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The bearish decline in solar energy stocks that began in 2011 was broken in the last two months. Solar energy stocks broke up to the upside after MidAmerican Energy, a unit of Berkshire Hathaway (NYSE:BRK.A), said it was paying nearly $2.5 billion for solar projects from SunPower (NASDAQ:SPWR). The Antelope Valley Solar Projects ("AVSP") is 579-megawatts and will create around 650 jobs when the solar photovoltaic power development is constructed.

Construction will begin in the first quarter of 2013, and will be completed by the end of the year in 2015. The impact of Berkshire's purchase to solar energy stocks was immediate. For the trading week, the sector was helped by the fiscal cliff resolution: Trina Solar (NYSE:TSL) rose over 18%, SunPower rose 56%, LDK Solar (NYSE:LDK) rose 60%, and Yingli Green Energy (NYSE:YGE) rose 20%. First Solar (NASDAQ:FSLR), recently reviewed when shares were around $26, rose 12% and traded recently at $33.57.

Is it time yet to invest in solar energy? The purpose of this article is to analyze two drivers required for the solar energy sector to improve: (1) Excess inventory and capacity, and (2) demand.

  1. Excess Inventory and Capacity

The solar sector remains weighed down negatively by excess capacity and inventories from China. The State Council recently said it wants to reform the industry by encouraging firms to merge. In addition, weak firms need to go bankrupt. Without bankruptcies and mergers, oversupply will continue into 2014. Firms like First Solar will still operate normally despite the oversupply, since the company relies on grid-connected utility scale markets for sustained sales. SunPower is also more likely to survive after the deal with Berkshire's unit.

Last fiscal year, debt reached the highest level for SunPower:

12/31/2008

12/31/2009

12/31/2010

12/31/2011

Long Term Debt

54.59

237.7

50

355

Values in millions USD
Data Source: kapitall.com

After shares doubled, LDK Solar shares could drop again as speculators take profits. The company has a bigger debt problem than that of SunPower. LDK doubled its debt to $1.23 billion in fiscal 2011, compared to the previous year.

Below is a chart illustrating the debt ratio for SunPower, First Solar, Yingli, Trina, and LDK Solar:

(click to enlarge)

Data Source: Kapitall.com

Trina Solar has the greatest risk, as excess capacity remains in the industry. In its last fiscal year, Trina's inventory levels rose to $249.77 million, up from $79.12 the year before.

  1. Demand

In the past, demand was driven by subsidies around the world. With these subsidies cancelled, solar energy demand will depend on China. The sector rallied in November 2012 when Reuters reported that domestic sales in China would support growth. Domestic demand will need generous subsidies from the Chinese government. This expectation was already priced in stocks at the start of last year in January, 2012.

Below is a chart illustrating the quarterly sales for SunPower, First Solar, Yingli, Trina, and LDK Solar:

(click to enlarge)

Conclusion

Solar energy stocks are likely close to a bottom for companies like First Solar and SunPower, but investors should not expect Trina or LDK shares to hold all of their gains. Investors should expect profit taking in the short-term. Excess capacity and high inventories remain a problem, which will make it difficult for the weaker players. Rising demand in 2013 will depend on more government subsidies.

China already doubled its solar subsidies in December 2012. This acted as the first catalyst for a rebound. China would benefit most from improving demand, so investors should expect the region to add subsidies again to help the domestic industry in the medium-term. If this happens, solar energy stocks could jump again.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: 2 Worries That Remain After The Solar Energy Rally