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Solar stocks: Ride the heat wave?

There may still be opportunities in the solar industry, which roughly doubled in 2013.

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After a rough couple years, solar stocks bounced back in a big way during 2013. Companies like Canadian Solar Inc. (CSIQ), SunPower Corporation (SPWR), JinkoSolar Holding Co., Ltd. (JKS), SolarCity Corporation (SCTY), and Amtech Systems, Inc. (ASYS) were top performers.

After the big rally, is there still money to be made in solar stocks? Possibly. Downstream installers and developers of solar projects, for one, might be worth exploring.

Cold front gives way to solar storm

Solar has long been touted as one of the most viable alternative energy sources. Yet the industry still depends greatly on federal support. After the financial crisis, several governments—facing dwindling tax receipts—chose to pull back on tax credits and subsidies for the solar industry. Expiring federal subsidies, particularly in Europe (e.g., Germany, Spain, and Italy), played a big role in the 2011 and 2012 solar stock cool-down.

2013 was a completely different story for solar stocks. Guggenheim Solar ETF (TAN) surged 135% last year as several forces came together to give a huge jolt to this group. Among them:

  • Less supply. Inventory capacity has been reduced dramatically, helping solar panel producer prices firm a bit. “We went through a massive oversupply and inventory buildup over the past two years,” says Anna Davydova, manager of the Fidelity Select Environment and Alternative Energy Portfolio (FSLEX). Consequently, prices found a bottom near a cash cost level that seems to have resulted in more rational behavior among solar suppliers. “In my view, the market appears to be in balance, for now, with supply roughly matching demand at the current price levels,” Davydova notes.
  • More demand. New end markets opened up for solar companies, due in large part to stronger subsidy programs (e.g., Japan and China); solar becoming more competitive in the energy marketplace; and meeting the needs for apparently underserved and unreliably supplied markets (e.g., India).
  • Dialed-down competition. The field narrowed, with several firms going out of business. Despite receiving significant support from the Chinese government, several Chinese solar players declared bankruptcy in 2013.
  • Bounce-back from low prices. Given that solar stocks had plummeted so far from their peaks in 2007 and 2008 to relative troughs in 2012, value buyers might have been responsible for some of last year’s exemplary performance.

Will solar stocks stay hot?

Even though the market has cooled a bit in 2014, solar stocks haven’t slowed down; TAN has risen nearly 14% as of mid-February 2014. However, solar companies might need a couple of things to happen in order to maintain their momentum.

What is polysilicon?

One of the key components of solar panel technology is polycrystalline silicon, commonly referred to as polysilicon. This raw material consists of small silicon crystals that, when manufactured into silicon-based solar panels, helps convert sunlight into energy.

Perhaps the most important of these is the sustained governmental support of the solar industry. Also of critical ongoing importance is the reduction of manufacturing costs per watt. This will help solar firms support margins and drive demand by bringing prices into a range that consumers are broadly willing to pay. Part of this cost management for some solar firms revolves around polysilicon prices (see the sidebar).

“Polysilicon prices have actually been on the rise recently, after bottoming near cash cost early last year, and have risen about twenty percent since then,” Davydova notes. However, she doesn’t think they will rise much further. Higher prices tend to result in more supply, which has an adverse impact on polysilicon-based solar panel manufacturers.

What to watch

Look for the innovators. The solar industry has some way to go, in terms of energy production efficiency, to more effectively compete with fossil fuels and other alternative energy sources. For example, solar investors might want to keep an eye on natural gas and coal prices. Quite obviously, consumers will gravitate toward lower prices—and lower fossil fuel prices generally reduce the incentive to convert to solar power.

Inventory levels for photovoltaic cells are worth monitoring as well. While an oversupply can lower prices and make it more attractive for consumers to go with solar, it can also hurt margins for solar companies, potentially causing stocks in this group to power down.

“I think we’re in a stabilization and improvement stage within the solar market, for now, but keep in mind that this industry still depends heavily on government subsidies and tends to be very volatile,” Davydova says. “In my opinion, downstream installers and solar project developers have a more differentiated and defensible business model at this point, and, thus, higher growth potential.”

A few of the top-performing solar stocks from last year are among those with downstream exposure, including SolarCitySunEdison (SUN) and First Solar, Inc. (FSLR).

Learn more

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