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UBS has recently published a report on investment opportunities in the solar industry. The key to surviving after the cyclical downturn, they claim, is to reduce the costs of producing solar modules. Innovation in the solar industry helps to reduce the cost per unit.

A correction in the prices of polysilicon (60% YTD, 20% Q4 2011), a key component of solar modules, will help the solar industry not only return to a more “cash neutral” position, but will help to increase the profitability of the firms as there is a drastic decrease in costs. This creates a shared value where the firms mutually benefit by increasing efficiency and output by cutting costs.

They believe that the cost leadership will determine the winners in the industry. While analyzing the solar stocks investors should keep in mind the following points:

  • Industry is suffering from the problem of over-supply. When margins recover, companies with low cost structures will benefit.
  • The steep decline in poly prices is going to cause the bottoming out process so keep an eye on average selling prices (ASP).
  • Look for any solar stocks that are about to reach “Grid Parity”.
  • Watch for companies aiming at cost reduction strategies. These strategies can be as follows:
  1. Produce higher quality materials: This includes decreasing the costs of crystallization and increasing the cell efficiency of polysilicon.
  2. Efficient production: This will lead to lower electricity consumption and help decrease costs further.
  3. Higher scale and throughput: An increase in plant capacity and optimization of production of polysilicon can decrease costs by a large amount.
  4. Moving to cheapest electricity countries: This can help decrease cash costs by up to 15%.

UBS forecasts the demand in Europe to remain fairly solid: from 21GW in 2011 to a 25GW in 2012. Despite the suggested decline in solar installation in Europe, the EU targets of 2020 would still be met.

The list of their favorite stocks is as follows (keep in mind that few of long term buys have short term sell recommendations owing to macro stability):

Yingli Solar (NYSE:YGE), a leading manufacturer of high-quality solar modules, is currently trading at $3.86 per share and is expected to reach a target price of $5. Despite the relatively large top line, UBS has recommended to sell the stock in the short term due to “macro uncertainties and near-term earning risks”. Yingli has shown an ASP premium over its rivals in the second quarter of 2011 and has the added benefit of share gains. A price-to-book-value ratio of 0.4x is expected in 2012.

Trina Solar (NYSE:TSL) is the world leader in photovoltaic module manufacturing. Its current price per share of $6.94 is expected to go north of $11. UBS has issued a 12-month buy rating on the stock but warn investors of short term uncertainties. It performed as one of the best companies after the 2009 downturn and its business strategies have kept its returns maximized among the module companies.

First Solar (NASDAQ:FSLR), the most cost efficient solar module manufacturer, is currently trading at $43.95 and has a target price of $53. Its price to earnings ratio of 5.9x is expected to increase slightly to 6.3x, indicating an undervalued stock. First Solar is most likely to be able to sell all of its modules, combined with the industry leading cost cutting measures it has implemented, making it a certain buy for investors. Lee Ainslie had more than $225 million in FSLR at the end of third quarter.

GT Advanced Technologies (GTAT) provides the solar industry with the equipment and services. With a price per share of $7.2, which is expected to go north of $9, this company is an investment opportunity. The current earnings per share of $1.27 are expected to slightly increase to $1.4 in 2012. GTAT is one of the magic formula stocks that are in Joel Greenblatt's portfolio.

MEMC (WFR), a global pioneer in wafer technology, has a stock price of $3.98 which is expected to double. Though there is a tough environment at this point, its earnings per share are also expected to increase from $0.50 to $0.75 in 2012.

SunPower Corporation (NASDAQ:SPWR) provides the solar industry with residential, commercial, and power plant solutions. Its stock is currently priced at $7.33 and is expected to go north of $9. Its negative earnings per share are expected to increase to $0.3 in 2012.

Suntech Power (NYSE:STP) is known for its cost-effective solar energy solutions. It is currently valued at $2.26 per share which is expected to go north of $3.7. Due to the current negative earnings per share of $1.72 (expected to rise to a positive $0.15) and a negative price to earnings ratio of 1.4x, UBS recommends not to buy in the short term but expects a recovery later in 2012.

The least preferred stocks can give investors long term selling opportunities and hedge their solar industry long holdings. Here is a list and description of few of the least preferred stocks:

JA Solar (NASDAQ:JASO) is a manufacturer of solar cells, based in China. It is currently priced at $1.54 and the stock price is expected to remain south of $2.3. UBS has given it a short-term sell rating because the EPS is expected to decline from $1.01 to $0.72. JASO has shown a weak ASP but plans to reduce its capex spending in 2012.

STR Holdings (NYSE:STRI) provides the world with solar panel encapsulation technology. With a share price of $8.54 (which is expected to remain south of $9) and an expected decrease in earnings per share (from $0.95 to $0.75), UBS remains neutral on the stock. A significant amount of sales of STR Holdings are from European customers where the utilization rates are much lower.

Rubicon Tech. (NASDAQ:RBCN) provides electronic material to the solar industry. Its stock is currently priced at $8.47 which expected to remain under of $10. Its earnings per share are expected to decrease from $1.83 to $0.50 in 2012. Stuart Peterson's Artis Capital boosted its stake in Rubicon by 300% over the third quarter.

Source: Top Solar Stocks Recommended By UBS