The Sun Will Shine on Solar

Leading global consultant McKinsey published a report this month envisioning a sunny future for solar energy. Investors feel skittish about this space, considering the beating it has taken in recent years. Still, an upturn might yet reward those who choose to invest over a longer time horizon. Right now, solar is the kid no one wants to invite to the party, which is exactly why you should be considering it.

McKinsey's scenario takes into account falling photovoltaic, or PV, prices and diminishing subsidies, and still predicts doubled manufacturing capacity in the next three to five years, as well as a decline in underlying costs of up to 10% annually by 2020. Companies that provide innovative products in multiple regions while controlling their costs will likely benefit.

If you could use a bit of a primer on solar, have a look at my colleague Jeremy Bowman's excellent work. For our purposes here, note that the crystalline silicon PV cell is the type of solar cell that has historically dominated the market. We will also touch on emerging organic PV technologies, which are less efficient than crystalline silicon technologies, but also cost much less.

The McKinsey study anticipates particular growth opportunities in areas of the world that currently have no access to electric grids, such as in India and large swaths of Africa. If McKinsey is right, four companies across the crystalline silicon PV value chain look especially bright.

MEMC Electronic Materials (NYSE: WFR) makes silicon wafers, and develops solar energy projects through its SunEdison subsidiary. MEMC is currently active across the U.S., Europe, and Asia, and is targeting new markets in South America, south and north Africa, and India. McKinsey identifies access to financing as a major barrier to adoption of solar systems, to which MEMC has a solution. In India, the company has partnered with such global financial institutions as the IFC to enable preapproved financing for residential and commercial systems.

Power-One (Nasdaq: PWER) makes inverters for the renewable energy industry. That basically means that its products help manage and convert power. Power-One is active in North America, Europe, and Asia. The company has product lines specifically designed for off-grid areas. McKinsey projects success for creative collaborations across industries. As it happens, Power-One designs power system solutions for the telecommunications industry as well. Given the access telecoms already have to a broad customer base, this could offer promising opportunities.

Applied Materials (Nasdaq: AMAT) makes components that improve efficiency in PV systems. As solar prices continue to plummet, efficiency gains will directly improve manufacturers' competitiveness. Applied Materials also makes equipment for the emerging organic PV technologies I mentioned earlier. The use of ultra-low-cost production techniques is one factor in many analysts' view that organic PV development is hugely promising. Applied Materials derives the bulk of its revenues from the Asia-Pacific region.

Siemens (NYSE: SI) is a big, integrated technology company with a diverse product range, but it also makes inverters for solar applications, turnkey PV systems, and power transmission products that minimize energy loss from source to grid. The company also has a financial services arm active in the energy space, with specific financing available for solar installations.

Let's have a look at a few numbers for these companies.

Source: The Motley Fool. *Cannot be calculated when earnings are negative, as is the case here.

As you can see, the first three companies look at first glance to be relatively cheap. Price to sales can help you assess a company with no earnings, such as MEMC, and is useful for small companies like Power-One, as well. A high debt-to-equity ratio can mean that a company has aggressively financed its growth with debt. With the exception of Siemens, these companies are difficult to assess because they have not generated positive cash flows in the past year, but it's worth digging behind these numbers in your assessment. The bottom line is that while all of these companies are currently underperforming the S&P 500, I don't expect that to be the case for long.

Without a doubt, risk and volatility characterize the solar space. Still, McKinsey lays out bright growth prospects for investors with the steely resolve to buy in now and hold on. The right companies are going to shine like the sun.