Is Solar Power Still a Viable Investment?

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The extraordinary rally of solar panels manufacturers’ stocks including SunPower (NASDAQ: SPWR) and First Solar (NASDAQ: FSLR) have raised this industry’s profile in recent months. Will the staggering rise in shares of solar companies persist? Is it still a good idea to purchase these stocks?

During 2013 (year to date) shares of solar panel manufacturers spiked: SunPower’s stock sharply increased by more than 272%, First Solar’s shares by 47%. One contributing factor for these companies’ sharp rise in the stock market is their spike in revenues in the first quarter of 2013: First Solar revenue jumped by nearly 52% (year-over-year); net sales of SunPower rose sharply by more than 28.6%. On the other hand, not all solar manufacturers have done well in recent quarter: SunEdison (NYSE: SUNE) revenue fell by 14.6% in the first quarter of 2013 (year-over-year). Moreover, the company is still losing money. But this didn’t stop the company’s stock spiking by more than 154% during 2013.

Looking forward, will these companies continue to show a sharp rise in revenues? Are these companies' current valuations justified?

Is solar power a growing market?

The solar industry is growing fast. The current expectations are that solar usage will sharply rise in the coming years: The Energy Information Administration predicts U.S consumption of solar power will rise by 30% to reach 0.306 quadrillion Btu in 2013. In comparison, the total renewable consumption in the U.S is expected to rise by only 3% in 2013 (year-over-year). Moreover, solar energy consumption will rise the highest among all other renewable energy alternatives. The Solar Energy Industries Association also showed 33% growth in the installation of photovoltaic (PV) capacity in the U.S during the first quarter of 2013. This sharp rise is projected to persist.

Furthermore, the decision of U.S policymakers to cut down CO2 emissions by reducing the consumption of coal for solar is likely to keep the high growth rate of this industry in the coming years.

Thus, the industry is expected to sharply rise in 2013, which will be reflected by growth in the revenue of leading solar panel manufacturers. Will this translate to higher profits?

Panel price is falling

Despite the high growth in revenues, the price of panels continues to dwindle. According to the Solar Energy Industries Association the price of PV systems dropped by 24% in the first quarter of 2013 to $3.37/w (year over year). This fall in prices is reflected in the very low profit margins of the above-mentioned companies.

SunPower and SunEdison continue to present operating losses; First Solar, however, turned a profit in the first quarter of 2013. But the company’s current operating profit margin is only 7.8%.

Nonetheless, don’t be confused by First Solar’s low P/E, which currently stands at 9.5. You should consider a different calculation using First Solar’s enterprise value to determine its attractiveness as an investment.

The table below shows the valuation of First Solar, its EV to EBIT ratio, and the ratio of Environmental and Electrical Equipment markets – two markets that First Solar is related to. Even though First Solar’s P/E is low compared to the Environmental and Electrical Equipment markets averages, the company’s EV to EBIT ratio is 9.36, which is higher than these markets averages. This means the company’s current stock is more expensive than the market averages.

<img alt="" src="http://g.fool.com/editorial/images/54995/first-solar_large.jpg" />

Funding growth

The biggest problem with high investment costs and little to no profits is finding ways to maintain this growth with funding. For now, it seems that investors and bankers still believe in the solar industry. This could explain how SunEdison has recently received $100 million in loan from Wells Fargo to finance a 2.7 gigawatt project the company is developing. Nonetheless, the company’s very high debt-to-equity ratio of 5.31 could hold back SunEdison; the company might eventually have to raise equity in order to keep banks funding its projects. The situation for SunPower and First Solar is much better as their current debt-to-equity ratios are much lower at 0.8 and 0.15, respectively.

The bottom line

Even though the consumption of solar energy is likely to further rise in the coming months, this industry is still very competitive, which means margins are likely to remain very low. Therefore, I suspect companies such as SunPower and First Solar won’t be able to turn revenues into higher profits that will benefit investors over time.

For further Reading see:

Will Natural Gas Remain Low in 2013?

Why Coal Isn’t Going Anywhere

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Lior Cohen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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