What’s wrong with solar stocks? Nothing, per se. The sector continues to grow, costs continue dropping across the board, and more locations are passing through grid parity or convergence, the point at which the price of solar electricity falls below that of energy from your local power company.
Still, it’s still easy to get burned here, so let’s take a look at what’s happening.
Big Trouble, Big China
The chief problem with the sector is China.
China is the dominant supplier, and most of the big solar players are Chinese. But these companies have been hammering one another in their struggle for dominance, and as a result they’re losing money. Companies like LDK Solar Co., Ltd (ADR) (NYSE:LDK) and Yingli Green Energy Hold. Co. Ltd. (ADR) (NYSE:YGE) are short-term losers, even if they’re long-term winners. They’re focused on driving under companies like Suntech Power Holdings Co., Ltd. (ADR) (NYSE:STP), which is fighting to pay back its debt and may well fail.
Suntech, by the way, is at the heart of one of the most misleading stories I’ve seen in some time. They are closing a factory near Phoenix as part of their survival effort. This is natural because costs remain higher here for a variety of reasons. That, and a continuing trade war over panels between subsidized Chinese companies and unsubsidized western countries, has reporters questioning the future of the whole solar sector.
Be assured — that sector is bright.
Buy Those Who Can Sell
The size of the Chinese players — nearly all of whom use the same polysilicon technology, combined with their dog-eat-dog competition — have driven down the industry’s indexes and its ETFs. China’s problems will work themselves out as that country scales up its own demand. But you don’t have to wait for demand to equal supply in order to make money.
The best places to play are among companies that can generate their own demand, that control their sales channel, either through inexpensive financing of small projects or an ability to sell utility-sized projects.
After bottoming-out over the summer, First Solar, Inc. (NASDAQ:FSLR) has recovered nicely, and now stands at roughly the same price it had a year ago. The Suntech problems caused a recent dip in the price, making it even more attractive.
First Solar, Inc. (NASDAQ:FSLR) makes its panels from what’s called cadmium telluride, byproducts of other mining processes, so it has some control over front-end costs. It has a big factory in Malaysia, so it has some control over labor costs. More important, it has proven itself adept as a solar developer, producing a number of utility-sized projects that it sells to power companies, including Mid-American, part of Berkshire Hathaway Inc. (NYSE:BRK.A). When you have control of both your costs and the downstream sales, you have a functioning business model.
The sector’s biggest winner has been SolarCity Corp (NASDAQ:SCTY), which is in the business of selling and financing small residential and commercial solar projects. SolarCity Corp (NASDAQ:SCTY) doesn’t make panels. It buys them, installs them, and finances the installations. It has salesmen who know how to create deals, and the deals it does is profitable. Just since its IPO last year, SolarCity Corp (NASDAQ:SCTY) is up nearly 40%, even with a recent pull-back. You can expect other, similar deals to come to IPO later this year, given this success.
A Final Warning
But beware. While you want to be on the selling side right now, the situation will shift as grid parity drives real demand. Margins are bound to decrease as a result of grid parity, just as they did in the computer industry 35 years ago when the PC emerged, and a mass market developed.
So while the profits of SolarCity Corp (NASDAQ:SCTY) may seem attractive, you want to be in companies like First Solar, Inc. (NASDAQ:FSLR). And be alert to new IPOs, based on newer, lower-cost technology. It’s not yet certain that materials like cadmium telluride will triumph in this sector, and you want to be in the newer, cheaper stuff as soon as you can.
Drive down the cost curve with solar and you will do OK.
The article A Foolish Take on Solar originally appeared on Fool.com and is written by Dana Blankenhorn.
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