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The solar industry has taken it on the chin, for good reason if you ask me, in the last 8 months or so. Lately however, I feel that there is something to look at here, with possible best of breed companies working through the malaise to offer tempting prices for those with long term investing horizons.

Specifically, I’ll be looking at several companies that seem strong, even in the face of a decline in demand, eroding margins, and financing difficulties that are making large scale solar projects harder to implement.

What Went Wrong?

Here’s a very brief rundown of the problems that have befallen the entire solar industry for about the last year or so that have caused the stocks of companies in this market to plunge:

  • Increased Supply: It’s no secret that everyone and their mom started a solar company within the last 3-5 years, with the last 2 years showing incredible venture capital being pumped into the sector.

As a result, solar panel manufacturers of all types, from thin film to standard rooftop panel producers, have flooded the market with more and more product. I don’t have to tell you what this does to prices.

  • Increased Supply 2: In addition, more and more polysilicon, the building block of most of these panels, went from being in short supply, to being overabundant within the last year or so as more companies are opening shop in the polysilicon business, as well as existing manufacturers putting out more and more of the raw material.

Spot prices for polysilicon have dropped to around $100 a kilogram after soaring to $500 a kg last year.

One of the companies in this space is MEMC Electronic Materials (NYSE: WFR), which has seen incredible demand erosion, as well as margin contraction because of lower spot silicon prices.

  • No Financing: The increased supply mentioned above was not a problem so long as all of that supply was being eaten up by ravenous customers around the world.

Lately, even though that demand is inherently there, the ability to finance that demand has eroded considerably, to the point where getting the necessary capital for a large scale solar project has become almost impossible.

The financial crisis has hit the solar industry in one of the most unsuspecting ways: nobody can get capital to finance solar projects, even though those projects are profitable from day 1, will last up to 30 years and will pay for themselves many times over.

  • No Financing 2: Along those same lines, even with the generous government incentives that were just passed with the economic stimulus package, retail customers are reining in their spending ways as well, and not putting solar on their roofs as rampantly as they were before not just because of the aforementioned lack of financing, but also because of fear of the down economy, uncertainty about property values and other related factors that would stop someone from a massive cash outlay of that magnitude, even though solar panels on homes increase resale value, and again, pay for themselves many times over.
  • Decreased Demand: Two of the largest solar installers were Spain and Germany (of all places!). That spigot has been shut off, or at least turned way down.

The governments of these two nations have curtailed their spending spree towards solar after large build outs and incentive programs aimed at ramping up installations in their countries and getting into the whole Green Movement.

These incentives have been scaled way back, and in some instances cut entirely, leading to further reduced demand.

  • Decreasing Margins: What happens when you can’t sell inventory and you have more on its way? Yea, you have to cut prices to get rid of what you got. This has been widely reported already, with SunPower (NASDAQ: SPWRA), (NASDAQ: SPWRB), reporting last week that they wrote down the value of their inventory because of this exact reason.

Further, analysts expect, and SunPower reported, that prices will likely come down another 20-50% depending on the company, the type of panels they make, and what they paid for polysilicon when prices were much higher.

What’s Going Right?

It’s not all gloom and doom though. There are some signs that things are at least stabilizing, and a recovery is in place.

In addition, who believes that the solar industry is irreparable and that these companies are doomed?

We all know that it is only a matter of time before solar comes back because of the worldwide movement towards cleaner alternative energy sources.

Here’s some reasons why things aren’t as bad as they seem:

  • Demand Stabilizing: As reported by several companies already, there has been a stabilization in demand, although they still foresee pricing pressure throughout 2009.

Both MEMC and SunPower reported that demand seems to have stabilized and MEMC reported a slight uptick in demand for polysilicon in the first half of Q2.

  • The Weak Will Fall: We’ve already seen several companies exit the business over the last few months, and get bought out by other larger competitors, such as the recently announced deal of First Solar (NASDAQ: FSLR) when it purchased OptiSolar and its assets.

There have been other companies closing shop lately, and this is standard procedure for boom and bust times.

This will only leave the strongest standing, and in better position to corner the market when things turn around.

  • Getting Leaner: The companies that remain are getting leaner. Both SunPower, MEMC and others in their industry have announced some combination of reduced staff, reduced output, lower capital expenditures, lower overhead, and tighter cost controls. These are probably items that needed to be addressed long ago, but the current environment is providing the impetus for these changes.
  • China On The Rampage: China has decided to enter the grand subsidy game by announcing huge potential incentives for large scale solar projects which could greatly benefit Chinese solar companies like Yingli Green Energy (NYSE: YGE) and Suntech Power (NYSE: STP). What remains to be seen is whether or not these incentives have a cap, how they will be structured, etc.
  • Results Not Spooking Investors: As we’ve seen in the last few weeks, these poor results and the solar stocks missing estimates badly and lowering guidance and expectations, hasn’t caused their stocks to decline anymore.

It appears that these stocks have been priced for these declines and skepticism, and just Friday, SunPower’s stock was down only modestly, after absolutely blowing their earnings announcement, and lowering full year guidance and projections, as well as writing down inventory.

  • Long Term Boom: As I mentioned above, long term, solar is here to stay, and is only going to proliferate more and more places that are seeking ways to take advantage of this alternative energy source.

Unlike other industries that have fallen on hard times, the solar industry is just in a temporary lull, and will come roaring back in very short order.

  • Charts Looking Good: I am not one for technical analysis on its own, but along with the news that demand may be stabilizing, and solar stocks might be working through their problems in good fashion, a look at the charts shows that most of these companies have stable chart patterns, and have stopped hemorrhaging losses with every little bad news announcement.

If I do decide to purchase shares of any company mentioned (more below), it would be with strict rules such as taking no more than a 15% loss, etc.

If the whole sector gets even more margin contraction, and prices plummet to a new “stable” level, you don’t want to be around for that, which could entail a 50% decline.

But as of right now, the entry point looks solid all things considered, and represents a fantastic contrarian play, as analysts are tripping over themselves to lower expectations, earnings projections, price targets and lowering their ratings to “Holds” and “Sells” as fast as they can.

This excites me tremendously, especially with a sector like this that has long term promise regardless of what is happening right now.

Some Names To Consider

Here are some names that you might consider in this space, ranked from my top choice to my least favorites, but you should do your own due diligence:

Top Names:

  • SunPower: SunPower represents the best in breed in the solar panel space. They are vertically integrated from start to finish, their panels are the most efficient on the market, and they are poised to ramp up production as soon as demand returns. Management is efficient, forward thinking, and the company is one of the stalwarts of the industry trading at historic lows. Be aware that the “B” shares trade at a discount, but are exactly the same as the “A” shares except they provide 10x the voting power.
  • First Solar (NASDAQ: FSLR): I personally do not like First Solar. I believe that the company has run too far too fast, and trades for a ridiculous premium over other solar names despite the fact that its margins are deteriorating, and more competition is coming on line even for thin film. It is however a great run company that has thus far executed beautifully, often smashing analysts' projections. Still, I am wary of the name, especially as regular solar panels become much cheaper.

A Cut Below:

  • Suntech Power (NYSE: STP): Suntech is a low cost manufacturer based in China that stands to benefit from the Chinese subsidies that were recently announced. I never much cared for Suntech’s “cheap” business model sort of like the Wal-Mart of solar companies. In fact Suntech got hit extremely hard lately as they fell victim to their own success when they overbought polysilicon at much higher prices, and were stuck with inventory they had to write down. Still, the company has been somewhat solid up to this point and is likely to be one of the low cost winners, but not one of my favorites.
  • Trina Solar (NYSE: TSL): Trina is in this group of Chinese manufacturers but has something going for it in that it is a vertical provider that offers end-to-end solar products from ingots and wafers, all the way through to solar cells. This offers the company economies of scale and some protection from spot polysilicon prices and a more diversified revenue stream. Trina is probably one of the better players in this next tier.
  • Yingli Green Energy (NYSE: YGE): Another Chinese name that could gain favorable traction as China enters the alternative energy subsidy game. Yingli is a cut below Suntech in my book, but still worth looking into if you are interested in playing the Chinese alternative energy group.
  • Evergreen Solar (NASDAQ: ESLR): Evergreen has some interesting technology to its name as well as rapidly increasing sales. It’s a cut below because of uncertainty concerning profitability and the current market overbuild, but it is a US company that is one notch below the top picks in this sector that provides more stability than its Chinese cousins do.

Don’t Bother:

  • Energy Conversion Devices (NASDAQ: ENER): Don’t bother with this company, their recent traction notwithstanding. ENER has been around for a long time, and has done nothing of substance to date. They managed to catch the final wave of solar stock’s run up, and demand spikes to make it look like there was a real business going on here. Save your money, and move on. I don’t trust the management team or the direction of the company past, present or future.
  • Akeena Solar (NASDAQ: AKNS): Akeena is a solar installer in California that has one foot in the grave already. Add it to the potential list of companies that aren’t long for this world. In boom times, Akeena actually looked like it might make it, but the bust times are proving what we all thought for a long time, this company just doesn’t have a sustainable business model right now, and shrinking revenues and profits and intense cash burn to boot. Stay away.
  • Canadian Solar (NASDAQ: CSIQ): I hate to be a broken record here, but this Chinese company, which tried to fake out investors with a name like Canadian Solar (I think that says it all), is not worth your time or money. It’s one of the stragglers that was riding the coattails of the big boys in the industry and its brethren from China during the glory days. Those days are over.

So Now What?

While not an exhaustive list of companies in this space, this was just an overview designed to bring this sector to your attention, and go through a few names that might be worth your time to investigate as time goes on.

As I mentioned before, I feel that this sector is a good contrarian play as financing gaps will be closing shortly, and more solar projects are going to start ramping up again in the next 6-12 months.

Since the stock market is a forward looking barometer of performance, it is in your best interest to scope out laggards before they turn around, and specifically, ones that have been shunned by Wall Street, but that have a bright future ahead of them, no pun intended.

No one in their right mind can argue that solar is dead as an industry, and in fact isn’t going to explode in the next decade.

Unlike the newspaper industry which is on its deathbed, the solar industry is up and coming, and just going through a temporary lag right now.

Use that lag, that is being caused because of the aforementioned problems, to your advantage and invest in the best companies in this sector to profit handsomely when things turn around.

That is the beauty of being a long term investor.

I may be early to the party, but because my focus is on the long term, I can wait things out till my investment thesis plays out, without worrying about trying to time the market.

I will warn one more time however, that if these charts and stocks show more fundamental weakness, I would be extremely careful and bail out with a 10-15% loss and no more.

If the sector gets revalued to a lower level, there’s no need to hold into that, just get out, take your loss, and get back in when things have settled at a lower level.

I personally feel we are close to that, if not already there, so a prudent 1/4 or 1/2 position in a couple of these names is warranted.

Source: Solar Stocks Look Ripe