Quarterly Newsletter #1
July - September 2024 | Notes from the Solar Industry
High on Enthusiasm, Low on Rhythm
When I tell people, I run, the most common question I get asked is the distance or my pace. However, if one truly loves long-distance running, one knows that both of those data points pale in front of the real joy which cannot be measured and that is rhythm, that feeling of unity in movement, where body, mind, breathe are all aligned, ego disappears, and everything is effortless.
There is a CNN documentary on one of the greatest runners of all time, Haile Gebreselassie. A part of that was shot in Berlin in 2007 when Haile broke the world record with a time of 2:04:26. You can hear the commentator say “it’s economy of effort and it’s above all, rhythm. His rhythm rarely alters.” In the last quarter, rhythm was something I could not find in the solar sector. Many flights, factory visits, and conferences later, I was left with a lot of hope, but I could not see rhythm. Maybe that is not expected of a sector which is riding on a booster rocket. That said the energy and enthusiasm were palpable. Not only at conferences and trade shows but also at factory sites where the construction is in full swing for newer and bigger solar plants with faster machinery and the latest technologies.
Here are big themes from the last quarter:
TOPCon - Tread with caution
While the world seems to have moved to n-type already, it seems that Mono PERC may stay around for longer. Two reasons:
Legal: The last few weeks saw several lawsuits being filed on TOPCon patents.
Technical: Ultra-Violet Induced Degradation (UVID) is a real challenge. It is without doubt the most recurring technical question in all the meetings. The root cause of UVID is a phenomenon the industry has not fully understood. A higher-than-expected degradation due to UVID may cause bigger warranty claims for module manufacturers and loss of project revenues.
The Power of Water
During my travels, I got a day off to visit the Grand Canyon. The grandness of it, is awe-inspiring yet scary. At the Canyon, I read a brochure that said something to the effect that “over time and with water, everything changes”.
While solar technology rapidly evolves, one must be careful of the environmental stressors of heat, humidity, cold and hail etc. Interestingly, moisture ingress continues to be one of the leading issues with solar modules that have been in the field for a few years. The forces of nature created the beautiful Grand Canyon; however, they have the power to ruin a long-term asset such as a solar plant. It is observed that developers flip assets every few years, and banks also down-sell their loans to recycle their books. It is hard to find that one entity that carries the tail risk of a solar plant.
Book Recommendation
I am really enjoying reading the book, “What I Learned About Investing from Darwin” by Pulak Prasad of Nalanda Capital. In the book, he draws parallels between evolutionary biology and investing decisions. While it’s raining IPOs for solar companies in India, it would be good to refer to some basic principles from his (or for that matter any good investor’s) framework. I strongly believe that long-distance running is a great teacher for investing but more on that later.
Two big takeaways for me from the book are that first, one should shy away from a regulated sector and second, one should invest in a firm that has some durable moat.
Policy Risks
Solar manufacturing boom is largely due to favorable policy and regulatory support, both in terms of carrot and stick.
Carrot - Demand creation, manufacturing incentives.
Stick - Anti-dumping duties and any other tools such as ALMM to keep competitive forces from other countries at bay.
The sector is highly open to policy risk and that is something one should be aware of before making investment decisions. This comment is agnostic to the country. I have seen time and again flip flops in policy support.
One may have a few years of allowing import of modules to support the developers to build large capacities for Net Zero / Clean Energy targets, then a few years later you have the policy to support the local manufacturing for building the local ecosystem and job creation. If the margins in your business are based on certain government policies, then, at least from my vantage point, that doesn’t give me control as a business. In the book Prasad writes about government-owned business - It’s not that the government objectives are “wrong” - they make sense in the light of the multiple constituencies whose needs they are trying to meet. Their objectives are just different from ours.
I am taking this argument forward and saying businesses with big policy risks give the power to the policy maker (or the one who can influence them) and takes away the locus of control from the entrepreneur.
Often, this policy risk doesn’t come as a large windfall gain or loss but the waiting period, the lacunae, the uncertainty is what creates all the stress. Many of my meetings this quarter ended with the statement “Let’s wait and see who wins the Presidential elections in November” i.e. not much will happen in the next few weeks leading up to the US elections.
If policy doesn’t play out to perfection, all of this capacity being deployed in India, or the US may turn out to be excess capacity. As you analyze the public markets - Please be sure that the goal post might change, the very next day. Some entrepreneurs / investors are ok with that risk, while some others are not.
Competitive Edge
Solar module manufacturing or electricity generation through solar plants are both commodity businesses with no real differentiation or competitive edge. Of course, one can focus on the micro details and run their plants well, use automation, or have a unique sales strategy but fundamentally there isn’t much of a differentiation within these two businesses.
Margins are thin (assuming no government support), products are alike, and there is fundamentally no technology moat. In fact, in the last quarter, we have seen firms that brought in the element of technology differentiation struggle against their ‘win with scale at low cost’ competitors.
I often ask founders how they are confident in setting up large capacities knowingly all these uncertainties - The answer is always “The market is big enough to accommodate everyone”. I agree that the solar market is growing at breakneck speed, but does an increase in market size alone be enough to accommodate so many players?
Aviation is a growing industry just like how textiles was, but we know that a growing market doesn’t always translate to sustained ROCE with a defensible moat. They say the quickest way to become a millionaire is to start with a billion dollars and launch an airline company!
That said, one area of differentiation is backward integration - Cell lines are complex with a defensible moat around cell efficiencies. Selling cells have higher margins than modules and also no “25-year” warranties.
One way to find defensibility in this sector is to judge the degree of backward integration + speed of execution of the management.
Hedge Funds - Event Driven, Long / Short
In the past quarter, I had some interesting conversations with hedge funds who were interested in trading on policy announcements + IPOs but also on near-term average sale price (ASP) movements and data on order backlogs. With more publicly traded companies joining this space, it will be interesting to see how institutions evaluate these stocks.
Opportunity
Finding, nurturing, and retaining talent is by far the biggest whitespace that everyone spoke of during the last quarter. The industry is growing fast and there is a need for good home-grown talent. This is across functions but more so in technical roles in applied research and manufacturing.
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Disclaimer: Views expressed are personal and not those of any organization that I am associated with.