Will the Sun Ever Set on Solar Energy Stocks?

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

Stocks of solar energy companies have delivered an outstanding performance over the past year. Just take a quick look at the chart for the Market Vectors Solar Energy ETF (KWT). 

<img alt="" src="http://app.quotemedia.com/quotetools/getChart?webmasterId=91022&snap=true&symbol=kwt&chscale=1y&chtype=AreaChart&chwid=284&chhig=150&chfill=ee0066CC&chfill2=110066CC&chln=0066CC&chmrg=0&chfrmon=false&chton=some" />

Since November 2012, the ETF jumped from $25 to around $50 today, a 100% gain in roughly eight months. That's quite a phenomenal performance. But the hidden gem belongs to a young company with a market cap of only $2.8 billion. SolarCity (NASDAQ: SCTY) first offered its shares to the public at the beginning of 2012 for a price-per-share of $9. It has since climbed to $50, only to retreat back to $38. That's an aggregate profit of 322% in a little over a year. Head to head with SolarCity are its rivals in the solar industry -- SunPower (NASDAQ: SPWR) and First Solar (NASDAQ: FSLR)

The core business

Some companies make money by producing electricity from solar resources and then selling it to third parties. It's a "utility- like" form of business. That's the core business of First Solar, for instance. According to the company's statements, its objective is to "reduce the cost of solar electricity to levels that compete on a non-subsidized basis with the price of retail electricity." But that's not the business SolarCity is in. SolarCity acts as a specialized financier. The company leases solar panels to homeowners on a 20-year contract, with no up-front cost to its customers.

The result is a predictable stream of lease payments to SolarCity, as the contracts mature and homeowners make monthly payments. It's like a bond that keeps paying interest on the capital invested. This business model is much safer than the former business model which entails heavy investments in infrastructure. I believe that under current conditions, it's very convenient to be a solar company, mainly due to the following two reasons. 

Factor #1: Less competition

In the last few years, a majority of solar energy companies have been fighting for their very survival with very few actually posting a profit. First Solar, for example, lost $40 million and $96 million in the years 2011 and 2012, respectively. That's why many people were questioning whether the company would survive in the long run. As a result, First Solar's market value fell from $27 billion to $4 billion based on these very worries.

The same holds true for SunPower, which lost a staggering $613 million and $352 million in the years 2011 and 2012, respectively. Many investors were heavily burnt in the process. But after a large number of solar energy companies went bankrupt in the last two quarters, there's simply fewer competitors, which means -- less competition for solar survivals to worry about. That's a cozy environment to make money in. 

Factor #2: Supportive legislation

Incentives for solar-panel installations are huge. Recently, the Obama administration issued permits for 10 gigawatts of renewable energy on public land, with the focus on a 200% increase in renewable energy generation by the year 2020. In addition, congress has also widened the 30% federal investment tax credit to residential and commercial solar installations up till 2016. As per the American Reinvestment and Recovery Act (ARRA), the U.S. Treasury Department had also adopted a program to give cash grants to make up for investment tax credit for renewable energy projects.

Substantial risks going forward

The industry, as a whole, is over-dependent on government subsidies. Without any help from the government, each and every solar company turns immediately into a money losing proposition. You should remember that this course of events can happen very quickly. In addition, prices have become hefty. Aside from First Solar, which trades at book value and at a P/E of only 9 times earnings, other rivals are pretty expensive. Investors are willing to pay almost 3 times book value for SunPower, and more than 15 times (!) book value for SolarCity. It seems that all the bright (and sunny) future has already been priced in. 

My Foolish conclusion

Hopes for a sunny future are always welcome, but they must be supported by solid fundamentals. In light of the fast and furious rise in the share prices of solar companies, and considering that the future of the solar industry is highly uncertain, I believe that you should wait for the industry to mature. This way, you'll know whether investors' lofty projections play out into the future or not. Invest accordingly. 

The best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.

Shmulik Karpf 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!

blog comments powered by Disqus