Thursday, November 19, 2009

The solar market and the 2nd-Derivative Paradox

How could equipment sales in an exponentially-growing market be anything but upward? It happens all the time. Welcome to the 2nd-Derivative Paradox. That's my name for the trap that one can fall into when it comes to capital equipment markets. Solar is a great example. It's hard to explain the paradox, though, so bear with me.

Start with installed capacity. If you are a power generator, you think in terms of the cumulative installed generating capacity in the world. This is what the users actually use. The figure shows three scenarios how that might play out, and they all look pretty much the same in this chart. Nice, steep slopes. Note how they all start at the same point and end up at the same point.

Then look at panel shipments. But the solar panel industry isn't interested in what's already out there. It needs to ship new panels every year. The shipments amount to a 1st derivative: the new capacity that's added to the infrastructure every year. Now the differences in the scenarios show through, as shown in the second figure. But the scenarios all show steep upward growth. What's to worry about?

Now look at panel manufacturing equipment. The solar manufacturing equipment industry, and that includes lasers--isn't even interested in solar shipments, but the need for more manufacturing capacity to make the panels. You only need more equipment when you are shipping more panels than before. That amounts to a 2nd derivative of the cumulative generating capacity, and can give wildly different results. New equipment is shipped in all three scenarios, but in the "sustaining" scenario the equipment shipments are flat year after year, while in the "slowing" scenario they start out strong, but then decline. Ouch.

Other traps. Of course we would all like to live in the "growing" scenario. The trouble is, strong positive exponential growth doesn't last indefinitely, no matter what they say. And that's not even considering some ups and downs along the way, like this year. A slight shift in the solar panel shipments wreaks total havoc for equipment shipments.

Other things that juice equipment sales. The same trap exists in other industries, too. But there are other details to consider. First, there is usually some churn in suppliers. Machines also get obsolete. And there is also the early obsolescence forced by things like Moore's Law. These all have to be considered.

Watch that 2nd derivative. Don't get me wrong. I love solar. I had a summer job at TI testing solar cells back in the Jimmy Carter era. We all believe it's going to be a great thing in coming decades. But it's not enough that the cumulative generating capacity will be on a steep upward slope for years to come, because when it comes to manufacturing equipment, it's the 2nd derivative that counts.

"There will be growth in the spring"

Our family recently watched the film classic "Being There" with Peter Sellers. It's the source of the phrase, "There will be growth in the spring." The character's proclamation arose from a misunderstanding, but was quickly seized on by politicians, the media, and a public weary of recession.

Modest growth, but better than none. Well, we've updated some numbers and in this recession, it really does look like there will be growth in the spring. Actually, it's happening right now in many segments, just modestly. In fact, the issue isn't whether there will be growth, but how much. We're talking growth around 10% for the most part, which is pretty modest on a quarterly basis. Stronger growth in sectors like semiconductor fab tools and telecom network equipment.

Forecasting is harder than it looks. You might think that predicting growth in 2010 is about as simple-minded as the character's observations in the film. Far from it. I cringe at so-called futurists who paint dramatic pictures of the future, without giving some near-term due dates or without working through some fairly obvious contradictions. Likewise for cheerleaders who think that the recession can be just wished away. (See one of my blog entries in April about this form of Coueism, here.)

Quarterly trends help. Our forecast is based on quarterly trends among key suppliers and customers in leading product sectors. With visibility within the supply chain barely better than at the beginning of this recession, every segment must be evaluated carefully with respect to what's possible. A strong comeback in telecom systems next year? Quite possible. A strong comeback in heavy manufacturing? Not likely at all. Modest growth? Possibly. (See for example comments from Fabtech from my colleague, David Belforte.)

Some context. To add some context, it now looks as if the stock market bottomed in March 2009, the GDP bottomed this fall, net employment will start increasing in 2010, and outstanding home foreclosures will start declining in 2011. You can't point to one thing and say "that's when the economy turned around." It's more complicated than that.

We will leak out more details as it firms up. Stay tuned. And remember, "there will be growth in the spring."

Tuesday, November 17, 2009

Who's ahead in photonics stocks

In the last post, I noted that some photonics stocks have done nicely in 2009 following the crash one year ago. My very cursory examinations suggests that a few companies in the LED space are doing very nicely indeed. Other are making good progress toward their 2007 and 2008 levels, even if there is a way to go.

Why it matters. A rising stock market is a sign that investors think that earnings (that is, profits) will rise over coming years. It also makes all those pesky owners happy so that layoffs will stop and staff can breathe easier. And sometimes the employee is one of those owners (or has an option to become one). So, a rising stock price is usually good news, provided you remember that it is a secondary market, something of a beauty contest. Not being a Wall Street financial analyst type, I generally stay away from following stock prices, but sometimes it's illuminating.

High fliers. One of the stars right now is Cree, the LED supplier. Its stock price has tripled from its low, and is well above its 2008 peak. Aixtron is even better, at about 6X above its low, and double its 2008 peak. Cymer has doubled to recover to its 2007 level. I think it's safe to say these stocks are ahead of the overall market average, although it depends on where you start counting.

Holding their own. Others are holding their own against the NASDAQ average. Omnivision is up about 3-4X from its low, more or less in its earlier territory. Coherent has approximately doubled, getting closer to its usual territory. FLIR hasn't reached its all-time peak, but it's back to some of its 2008 level. IPG is getting there.

In the dog house. Some companies seem to be in a long U-shaped recession, well below the overall stock market. Rofin is deep into manufacturing, where the stock market doesn't expect good earnings for a while. Telecom system vendors like Alcatel-Lucent, Ciena, and Infinera are also well below the NASDAQ average for the period. Especially Infinera.

What about P/E ratios? High prices are nice, but what about the P/E ratio? That would say something about the kind of stock bargains that are out there. Here the news isn't so good. High-flying Cree is at 94 today. Cymer is near 300, Rofin at 75. But this is hardly fair, since these companies actually have positive earnings even now, and while many others don't. More down-to-earth, by the way, is FLIR, at a P/E ratio of 20.

I couldn't post the Yahoo graphs into this blog, but you can run the charts yourself here.

Monday, November 16, 2009

The photonics market, one year later

Do you believe the stock market, GDP, or unemployment figures? Are we in a recovery, or still in recession? V-shaped, W-shaped, or U-shaped? As we do our annual survey and forecast for Laser Focus World magazine and the upcoming Marketplace Seminar, a lot of this gets mixed up. There will be more to come later, but here are some early thoughts.

Many public photonics companies have seen great stock returns. The stock market looks at future earnings--that is, profits--regardless of jobs or where the jobs are. A rising market says that investors think the future is good, and it's good for employee stock options and so forth. Some photonics stocks have shot way up, well beyond the average. LED companies in particular. Even those that haven't are seeing a bounce off the bottom, suggesting that it won't get worse. Stay tuned to this blog for more on this.

Small photonics companies span the spectrum. The stock market doesn't say anything about small businesses, but there are far more small, private photonics companies than public ones. I love these companies because many are much more profitable than their more visible brethren. For example, think of suppliers for military contracts, medical systems, and so forth. But, small businesses have very little wiggle room in a recession like this. California public radio explained it well in a piece today, using the example of a maker of tortilla-making equipment that sells for up to $3 million. It has gone from 55 employees to 9, and still has problems getting credit a year into the crisis.

Large capital equipment to make large capital equipment is hit hardest. The radio piece highlights a point I've been making, that the recession will be especially long for companies that make large capital equipment, and especially large capital equipment that makes large capital equipment. So for example, the market for welding systems for making cars is likely to be slow for another year or two, while the LED market will jump ahead next year.

Use economic indicators with caution. Use economic indicators with caution. One tool for forecasting is to look at economic indicators. Of course, they are complicated, but they can be very useful. But you do need to understand some of the limitations of the indicators, though. For example, Joe Webb points out in his blog article for the print industry how leading indicators often get it wrong. The blog piece is appropriately titled, "Beware the Cheerleaders."

Even as we all bask in the news that the economy grew last quarter, economists are working to correct errors that likely overstate the value of GDP growth. When goods and services are moved offshore, the total value may be counted in the current accounts, but it may not be allocated correctly to specific industries. It's as if you compare two companies that manufacture in China: one outsources it while the other operates it itself. The productivity of the former would look better than the latter if you don't count the outsourced labor.

A similar issue arises when you look at the trade deficit but not the entire current accounts, or for that matter, capital accounts. So what if iPhones are made in China? China adds only a few percent of the value, Japan adds much more, but the U.S. captures as much as 50% of the retail value. Yet, it looks as if it is imported from China so the other contributions are lost in our trade statistics. It should wash out in China's numbers, but not all of it will wash out in the U.S. numbers. But that is part of a very large topic, better saved for another time.