Do Solar Stocks Deserve a Place in Your Portfolio?

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

While solar technology was once confined to pipe dreams and college kit car races, technological advances and government mandates have moved the solar business into the mainstream.  Consumer demand generated by healthy tax credits has allowed companies to gain manufacturing efficiencies and lower unit costs, helping to move the industry closer to parity with fossil fuels.  Even the utility sector has finally taken notice, as giants like NRG Energy, Exelon, and Berkshire Hathaway’s MidAmerican subsidiary are investing billions in solar plants.  Despite profit challenges for the industry, renewable energy is here to stay.  So, how does an investor play this sector?

Go with a leader

SunPower (NASDAQ: SPWR) would be a good choice, as it has been a pioneer in the solar business with silicon-based solar cells that lead the industry in efficiency.  The company has a strong position in the residential segment, but has been making a push into large commercial projects, including California’s massive Antelope Valley Solar Project.  SunPower has also pushed economies of vertical integration through its joint ventures in the silicon production and wafer processing areas.

SunPower had trouble gaining sales momentum in FY2012, with total revenue up 1.8%, as growth in its Americas and Asia-Pacific regions was offset by very weak performance in its European region.  Despite delivering 13% more solar products than in the previous year, based on electricity generating capacity, the company's product prices continued to decline due to excess inventories around the world.  In addition, some countries have downwardly revised their subsidies to the industry, especially members of the European Union.

Regardless of the industry’s current supply-demand imbalance, SunPower is thinking long term and is working to complete its plant in Mexico, which will add 12 assembly lines and nearly double its annual capacity.  Given lower expected future prices for solar products, the company needs to gain greater scale in order to reach its profit breakeven level.  Fortunately, SunPower has a strong ally in majority shareholder Total S.A., which provides crucial capital and a global network of contacts.

Another good choice would be First Solar (NASDAQ: FSLR), the world’s largest producer of thin film-based solar products.  Despite a slight overall disadvantage to silicon technology in sunlight conversion efficiency, thin film products perform better in high temperature, sunny climates that figure prominently in utility companies’ future capital plans.  More importantly, First Solar’s technology allows it to avoid the high costs of the silicon supply chain, leading to a higher gross margin across business cycles.

Despite the industry supply glut, First Solar outperformed its smaller competitor in FY2012, due to its focus on large projects in the North American market.  For the period, the company reported increases in revenues and adjusted operating income of 21.8% and 12.1%, respectively, compared to the prior year.  While First Solar’s gross margin slipped sharply, due to industry pricing pressures, the company delivered costs savings in its overhead that allowed it to maintain solid cash flow.  Looking ahead, First Solar is hoping to duplicate its North American success in international markets, as it pursues growth in countries with strong renewable mandates.

Or look downstream

Alternatively, investors could look at companies that are managing solar systems for small and mid-sized businesses, providing renewable energy without the upfront capital costs.  One intriguing possibility is SunEdison (NYSE: SUNE), which is building strong market share in the development and management of small scale solar projects that are leased to customers for lengthy periods, usually over twenty years.  The company is also a leading global provider of silicon wafers, primarily to the semiconductor industry, which provides a competitive cost advantage in its solar manufacturing operations.

In its latest fiscal year, SunEdison reported generally improved financial results, as the positive effects from its 2011 restructuring plan began to flow through to the bottom line.  While the company’s overall revenues showed a 6.8% decline, due to continued weakness in the semiconductor industry, SunEdison delivered a 73% increase in solar products that helped to deliver an operating profit for its solar segment.  The company is also building a long term recurring revenue and profit stream, due to its strategic decision to lease rather than sell most of its completed solar products.  As long as the company’s financing costs remain manageable, it should be able to ramp up its mini-utility business for the foreseeable future.

The bottom line

The Solar Energy Industries Association is forecasting strong growth in solar facility construction, with 4.4 billion gW coming on line in 2013.  While the industry will go through its share of growing pains, investors need to make the sector part of their portfolio.  For my money, SunEdison’s recurring business model make it the one to watch.

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Robert Hanley owns shares of SunEdison. 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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