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The hidden forex risks of investing in solar stocks

February 8th, 2011 · 1 Comment

From Forextrader.com for Shareholdersunite

Investing in Domestic Solar Technology Firms May Involve Forex Risk

As the price for a barrel of oil begins to threaten the $100 figure once again, the demand for renewable energy companies strengthens as the potential for attractive margins returns to this industry sector. Solar panels and related battery storage technology have literally been the “hot spots” in the renewables space, but these mid-size firms need not only be fleet of foot in their engineering resources, but also must have competencies that pertain to dealing in the global marketplace. Components may come from all over the world, necessitating a network of international purchasing professionals, and buyers will most likely be spread out across the planet as well, especially in Germany, the largest buyer of solar products at present.

Since supply chain items and finished goods deliveries will naturally traverse several national boundaries, the issue of foreign exchange risk must be dealt with at each stage in the manufacturing and selling process. These forex risks are typically addressed with internal hedging strategies that use a variety of selected derivatives offered by only a small group of forex brokers. Treasury professionals work with these brokers or through their bankers to mitigate known currency exposures, and the result of their efforts are typically disclosed in the footnotes of the firm’s financial statements in their respective annual reports.

The concern for investors is whether the targeted company has acknowledged the forex risks related to his supply and distribution channels and put a process in place to deal effectively with them over time. China, at present, is the global market share leader in solar panel production. The source for many components may necessarily be from Chinese or Asian producers. In many cases, these firms will be willing to contract in U.S. Dollars since their national currencies are pegged to the greenback to some degree. Forwards and forex options are generally the hedging instruments of choice if the contracts cannot be fixed in Dollars.

On the distribution side, if customers are all domestic, then forex risk is non-existent. If a material portion of sales is international, however, than those cash flows need to be estimated and sourced by currency. If hedging is warranted, then similar processes that handled purchasing risks can be deployed.

Typically, corporate hedging is a “netting” process where expenses and revenues reduce the forex exposure to a “net” figure. The issue for solar firms, however, is that supply and distribution points will not necessarily be within the same subset of countries. The “netting” process will not naturally reduce forex exposures as with foreign subsidiaries. More attention will be required to reduce the impact of adverse currency movements on earnings.

If investors choose to invest in a solar technology ETF, or exchange-traded fund, then the portfolio may also include many global entities, each one attempting to moderate its own respective forex risk exposures. If the shares are exchanged in a “USD” market, then the risk will be handled directly by the fund managers based on the guidelines disclosed within their prospectus. In these situations, diversification helps to minimize overall risk, but if the Dollar strengthens over the holding period, it may diminish a portion of the funds return. Some ETFs have attempted to hedge these risk concerns, but results have been mixed.

Investing today does require more due diligence than in the past. The era of globalization is upon us. National borders are dissolving as “barriers to entry” for commerce for small to medium-sized companies. As with any new opportunity, there are new risks to consider, and foreign exchange management is one of these new risks to consider.

Tags: Alternative energy · currencies

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