations, more than a third of expected global volume.

There are few positive triggers in the short term for an industry currently suffering from overcapacity, tight credit conditions and a lack of project funding.

However, analysts said that solar retailers -- who install solar panels on customers' roofs -- should benefit in Germany, where demand is suffering less and financing conditions are better than elsewhere.

"In contrast to the project business, the German retail market is developing quite promisingly and common expectations regarding the total size of the German (Photovoltaic) market in 2009 are in a range of 2-2.5 gigawatt peak (2008: 1.5 gigawatt peak)," Sal Oppenheim analysts wrote in a note.

The solar value chain consists of upstream players -- companies such as Q-Cells, LDK Solar and Sunpower that are active in product manufacturing and distribution -- and downstream players, who deal with end customers and install the actual solar products, including Centrosolar and Phoenix Solar.

"As end customers access is becoming the most important asset for PV companies, we favor system integrators over manufacturers in our coverage universe," BHF Bank analyst Goetz Fischbeck wrote in a note.

NOT IMMUNE

Financing conditions for the funding-hungry solar industry have deteriorated worldwide, with banks being less willing to provide credit lines, hitting upstream players hard at a time when they are suffering from an oversupply of cells and modules.

"The solar industry remains over supplied and financing remains tight, especially outside Germany," Credit Suisse said in a note.

While Germany has held up relatively well, upstream players are not immune to the industry's troubles.

Eastern Germany-based Q-Cells, the world's biggest maker of solar cells, for example, had to cut its 2009 sales outlook three times within less than six months, as pricing pressure and oversupply hit the company.

Add favorable legislation regarding small end-customer oriented installations -- roof installations of solar systems receive higher subsidies per kilowatt hour than big, free-field installations -- and it is obvious why German downstream companies are faring better.

"With the German incentives directed more favorably toward small scale installations, we expect increasing focus around opportunities in the fast growing BIPV (Building Integrated Photovoltaic) market," Barclays Capital analyst Vishal Shah wrote in a note.

"We expect the BIPV market segment to remain an attractive niche segment where returns on projects are still expected to be healthy on low subsidy regime."

BIPV refers to solar systems that are integrated into the architecture of a building, such as windows or walls made out of solar cells.

GOOD VALUE

Based on the average of 10 European solar upstream and downstream players, calculations show that both groups have gained about 70 percent since European markets reached a 2009 low on March 9, according to Reuters data, outperforming the FTSE clean tech index by about 13 percentage points.

But according to StarMine, which weights analyst estimates based on their track records, the group of upstream players trades at an average 14.8 times estimated 12-month forward earnings, a premium to the downstream players' 10 times.

HSBC analyst Burkhard Weiss, who generally prefers larger silicon and wafer upstream players, said: "From a valuation point of view, there are some interesting picks at the moment in the downstream sector."

German solar module maker Aleo Solar is a case in point. Despite posting a loss for the first quarter of 2009 -- a dire one for the whole industry -- analysts regard its closeness to end-customers in Germany as a clear asset.

However, the company trades at the lower end of its peer group in terms of 12-month forward earnings.

"We believe Aleo may be more insulated due to its large proportion of sales in Germany which to date has proved more resilient to the economic downturn," Goldman Sachs analysts wrote in a recent note, upgrading the stock to "buy" from "neutral."

(Reporting by Christoph Steitz, Editing by Sitaraman Shankar)