Beware of Following Warren Buffett into This Sector

You're Crazy to Follow Warren Buffett into This Sector

By Larsen Kusick, analyst, Phase 1 Investor

Monday, December 12, 2011

"Buffett Makes a Big Bet on Solar."

That headline and similar ones were splashed all over the papers last week. The stories reported MidAmerican Energy's $2 billion purchase of a California solar plant. MidAmerican is part of Berkshire Hathaway, the giant conglomerate run by legendary investor Warren Buffett.

The news sent "green energy" advocates into a frenzy. Many reporters called the deal a "vote of confidence" in the solar industry.
Green energy firms have been losing investments for years… But are the recent articles onto something? Is the time finally right for buying solar?

No.

It's true that Buffett got a great deal… MidAmerican agreed to buy a solar farm that just started construction. Because it got going before the end of the year, it will qualify for massive tax credits, worth about $600 million.

And even though the plant won't be up and running for another three years, a buying agreement is already in place. Spurred by California's requirement that utilities get a portion of their electricity from renewable sources, a big California firm signed a 25-year contract that will pay MidAmerican between two and four times today's going rate for electricity.

It's not hard to see why MidAmerican would be happy to get involved, with the government stacking the debt in this deal's favor, but solar stock investors don't have a prayer of repeating it.

The long-term problem with solar as a business is that it's still far from being economic. That's because solar panels aren't efficient when it comes to converting the sun's energy into power. Even the most technologically-advanced panels can only convert 25%. And then there's the whole "night" problem…

Solar power is more expensive to produce than every other type of power. According to the U.S. Energy Information Administration, solar power costs about $0.21 per kilowatt hour. (That's the unit for electricity use that appears on your electric bill.) Natural gas and coal cost 6.5 cents and 9.5 cents per kWh, respectively.

So buying a solar stock is like buying a gas station that sells its product for $12 a gallon… right down the street from another guy who's selling it at the market.

Until recently, the stupidity of that business model might not have been clear. Governments around the world have been pouring billions of taxpayer dollars into subsidizing the solar industry, though it's tough to quantify exactly how much.

Take the situation with private solar company Solyndra, for example. A few months ago, it went bankrupt. Solyndra had a $535 million loan guarantee from the U.S. government. Now that the company has failed, taxpayers are on the hook for that sum.

The U.S. Treasury and FBI are currently investigating Solyndra to find out if there was wrongdoing. What we do know is it was a bad business that existed because of the government's willingness to hand it money.

But these days, every developed nation is talking about the need for cuts in government spending. Italy, for example, has cut its solar subsidies in half over the past 18 months. Germany has been slowly lowering its solar subsidies for years. And in October, German Chancellor Angela Merkel called for further cuts.

Adding to solar firms' troubles, prices for solar panels have been in a tailspin for years now.

At the height of the "solar craze" in 2008, First Solar – one of the biggest names in the sector – had a gross profit of over 54% on sales of its products. That means for every $1 in revenue, it only spent $0.46. Today, profitability is collapsing. In the most recent two quarters, First Solar's gross profit fell to 37%.

That number is expected to fall below 35% in 2012. And I expect it'll keep dropping from there.

In short, solar is one of the world's worst industries for investment. And while Warren Buffett might be able to get sweetheart government deals in the sector, you're not going to be able to do the same. The mainstream hype is crazy… And investors should steer clear.

Good investing,

Larsen