The Solar Power Equipment Market
Opportunities and Risks for Asset-Based Lenders
Date may 2013
Featured in The Secured Lender
Despite some perception of the volatility of technology industries, including solar, asset-based lenders can find compelling opportunities today to lend against solar and other technology equipment and inventory as a means of diversifying loan portfolios and capitalizing on an under-recognized growth story. Selective, disciplined lenders can identify strong potential borrowers in the technology sector and specifically within the solar market by understanding the industry and where the opportunities - and risks - can be found.
In recent years, solar energy and its attendant equipment market have taken a beating in the realm of popular perception due to some highly-publicized failures (e.g., Solyndra), ongoing downward pressure on component prices and corresponding declines in revenue. With low-cost manufacturers in China and elsewhere contributing to a global oversupply of one of the key components of photovoltaic power systems – panels – Western manufacturers have found the current environment challenging to say the least.
A look at ongoing adoption and new installation data, however, reveals that the domestic U.S. solar energy industry continues to grow. New adopters continue to enter the solar market as a result of innovative financing methods, declining system costs, and the compelling value proposition of solar energy itself, resulting in sustained increases in capacity installation in each of the three major market segments (residential, commercial and utility-grade) over the last three years. Industry analysts expect this trend to continue over the next several years, as well.
For asset-based lenders seeking to diversify their loan portfolios and tap into an under-recognized domestic growth story, attractive opportunities exist to deploy capital in the market for solar power equipment. Given current pricing and competitive trends in this sector, however, ABLs will need a thoughtful strategy, in-depth understanding of the industry, and experienced partners who understand the inventory and equipment within this market in order to be successful.
Solar Power Equipment: An Underrecognized Opportunity for Asset-Based Lenders
End users in every segment of the U.S. energy market – residential, commercial and utility – continue to recognize the compelling value proposition of solar power. According to the Solar Energy Industries Association (SEIA), domestic solar installations more than doubled in 2010 versus 2009, then doubled again in 2011. New U.S. installations through the first three quarters of 2012 surpassed all capacity installations for 2011, while the 684 megawatts of capacity installed in Q3 2012 represented a 44% year-over-year increase in deployment versus the third quarter of 2011.
SEIA predicts continued growth in U.S. installations over the next few years, as well, with total capacity expected to reach 8 gigawatts in 2016, up from approximately 3.2 gigawatts at the end of 2012.
This exceptional growth story is not without challenges, though. Low-cost manufacturers in China and elsewhere have contributed to an oversupply of solar panels, the more commoditized of the two principal components of a solar power system. (We provide an overview of a typical solar installation and the two types of equipment that comprise a system – panels and inverters – below.) The resulting pricing pressure from overseas manufacturers has created a difficult competitive environment for domestic makers of solar power equipment. Although the U.S. Department of Commerce imposed a series of anti-dumping and anti-subsidy tariffs on Chinese panel manufacturers in May 2012, these measures have had limited real impact, indicating that some amount of price compression is likely to continue.
Solar Power Equipment: Two Connected – Yet Distinct – Asset Markets
Solar power installations are broadly comprised of two principal types of equipment – panels and inverters – with interrelated but distinct market dynamics around each. To help make sense of these distinct markets and their implications for lenders, a brief primer on solar power systems is in order.
Solar Power System Primer: A typical residential solar energy installation consists of a number of southward-facing, rack-mounted and interconnected solar panels located on the user’s roof. The number of panels depends on the customer’s power usage. As a result of tiered rate structures, systems are built to generate roughly 75% of the homeowner’s power usage to maximize return.
The panel assembly connects to an inverter, which converts the panels’ variable direct current output into a utility frequency alternating current that can then be fed into the local power grid or used in an off-grid network. Users can choose between roof-mounted micro-inverters, which enable any panels not affected by shade to continue to function at full capacity, or string inverters, which decrease the output of the system when shade is introduced.
The residential system ties into the local power grid in conjunction with the user’s power meter. During daylight hours, the meter moves backward, generating credits from the local utility which can then be consumed at night. This benefit to solar users is referred to as “net metering.”
Commercial and utility-grade installations function in much the same way as the residential system described above, but employ higher-capacity equipment with a greater degree of customization and/or specialization.
Panels and inverters require very different levels of technical expertise to manufacture, and are therefore subject to distinct competitive factors. For asset-based lenders, this means that the markets for panels and inverters exhibit crucial distinctions in valuation and volatility.
Panels: Pricing and collateral values for solar panels are typically much more volatile than pricing for inverters. In recent years, panels have seen instances of significant single-year price declines, while price compression in the segment overall has been much more rapid. With panels’ relatively straightforward production process and minimal technical requirements, low-cost manufacturers in China and elsewhere have entered this market in large numbers, leading to oversupply and driving prices down. Recently, however, panel prices have fallen at a slower rate, with price reductions in 2012 below those in 2011, and some signs of potential price stabilization in 2013.
While asset-based lenders looking to develop a presence in the solar power equipment segment may find attractive opportunities to lend against inventories of panels, we recommend frequent re-assessments of inventory values – ideally at least once per quarter – to safeguard against the potential effects of ongoing price compression.
Inverters: Thanks to greater technical demands in the production process, barriers to entry in the market for inverters are much higher than in the market for panels. While inverters have also experienced price compression in recent years, declines in this market have tended to be gradual and stable, leading to less volatility in collateral values for asset-based lenders.
In assessing opportunities to lend against inventories of inverters, asset-based lenders should be aware that collateral values will depend upon the end market for which the equipment was manufactured. In general, inverters for residential installations tend to retain the strongest prospects for resale in a liquidation scenario, due to the ongoing growth of the residential market and the corresponding prevalence of installers for the equipment nationwide.
Collateral values for commercial inverters tend to be significantly lower, as demand in this segment may be more limited, and the equipment more specialized. For utility-grade inverters, caution is required as demand may be even more limited due to the high degree of customization and / or specialization typically required by end customers in the utility industry; accordingly, fewer potential buyers may be available for existing utility-grade equipment in a liquidation scenario.
According to representatives of top inverter vendors, annual price reductions of inverters are expected to continue in the 5% range, with only incremental gains in efficiency. Competition among the major inverter manufactures is largely driven by their ability to reduce manufacturing costs to deliver a cheaper system, and innovation in new products such as transformerless inverters and microinverters.
Additional Considerations for a Complex Market
Beyond the market dynamics noted above for panels and inverters, a number of other factors may impact collateral valuations in the sector. Asset-based lenders seeking to develop a presence in this space may wish to consider working with an experienced valuation partner that understands and has visibility into each of the factors below as they formulate and execute their strategy for navigating this market.
Ongoing Shifts in Domestic and Global Markets for Solar Power: Lenders should be closely attuned to signs of shifting demand in the U.S. residential, commercial and utility markets, including changes by geographic region. In addition, changes in the global competitive landscape – including, for example, significant entry by Asian manufacturers into the inverter segment of the market – could have substantial impacts on equipment values and necessitate adjustments in lenders’ strategies.
Policy Impacts: Certain federal policy measures have played a key role in shaping the domestic market for solar power equipment in recent years. The U.S. Treasury’s 1603 Grant program, for example, created an incentive to solar energy companies by providing cash grants of up to 30% of project costs that includes equipment purchased through this program prior to the end of 2011, as opposed to the tax credits that had previously been available. This program led to a number of companies taking significant positions in solar inventory, leading to a spike in sales of both panels and inverters. By blending Treasury Grant inventory with non-qualified inventory, solar installers continue to deploy this inventory and enjoy the benefit of the cash grants. The expiration of this program did not lead to oversupply, but did temporarily reduce demand on key solar components. Asset-based lenders should be aware of the potential impacts of similar legislation on inventory values in the future.
Collateral Eligibility: Certain SKUs within a borrower’s inventory may not be eligible to function as collateral in an asset-based lending structure. As many solar equipment manufacturers are based in Asia, for example, significant amounts of inventory may be in transit at any given time, or may be located offsite or otherwise unavailable for resale in a timely manner in a liquidation scenario. Lenders should also be aware that ancillary equipment such as cabling and racks may return substantially reduced values in liquidation.
Contrary to recent popular perception, solar power has continued to experience strong domestic installation rates in recent years, with ongoing growth in the attendant markets for its component equipment, as well. While industry analysts expect to see a continuation of this momentum in the years ahead, the proliferation of low-cost producers in China and elsewhere and the resultant excess supply of global panel inventory, among other factors, will mean that asset-based lenders hoping to capitalize on the solar power industry’s positive trajectory will be well-served to keep a lookout for potential risks as well as opportunities.
Despite the challenges, we believe that savvy asset-based lenders with deep industry knowledge, strong diligence capabilities and an experienced partner will continue to find compelling prospects to diversify their loan portfolios and participate in an exceptional growth story by developing a presence in the market for solar power inventory and equipment.